Guotai Junan's Chief Strategist Fang Yi: Currently, the investment focus is on blue-chip stocks, paying attention to two major investment themes

According to the Wise Finance APP, on June 18, Guotai Junan Securities held the 2024 Mid-term Strategy Conference. Guotai Junan's Chief Strategy Analyst Fang Yi stated that when uncertainty decreases but investors' risk appetite remains low, the focus of investment should be on blue-chip stocks with products, orders, performance, and reasonable valuations. The new "Guo Nine Articles" and the reform of the stock market's basic system both point to the need for investment strategies to focus on operational quality and corporate governance. At this stage, the investment focus is on blue-chip stocks, with two main investment themes: 1) Overseas geopolitical complexity and slow domestic demand boost, stable large-cap value stocks such as A/H dividend assets still have allocation value: coal/electricity/finance/Hong Kong-listed central SOEs, etc.; 2) In addition to large-cap value, increase allocation to technology blue-chips and high-quality Hong Kong-listed companies. With the expected warming of economic system reform, new quality productivity-related areas are expected to receive support, and technology blue-chips are expected to see a turning point: Hong Kong-listed internet companies, as well as A-share semiconductor/communication/mechanical/military industry leaders/pharmaceuticals.

Highlights of the speeches by various guest speakers are as follows:

Huang Runan - Co-Chief Macro Analyst, Guotai Junan

The Decline of Uncertainty and the Arrival of a New Equilibrium

Since the beginning of the year, three changes in the domestic macro environment have led to a decrease in uncertainty:

1. The economic fundamentals measured by "quantity" have gradually stabilized, mainly benefiting from exports exceeding expectations, local industrial investment replacing infrastructure investment to offset the negative impact of debt restrictions, while inventory has fluctuated at the bottom, and prices have basically returned to normal seasonal levels on a month-on-month basis;

2. Macroeconomic expectations are gradually returning to stability, with labor gradually flowing from large cities to small and medium-sized cities, the "scar effect" being repaired, and the cautious motivation of residents being largely digested;

3. After the April 30th Political Bureau meeting, the policy logic has become smoother, and looking at policy uncertainty from the short, medium, and long-term perspectives, uncertainty has decreased.

The nominal GDP is likely to have hit its lowest point in the first quarter; looking ahead to the second half of the year, it is expected that exports will maintain resilience, government debt supply will drive improvement in physical work volume, and price indicators will moderately rebound; however, upward momentum still depends on economic clearance and the clarity of medium and long-term policies.

Clearing in the four major areas and the clarity of medium and long-term economic policies are the necessary steps for the economy to enter a "new equilibrium."

Firstly, the "new equilibrium" in the four major areas includes:

1) "Quantity and Price New Equilibrium" in the real estate market. Since 2021, the Chinese real estate market has undergone a considerable degree of clearing, and the collection and storage policies are expected to become stabilizers of quantity and price. Beyond housing prices, more importantly is the future income expectations of residents.

2) "Supply and Demand New Equilibrium" of new quality productivity. The ability of new quality productivity to drive demand in other industries is stronger than the construction chain, supporting the past few years of real estate clearing from dragging down "quantity." However, there is excess capacity in some industries of new quality productivity, and substantial improvement can only be observed when industry concentration increases.

3) "New Equilibrium" of residents' consumption willingness and ability. Consumption patterns in third and fourth-tier cities are converging towards first and second-tier cities, and the consumption upgrade of low- and middle-income groups in third and fourth-tier cities in essential categories is still ongoing 4) The "New Balance" between Social Financing and the Real Economy. Over the past two years, new productive loans represented by green loans have to some extent offset the decline in real estate-related loans. On the one hand, it is the real industrial demand in the process of economic transformation, and on the other hand, there is also a certain degree of idle funds. With the decrease in the credit expansion speed of government departments and the impact of credit "squeezing out water," the central probability of future social financing and credit growth rates is likely to decline.

Secondly, the upcoming Third Plenary Session is expected to clarify long-term economic issues:

1. Optimizing the layout of productivity corresponds to "developing new productive forces according to local conditions," avoiding blind excess capacity, with Inner Mongolia and the three northeastern provinces as examples;

2. The new round of financial and tax system reforms is expected to involve the redivision of central-local financial rights and responsibilities, transfer payments, tax reforms (such as consumption tax), and reforms of the financial system below the provincial level, aiming to reshape the central-local relationship;

3. Construction of a unified national large market, which may include the unification of labor and land markets, data, and energy markets.

Since the beginning of the year, the U.S. economy and inflation have shown signs of improvement, but the direction of Fed rate cuts will not change. The short-term economic strength is mainly driven by the wealth effect brought about by the rise in the stock market; the downward slope of inflation is lower than expected, with rent + super core inflation stickiness being the main contribution, but the direction remains clear; it is expected that the Fed will cut rates 1-2 times throughout the year. Regardless of the number of rate cuts and the extent, the expectations for U.S. bond rates are relatively sufficient, and the downward trend of U.S. bond rates during the year is not significant.

