Returning to the basics of "food, clothing, shelter, and transportation," can Chinese concept stocks escape the "bottoming out" curse?

Before the holiday, eager and unsatisfied, the market surged during the holiday, bringing joy. However, returning from the holiday with high expectations, investors were met with a cold reality from the market. This is likely the true portrayal of Chinese overseas investors during this National Day holiday.

Since the easing of the epidemic, Chinese assets have experienced a rush followed by a decline, and then a long period of stagnation. For this round of gains, if the question before the holiday was how much further it could rise, the most pressing question after the holiday is likely how fast it will fall. However, before answering this question, it is necessary to understand the possible economic combinations under the resonance between China and the United States. Therefore, let's start by looking at the latest data on the U.S. economy.

I. Is the U.S. Economy Moving Away from Recession Logic?

As one of the most important macroeconomic indicators in observing the trend of the U.S. economy, U.S. non-farm payrolls have seen significant adjustments. Not only did the job vacancies in August reported by JOLTS greatly exceed expectations, but the number of non-farm payrolls in September also significantly surpassed expectations.

For example, based on the 8 million job vacancies reported by JOLTS in August and the addition of 159,000 new non-farm jobs during that period, it is equivalent to a net increase of 490,000 job demands by enterprises in August, completely reversing the situation of net layoffs by enterprises in the previous two months. In other words, the net layoffs in the first two months may have been more related to temporary off-site work by companies due to extreme weather conditions, rather than trend-based layoffs.

At the same time, the addition of 254,000 new non-farm jobs in September once again significantly exceeded the monthly increase of 225,000 people in the overall U.S. labor force (including the labor force and non-labor force). With the current employment supply and demand in basic balance (1.13 job positions corresponding to 1 unemployed person), even the most basic supply and demand are matching each other, and the unemployment rate is likely to stabilize around 4-4.2%.

In terms of industries, the demand for infrastructure workers, representing the post-epidemic reconstruction in the United States, remains strong. However, in the manufacturing sector, both durable and non-durable goods industries are still in net layoffs, although the intensity of layoffs has slowed down.

In the spotlight of employment, the two most typical industries in the service sector, one being the continuously labor-stricken medical assistance and the other being the labor-intensive food service industry, both saw increases in September.

It is important to note that another blue-collar intensive sector, temporary help services, is still in net layoffs, implying that the overall employment situation for blue-collar workers remains weak. On the other hand, the performance of third-party professional services in the professional business services sector, such as computer services, legal services, scientific research, management services, advertising, and accounting, has been good.

The employment situation for white-collar workers is still significantly better than that for blue-collar workers. Behind the increasing class differentiation, it reflects that the high-interest environment has indeed begun to impact the most vulnerable groups, whether it is the rapidly rising credit card default rate or the weaker performance of Dollar Tree and Dollar General in the cost-effective retail format echoing each other.

Moreover, the JOLTS data for August once again indicates that the recent increase in the unemployment rate is more due to the large influx of immigrants bringing in more labor supply, rather than widespread job cuts by companies, thus not leading to corporate layoffs—a negative cycle of reduced consumer spending.

If the non-farm payroll data fluctuates too much and loses credibility, the simultaneous increase in new orders for both manufacturing and service PMI in August implies a relatively stable economic trend and a signal leaning towards a soft landing in the future.

II. If the United States experiences a soft landing, how much policy space does China really have?

After the release of the September U.S. employment data, a natural market pricing is that the rate cut for this year may be reduced. Similarly, a question arises: if the rate cut in the U.S. decreases, will it constrain the domestic policy space? The answer from Dolphin is that it may have an impact but not necessarily significant. The key point here is as mentioned in Dolphin's previous strategy weekly report "Crazy Chinese Concepts: How Long Can the 'Chicken Blood' Last?":

a. Regardless of employment fluctuations, the current labor supply and demand are already in a balanced state before the pandemic. In terms of additional supply, the current monthly addition of 200,000+ labor force (mainly due to immigrant influx) requires companies to create around 200,000 new positions and jobs each month, which is roughly in line with the pre-pandemic monthly non-farm job growth of around 180,000.

However, the key issue here is that the pre-pandemic balance was achieved in a long-term low-interest rate environment, and the current interest rates are too high, with overall suppressive effects being quite evident. It is likely to be quite challenging to sustain labor market equilibrium with the current benchmark interest rate of 4.75%-5%.

b. The previous round of zero interest rates + unlimited easing + fiscal stimulus to ensure demand-side purchasing power, allowing businesses and residents to leverage at low interest rates. With higher interest rates later on, residents and businesses no longer need to leverage, so high interest rates have limited economic impact. Moreover, a significant portion of the current inflation is due to the pandemic resurgence and the Russia-Ukraine conflict, rather than demand-side reasons In other words, in the current situation where supply-side inflation risks have receded while demand-side has basically stabilized, even though the economy is still facing issues, under the current policy goal of the Fed for a "Perfecting landing", with the current policy rate at 5%, there is still considerable room for interest rate cuts compared to the inflation trend of over 2%.

In this scenario, if domestic policies shift from focusing solely on advancing towards the vast ocean of stars (driving high-tech new productive forces such as capacity and industrial investment on the supply side), and if this can truly transform into addressing the reality of daily life concerns (such as housing prices, unemployment, income, consumption, confidence) that the common people care about, then policy stimulus will probably need to truly shift towards boosting demand.

Therefore, it may be worth considering a possible policy combination between China and the United States in the future: the US soft landing with interest rate cuts, coupled with China stimulating re-inflation, will lead to a more balanced global economic growth with China gradually transitioning from deflation expectations to re-inflation expectations, and Chinese asset trading may also enter a re-inflation environment by 2025.

