Hell vs Heaven: What are US and HK really trading?

Hello everyone, below are key takeaways of portfolio strategy summarized by Dolphin this week:

1) United States: To decline or not to decline. Personal consumption expenditure has once again verified the consumption resilience brought by employment and hourly wages in the absence of financial stability threats, especially in April, when personal consumption expenditure not only contributed to income growth, but also saw an increase in the downward trend of the savings rate. This is in stark contrast to the trend of declining consumption acceleration due to the decline in income and the increase in the savings rate in China.

2) China: To prosper or not to prosper. However, at present, the deep recession expectation of domestic transactions requires vigilance against two risks in the case of sufficient valuation callback:

a. It is risky to conclude that the recovery has passed and the deflation trend is approaching based solely on one month of macro data, especially when April is a seasonal off-month after a strong first quarter.

b. If there is really such a long-term structural trend of deflation, will the policy let it go? From a policy perspective, there is also a risk of continuing to short.

3) This week, PMI will be released in China, and a new round of employment and hourly wage data that will lay the foundation for the resilience of the US economy in May will be released in the United States. In the case where the economic expectations of China and the United States at the beginning of the year have already been traded, we need to be vigilant about the risks that new monthly data may bring about macro changes.

4) Based on the judgment of last week, Dolphin believes that the domestic asset callback has been sufficient, and has made additional positions based on two major ideas:

a. Low growth: high valuation cost-effectiveness ratio; the fundamentals are not lagging behind, there is a performance repair logic and fundamental verification; there is cash, dividend/buyback protection cushion;

b. Real growth: stocks with truly strong revenue, reasonable valuation.

For specific stocks, please refer to the main text.

The following is the detailed content:

I. United States: To decline or not to decline

The macro data recently released by the United States almost perfectly matches, with highly consistent information, that is, the United States is not in recession.

As Dolphin mentioned in last week's combination weekly report, in the current situation where the savings rate in the United States is at a historical level and loan interest rates are high, employment, employment expectations, and wage growth are the fundamental driving forces for the US economy. The strong employment and hourly wage growth data in April have laid the "resilient" main tone for the US economy.

The channel retail data calculated by enterprise collection, and the personal consumption expenditure data calculated by resident spending, are just two sides of the same coin for C-end demand.

If we talk about the difference, personal consumption expenditure is the money spent from residents' wallets, and this number, after deducting inflation, directly accounts for more than 70% of GDP weight. On the other hand, social retail data is mainly based on resident commodity consumption, and the services that residents spend more on are not well reflected.

1.1) Marginal acceleration of personal income

In April, the total annualized personal income of the United States (seasonally adjusted nominal) increased by 80 billion US dollars compared to March, which is significantly higher than the month-on-month increase in March and April , and the month-on-month growth rate has increased to 0.4%, which is exactly the same as the hourly wage growth rate and social retail growth rate.0.4% monthly growth is equivalent to 4.9% YoY growth.

Of the five main sources of personal income - employee compensation (62%), business income, property income, rental income, and transfer income - employee compensation has seen a significant increase, which is consistent with the hourly wage and employment data from early April.

Looking at the outflow direction of the $80 billion in new income: although the total net increase in income is only $80 billion, the net increase in consumption is as much as $150 billion, and the key here is that savings have decreased by $77 billion.

This means that none of the newly added income this month has been converted into savings (including banking accounts and investment), and even the part of the monthly income that would have flowed into savings has been spent instead. Therefore, the US savings rate in April did not continue to rise from its historical low point, but instead turned downward again.

At this point, we can see that the macroeconomic path that the market previously assumed (high interest rates affecting employment - worsening expectations - residents replenishing savings - rising unemployment rates, rapid slowdown in income growth, excess savings depleted, and rising savings rates killing residents' consumption) did not happen at all.

The actual situation of the US economy in April was:

a. Employment continued to be strong, hourly wage growth was guaranteed, and the stable balance sheets of most sectors and sufficient employment made residents feel secure. With no slowdown in income growth, the downward trend of the savings rate resonated with the increase in consumption, which actually increased.

b. The two problems with toxic assets represented by government debt, the sector that truly leveraged in the three major sectoral balance sheet shifts during the epidemic, during this round of interest rate hikes: i. The problem of the debt ceiling was precisely resolved after the two parties pulled to their limits last weekend; ii. The crisis in the small and medium-sized banking industry caused by these types of assets was a familiar blasting scene. However, due to the special nature of these toxic assets, the Fed has the ability and has quickly extinguished the fire.

As long as residents' deposits do not flow out of the entire banking system quickly and systematically, the structural transfer of deposits between different banks will only bring about mergers and acquisitions in the banking industry, and there will be no systemic financial risks that threaten the pace of interest rate hikes and cuts.

Under these circumstances, the liquidity blasting of small and medium-sized banks is difficult to cause waves. The latest balance sheet of commercial banks across the United States once again confirms this change:

Deposits are no longer flowing out, but are instead flowing in, and the total assets have also recovered somewhat - the US banking industry's deleveraging speed has slowed down. In this situation, the US banking industry is only continuing to reduce its holdings of "toxic assets" in fixed-income assets, while credit assets, whether they are to B industrial and commercial loans, mortgage loans, or to C consumer loans, were all net invested in the latest disclosed week of May 17.