From a macro perspective, Guotai Junan Securities points out three investment themes for the second half of the year:

1. Screening new productive industries from two dimensions. First, using input-output tables to screen out six major secondary industries: communication equipment and technology services, electronic semiconductors, aerospace and defense, power equipment, passenger cars and components, medical and pharmaceuticals; Second, in terms of upgrading traditional industries, from the perspectives of production capacity expansion, demand, and willingness, industries more likely to expand production capacity are concentrated in the upstream mining and raw material manufacturing sectors.

2. The downward trend in the real estate cycle has led to a central rise in Chinese residents' savings after 2018, bringing long-term dominance of low-risk assets. After 2022, the anchor of the weighted average interest rate on bank loans - non-performing loan ratio as the lower limit of long-term bond yields gradually confirms. The possibility of the central bank selling bonds to maintain long-term bond rates is unlikely.

3. Despite facing many constraints in global "reindustrialization," under the backdrop of deglobalization, the direction of "reindustrialization" is certain, leading to a long-term logic of central rise in commodity prices. After 2021, the correlation between the SSE 50 and copper prices is weakening, indicating that demand outside of China is more dominant in marginal pricing.

Fang Yi - Chief Analyst of Guotai Junan Strategy

Investing in China: Taking the Offensive with Blue Chips

How to understand the changes in the stock market in recent years? The dominant trend and investment style are driven by the understanding of risks and uncertainties. Various geopolitical, economic, and social factors are complex, and market participants' outlook and expectations for the future have shortened. Therefore, the dominant trend and investment style are not based on cyclical understanding and value discovery, but on how to understand risks and uncertainties and the degree of acceptance of risks When subjective risk judgment rises, the value in value rises (high dividends/stable cash flow); when subjective risk evaluation decreases, growth in growth outperforms (technology investment).

After years of adjustments, the decline in the Chinese stock market, the clearing of trading structures, and the pricing of unfavorable factors have been quite sufficient. Currently, most investors only see the negative impact of macro risk exposure, but this expectation has been reflected in years of continuous adjustments and the market volatility at the beginning of the year. Even compared to the adjustment of the Japanese stock index from 1989 to 2003 (a decline of 80%), the Hang Seng Tech Index representing Chinese risk assets has retraced 75% since 2021, the CSI 300 Index has retraced nearly 50%, the A-share price-to-book ratio level exceeds all previous market bottoms, and asset prices have fully priced in unfavorable factors and macro prospects. Guotai Junan Securities judged that after winter, spring is still there in February, and in 2024, potential investment opportunities should be seen. The unanimously low consensus implies the possibility of unexpected returns.

Reducing uncertainty is the key driving force for the Chinese stock market, and it is optimistic about the index's "two steps forward, one step back" oscillation. Guotai Junan Securities' optimism about the stock market is not based on an immediate improvement in economic prospects, but on the market's full understanding of macro expectations and negative factors, which has already formed. Positive changes are beginning to emerge, but this is not the end: 1) Stock market volatility is decreasing. The decision-making level points out "enhancing the intrinsic stability of the capital market," and "promoting the stable and healthy development of the capital market is an important manifestation of economic development and governance capabilities," implying a clear bottom line for stock market volatility; 2) Economic policy uncertainty is decreasing. Central finance enters an expansion cycle, the real estate "digestion of existing stock" policy targets the crux, and the monetary policy toolbox anchored to inflation targets is opened; 3) Economic uncertainty is decreasing. The real estate drag enters the final stage, price inflation is expected to recover moderately, and nominal GDP is expected to see a turning point. Rome was not built in a day, and investors' acceptance of uncertainty is a gradual process, daring to position against the market adjustment.

Investing in China: Taking the offensive instead of the defensive, with blue chips as the tip of the spear. When uncertainty decreases but investors' risk appetite remains low, the focus of investment is on blue-chip stocks with products, orders, performance, and reasonable valuations. The new "Nine Articles of the Nation" and the simultaneous reform of the stock market's basic system point to the need to focus on operational quality and corporate governance in investment strategies. At this stage, the focus of investment is on blue-chip stocks, with two main investment themes: 1) Overseas geopolitical complexity and slow domestic demand boost, stable large-cap value stocks such as A/H dividend assets still have allocation value: coal/electricity/finance/Hong Kong central SOEs, etc.; 2) In addition to large-cap value, increase allocation to technology blue chips and high-quality Hong Kong stocks. With the expectation of economic system reform heating up, support for new quality productivity-related areas is expected to increase, and technology blue chips are expected to usher in a turning point: Hong Kong Internet companies, as well as A-share semiconductor/communication/machinery/defense industry leaders/pharmaceuticals.