In this scenario, the various consumer and internet companies covered by Dolphin Jun, which should have followed the logic of increasing penetration rates and reducing prices, are still undervalued, especially in e-commerce, advertising, and food and beverage leading companies. Their valuations are still relatively low, and if EPS can be significantly restored, could they also usher in a "Davis double-click"?

Of course, the key transformation here is to see policy objectives taking action to drive the rise in prices of goods and assets, halt deflation expectations, and truly stimulate domestic demand.

Dolphin Jun also mentioned that there has been a clear change in the tone of high-level policies, and this change does not seem to be solely aimed at achieving the GDP target for the whole year in the fourth quarter, but rather appears to be a systemic shift in policy direction. At the same time, the tone of monetary policy is also very positive.

During the process of the stock market rebound before the National Day holiday, market expectations for the stimulus intensity have increased from 2 trillion to 5 trillion or even more, but the disappointing outcomes of the ministries' meetings after the holiday did not provide much incremental information.

However, Dolphin Jun believes that in terms of timing, the more crucial adjustment of the fiscal policy for 2025 still needs to wait until the October meeting and the Central Economic Work Conference at the end of the year. With market expectations continuously escalating layer by layer, it is indeed easy to be disappointed.

Such major macro policies, from a shift in the overall direction to policy brewing, formulation, and implementation, naturally require a relatively long time. In the short term, with expectations running too high, indices generally rebound by 50% from the low point to the high point, but the weak fundamental support is clearly insufficient at present.

Especially from a fundamental perspective, as soon as October returns, companies will have to face the grim reality of the third-quarter financial reports: the performance in the third quarter is likely to be poor, and in the current situation where policies are still unclear, listed companies are probably either not providing specific guidance for the fourth quarter or giving a conservative one.

In other words, as the third-quarter earnings season begins, the season of performance disappointments is about to start, and with the recent noticeable rise in Chinese asset prices, a pullback is probably inevitable Looking ahead to 2025 at the current moment, if both China and the United States can deliver on the expected U.S. interest rate cut soft landing + Chinese stimulus re-inflation, then the investment logic for Chinese assets entering a cyclical upturn in an inflationary environment next year, the various Chinese concept internet and consumer assets covered by Dolphin Jun, indeed have the potential to usher in a Davis double-click opportunity of EPS stabilization and valuation recovery.

III. Portfolio Rebalancing and Returns

Therefore, based on the above logic, it will take time for the short-term fiscal policy of Chinese assets to materialize, and with the thunder of the third-quarter financial reports approaching, Dolphin Jun will adjust the portfolio by slightly weakening the fundamentals and removing index components, while focusing on the thundering situation of the third-quarter financial reports and the possibility of GDP rebound in the subsequent fourth quarter.

In particular, from the meeting yesterday, the NDRC meeting remains relatively positive about maintaining a 5% GDP growth for the whole year. Due to the weaker GDP growth in the third quarter, maintaining a 5% annual target essentially means that GDP in the fourth quarter must accelerate its rebound, at least ensuring a 4.5% GDP growth.

Therefore, regarding this correction in Chinese concept stocks, Dolphin Jun believes that unlike the sharp rise and subsequent floor friction after the post-pandemic rebound, this correction may be for a better return. Therefore, after this adjustment, Dolphin Jun will pay more attention to the intensity of fiscal policy and the landing of domestic economic indicators in the fourth quarter. If the fundamentals improve, in anticipation of the recovery in 2025, Dolphin Jun believes that after this wave of emotional correction and the thundering of the financial reporting season, overseas Chinese assets may instead usher in sustained opportunities.

The Dolphin Jun portfolio adjustment for this week is as follows:

Since the start of the portfolio testing (March 25, 2022) until last weekend, the absolute return of the portfolio is 72%, with an excess return compared to MSCI China of 6%. From the perspective of asset net value, starting with a virtual asset of $100 million, Dolphin Jun's portfolio exceeded $170 million by last weekend.

IV. Portfolio Asset Allocation

The Alpha Dolphin virtual portfolio holds a total of 14 individual stocks and equity ETFs, with 3 core holdings and 8 equity assets underweighted. The rest are distributed in gold, U.S. bonds, and U.S. dollar cash. As of last weekend, the asset allocation and equity asset weightings of Alpha Dolphin are as follows:

Risk Disclosure and Disclaimer for this article: Dolphin Research Disclaimer and General Disclosure Please refer to the recent weekly reports from the Dolphin Investment Research Portfolio:

《Crazy Chinese Concepts: How Long Can the "Chicken Blood" Last?》

《Directly Lowering by 50 Basis Points, Is the Federal Reserve the Ultimate Boss of US Stocks?》

《After the Slaughter, Does Chinese Concepts Still Have a Chance?》

《US Stocks: Scared Enough, Ready for the Next Act?》

《US Stocks Keep Exploding with "Ghost Stories", Is There No Bottom in Sight?》《Economic and consumption are doing well, will the Fed really cut interest rates in September and cut three times in a row?》

《Are the "brilliant" small-cap stocks in the United States nourished by economic fundamentals?》

《Soft landing of US stocks = control by giants + scattering of retail investors?》

《The head of the US consumption train leaked, can we still trade a soft landing?》

《Deflated social zero, soft landing economy, will it drag down Chinese assets?》

《The US government is spending money "without closing the door", trading interest rate cuts still requires caution》

《US Stock Market Cuts Interest Rates Expectations and Shoots Back, Is It Reliable This Time?》

《Hong Kong Stock Market Suddenly Changes, To Escape or to Accept?》