Just a Dead Cat Bounce?


The Fed’s message at the Jackson Hole conference this year was brief and straightforward, emphasizing that monetary policy will continue to tighten. This is a stark contrast from last year’s meeting, where Powell spent a large portion of his speech discussing transitory inflation in the 1950s and hyperinflation in the 1970s. He also indicated that more data was needed to determine the nature of the inflation taking place at the time.

The Fed has just announced the third 75 bps rise in a row to a target interest rate of 3.00% – 3.25% in the late September FOMC meeting. According to the dot plot released at the meeting, the federal funds rate is expected to reach 4.375% by the end of this year. Until there is a major slowdown in inflation, it seems the Fed will continue to hike.

With just two more Fed meetings scheduled to take place in early November and mid-December, to reach the year-end projection of 4.375%, we are likely to see two more rate hikes, both by at least 50 bps.

At the moment, the 3-Month Treasury Rate was still slightly lower than the 10-year rate, not showing an inverted yield curve yet. However, if the federal funds rate keeps staying over 3%, there will be a much greater chance of an inverted yield curve. Historically, the U.S. economy would be facing a recession 6-12 months after an inversion, which means the July/August market rally was likely just a dead cat bounce.

While the U.S. is in its rate hike cycle, the Chinese economy has been sluggish. Pandemic restrictions may only ease after the 20th Party Congress, and it will take some time for economic activities to pick up after relaxed COVID measures. With many uncertainties still in the air, from the development of the Russia-Ukraine conflict to potential policy shifts after the Party Congress, it is hard for anyone to predict when the global stock market may bottom.

However, investors should avoid being overly pessimistic due to the currently gloomy market outlook. More people shifting towards a bearish market view usually implies a bottoming stock market. And now is the perfect time to do some homework, as opportunities are for those who are best prepared. 

How to get prepared you may ask? We can start by analyzing stock market trends from two perspectives: the macro view and the micro view. The macro view focuses on how capital flows and economic cycles may affect the stock market, while the micro view is about analyzing the return on equity, operating margin, and debt ratio of the company, etc.

The overall return on equity (RoE) of China’s A-share market, both non-financial and financial stocks, has been on a downward trend over the past decade. The RoE for non-financial stocks has fallen from 10% in 2012 to 8% by the end of 2021. The main reason for this is that asset turnover has dropped from 0.91x to 0.68x. Companies had to use more assets to do the same amount of business as a result of excess capacity. As for the net profit margin, it has remained relatively stable at 4.5% over the past decade. Debt ratios have also remained relatively stable over the past decade after a sharp increase from 2008 to 2012.

According to the stock valuation formula, a fair price is determined in part by the discount rate (the lower the interest rate, the higher the price) and in part by the size of the dividend and the growth rate. Both of these are directly related to RoE, so companies with high RoE are usually valued higher as well.

In light of the present situation, if the asset turnover in China’s stock market slowly improves, we can expect RoE to improve at the same time. By then, another bull market shall begin.


Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

Revisiting e-commerce platforms


An investing quote goes: When the last bullish investor turns bearish, it’s only a matter of time before the market bottoms out. Masayoshi Son, Softbank’s chief executive officer and a staunch supporter of Chinese e-commerce stocks, recently reduced the company’s holdings of Alibaba stocks from 23.7% to 14.6% – could Son be that last bullish investor? All jokes aside, Softbank does have to raise cash to pay off some of its loans, and now could be a good time to review how investors should approach the businesses of e-commerce platforms.

Increasingly fierce competition

Investors who have looked closely at Alibaba’s results over the past few fiscal quarters must have noticed what management attributed to having impacted its earnings: Intensifying competition. Though of course, most investors know full well that the tightening regulatory oversight should also be among the factors that have had a bearing on Alibaba’s results. But its management, with Alibaba being at the forefront of regulatory actions, clearly knows better than to speak in public about anything related to the government. Indeed, the domestic e-commerce space has seen competition flare up significantly over the past few years. Pinduoduo, for example, now boasts active users whose number rivals that of Alibaba, while its gross merchandise value jumped 16-fold in the previous four years, up from just 3% to 30% of the gross merchandise value of Alibaba’s China commerce at the end of last year. Given that each active user spends around CNY 2800 annually on the Pinduoduo platform, just a fraction of the CNY 8800 annual spending of Alibaba’s active users, there should be plenty of scope for Pinduoduo to grow. While the company has repeatedly emphasised in the past that the platform focuses on agricultural products, as long as it garners enough users, it should be able to expand into other product categories with relative ease.

Apart from Pinduoduo, some short video platforms are also accelerating their livestream shopping businesses. Despite the Chinese government’s ongoing attempts to tighten regulatory control since late last year over the livestream shopping industry, Kuaishou still managed to grow its gross merchandise value by 47% in the March quarter compared with the same period the previous year. And in the last 12 months until the end of the March quarter, its gross merchandise value reached CNY 730 billion, close to 9% of what Alibaba made. While there’s no official data on TikTok, given that it’s still a private company, surely TikTok would boast more livestream transactions than Kuaishou. Clearly, competition among e-commerce platforms looks set to get increasingly fierce.

Earnings outlook

There are many one-time charges in Alibaba’s financial statements that if one is to get a good grasp of its earnings trends, one will have to look not only at its annual report, but also keep track of its core earnings per share in each fiscal quarter with all one-time charges removed from the analysis. Alibaba’s year-on-year core earnings per share started to drop since fiscal third quarter last year, and continued into fiscal second quarter this year without showing signs of narrowing in the scale of the decline. Given a slowdown in China’s economy induced by Covid-related lockdowns beginning in March, it remains unclear where the bottom of Alibaba’s earnings lies. As such, the pace at which Alibaba’s year-on-year earnings grow in fiscal second quarter becomes even more important – even though a low base last year would mean that the company should be able to achieve a year-on-year increase in earnings relatively easily, investors will need to be mindful of the residual effect of Covid-related lockdowns on Alibaba. And despite a plethora of investment initiatives, there’s no denying that, thus far, Alibaba generates a large part of its profits from the traditional retail e-commerce business in the domestic market. Unless any of its businesses make a breakthrough, we think it’s unlikely that Alibaba will see its earnings grow at the same scale as before.

The valuation of Alibaba

Alibaba has seen a decline in its year-on-year earnings since fiscal third quarter last year. Assuming a full-year drop in its core earnings in fiscal third quarter this year, and taking that into account in the calculation of its price-to-earnings ratio (P/E ratio), it will place Alibaba’s current P/E ratio at around 13.3x. Unless its earnings fall further on a year-on-year basis, we believe this P/E ratio looks quite fair.

Last but not least, given Alibaba’s plan to make Hong Kong its primary listing destination, capital from mainland China will likely stream across the border into Alibaba at the end of the year, supporting its stock price. 

Conclusion

To summarise our analysis of Alibaba above, as the domestic e-commerce industry grows ever more competitive, we don’t see any new growth area for the time being unless there is a breakthrough in Alibaba’s new businesses. But if its earnings stabilises on a year-on-year basis in the coming fiscal quarter, there should be limited room for the stock price to retreat further from its P/E valuation of 13x. Meanwhile, it should help that Alibaba is seeking a primary listing in Hong Kong, whose capital inflow from China will likely support its share price.


Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.