Zhou Tianle - Chief Analyst of Guotai Junan Small and Medium Cap Stocks

Theme Investment Focuses on New Productivity

Based on the DDM model, cash flow expectations, risk-free interest rates, and risk preferences are the three key indicators that affect theme investment. By breaking down the DDM model and ranking by importance, Guotai Junan Securities believes that the main influencing factors of theme investment are risk preferences, risk-free interest rates, and company cash flow expectations.

With the implementation of strict regulatory policies, the adjusted valuation safety margin is high, which will increase the risk tolerance of small and medium-sized caps. Policies such as delisting and programmatic trading have been implemented, and after six months of adjustment, the valuation of small and medium-sized caps is at a historical low. The risk preference for small and medium-sized caps is expected to increase in 2024H2.

Loose monetary policy will drive down risk-free interest rates, and the pace of performance recovery for small and medium-sized enterprises will gradually increase. Guotai Junan Securities believes that the monetary policy in 2024H2 will be relatively loose, driving down real interest rates; at the same time, small and medium-sized enterprises will benefit more from credit expansion, and performance recovery is expected to accelerate.

Developing new productivity is an effective way to improve capital return rates and adjust industrial structure. The transformation of the real estate industry has led to a lack of pillar industries, and domestic capital return rates have been declining since 2012. Developing new productivity is expected to support high-return pillar industries.

Wang Zheng - Chief Analyst of Guotai Junan's New Stock Research

Both listing and delisting are being handled, and IPO quality is being improved

1) The new "Nine Regulations" have been implemented, improving the quality of IPO issuance and reducing the speed of new stock trading profits. According to calculations based on the ideal scenario of full project allocation and 100% qualification, as of May 31, 2024, the new stock trading profits for A/B accounts in 2024 were 1.7424/1.4010 million RMB respectively, with corresponding thick profit rates of 0.33%/0.27% for accounts with a scale of 500 million RMB. On April 12, 2024, the State Council issued the new "Nine Regulations," followed by the China Securities Regulatory Commission and stock exchanges releasing supporting regulatory documents, raising the listing threshold, strengthening delisting supervision, and promoting the capital market's rectification. The speed of new stock issuance has slowed down, with a total of 38 A-share IPOs in January-May 2024, raising 27.185 billion RMB, continuing to decline compared to the previous period.

2) Low issuance valuation combined with scarcity of new stocks, leading to good first-day performance of IPOs in January-May 2024. The pricing range for new stocks in January-May 2024 remained at a high level of around 5%-10%, with an average PE of 23.18 times, at a relatively low level. In addition, the slow issuance of new stocks has brought about a certain scarcity. The combination of these two factors led to an average first-day increase of 135.46% for new stocks listed in January-May 2024, with only 1 stock breaking on the first day.

3) The concentration of new stock trading profits in January-May 2024 is high, and the importance of key projects in the qualification process is significant. In January-May 2024, a total of 25 new stocks were issued offline, with the top five projects in terms of profits accounting for 56.23% of the total new stock trading profits. Only Airon Energy and Nova Nebula, two stocks with relatively high fundraising and price increases, contributed more than 30% of the new stock trading profits, highlighting the significance of key projects in the qualification process 4) It is expected that new stocks will maintain a relatively slow issuance pace in 2024, with a neutral forecast that the annual thick profit rate for Class A accounts under ideal conditions will be around 1.55%. It is expected that stocks in the main board and the ChiNext board will continue to maintain a relatively slow issuance pace in 2024, with an estimated total of 70 to 100 companies going public, raising a total of 50 to 100 billion RMB. It is projected that there will be 20, 35, and 30 new listings on the Sci-Tech Innovation Board, ChiNext Board, and Main Board respectively throughout the year, with the number of A/B type participating accounts being 4300/2900, 3700/2400, and 4100/2900 households respectively, with a 95% qualification rate. The neutral forecast calculation assumes that the average first-day price increase for new listings on the Sci-Tech Innovation Board, ChiNext Board, and Main Board will be 120%, 150%, and 120% respectively. Based on this, the thick profit rate for Class A accounts with a size of 500 million RMB in 2024 is estimated to be around 1.55%, while the thick profit rate for Class B accounts with a size of 200 million RMB in the coming year is estimated to be around 1.71%.

Hu Jianwen - Senior Analyst, Fixed Income Research, Guotai Junan Securities

Three New Features of the Chinese Bond Market

Increased bullish sentiment, actively following the trend. Feature One: The increased impact of external balance on the Chinese bond market. Feature Two: The decreasing reference value of year-on-year social financing growth and its reduced trading value for the bond market. Feature Three: The increasing marginal pricing power of institutional inflows and outflows on the bond market