II. Cyclical Differences: No Comparison, No Harm

Looking back at the income and expenditure situation of residents in this round of cycles in China:

a. The growth rate of residents' income has declined: By March of this year, the growth rate of actual disposable income fell from 6% year-on-year before the epidemic to 4% after the epidemic;

b. Residents' savings have increased: By the first quarter of this year, the savings rate of residents was still relatively high compared to before the epidemic;

c. With the slowdown in the growth rate of residents' income and the two major directions of income outflow, the savings rate has instead increased, indicating that the growth rate of residents' consumption is slowing down at a faster rate than their income.

Once this trend is confirmed, it will be a relatively large harm to any domestic demand-driven economy.

In the triangle relationship between income, savings, and consumption, the real driving force behind consumption comes from the increase in income, followed by the expectation of income improvement (reducing the savings rate).

Recently, Dolphin Analyst has looked back at the trend of the Japanese economy and found that residents' income, consumption, and savings have also experienced similar situations:

Before the GDP decline in the early 1990s, the government's violent crackdown on real estate and stock market bubbles was the trigger; after the assets shrank and income growth accelerated, the savings rate accelerated instead, and the rebalancing of income outflows led to a faster decline in consumption than income. This was followed by 20 years of long-term deflation, with CPI hovering around 0 year-round, until 2022 when Japan relied on imported inflation to bring CPI back to the 2 era.These country comparisons clearly show that: after the special economic cycle brought about by this wave of natural disasters, under different crisis management policies, the savings rate of American residents has decreased, while the savings rate of Chinese residents has increased, and the income growth rate has accelerated and slowed down, corresponding to one cold and one hot consumption.

While in the stage of reopening and recovery, the rapid deflation of consumption data in April, especially in the context of high unemployment rates and poor expectations for household income recovery, does require vigilance against the double decline in household asset and income expectations, which may turn high savings during the epidemic into a new normal, and the income that flows into consumption may slow down, leading to a structural decline in the economy.

The "deep recession" expected to result from the structural decline in the economy corresponds to the beta-level valuation of Chinese assets that have been opened since mid-May, regardless of alpha. In this environment, scarce assets have real growth (income side) and assets with generous dividends/valuation.

The risks that this trading logic must confront are:

To conclude that the high light of recovery has passed and deflationary trends are approaching based solely on one month of macro data, especially in April, which is a seasonal lull after a strong first quarter;

If there is really a long-term structural trend of deflation, will policies let it go? Policies may also continue to pose risks of shorting.

Where has the market pricing of "Is America declining or not, and is China prospering or not" gone?

The interest rate market in the United States has begun to price in the Federal Reserve's continued rate hikes in June and July;

Moreover, the expected rate cut has been largely eliminated as the one-year Treasury bond yield is currently trading at 5.25%;

China's loose expectations, coupled with the US rate hike expectations, have led to a slight widening of the yield spread between the 10-year Treasury bonds of China and the US.

Dolphin Analyst said that the turning point in trading did not come last week. The yield on 10-year US Treasuries has risen to 3.8%, suggesting that the market is trading on the belief that the US economy is adapting to a high-interest environment.

From the perspective of valuation percentile, the Hang Seng Index has already approached a historical low, and domestic stock indices have also fallen significantly. The valuation of all Chinese assets is now relatively low.

And there is also the latest PMI data this week, such as the continued contraction of manufacturing PMI, which may once again hit confidence. On Friday, there will be a new round of employment data in the United States, which may provide core guidance for the strength of the US economy in May.

In the case of the resolution of the US debt ceiling and the issuance of new national debt, funds may flow from the stock market/bank deposits to the bond market. As long as the wind direction of the two countries' high-frequency macro data changes slightly, it can bring changes in trading direction.

IV. Alpha Dolphin Portfolio Adjustment

Dolphin Analyst stated in last week's portfolio strategy that adjustments would be made to the portfolio last week.

a. The adjustment ideas of Chinese assets are mainly based on the above macro logic:

1) Low-growth assets must at least have a basic level of fundamentals, with performance repair logic and fundamental verification, high cost-effectiveness, cash, and dividend/buyback protection-Vipshop, NetEase, and New Oriental;

2) Either have real growth-Pinduoduo, because Dolphin Analyst mentioned in last week's portfolio that JD.com and Alibaba's revenue growth was lagging behind, Pinduoduo has the possibility of exceeding expectations, and based on certainty, Pinduoduo was put into the portfolio ahead of time.

b. In the US semiconductor sector, due to Nvidia's own performance repair, Dolphin Analyst's original expectation was that revenue was likely to meet expectations, and there were no surprises or shocks when revenue came out. However, the degree of exceeding expectations implies the start of the AI cycle. Based on the latest performance, the PE estimate is around 50 times, which is not particularly outrageous in the big cycle. Therefore, it is still underweight.

V. Portfolio Returns

On May 26th, Alpha Dolphin's virtual portfolio rose by 0.9% and fell by 0.9%, outperforming the MSCI China Index (-3.5%), the CSI 300, and the S&P 500 Index (+0.3%).

From the beginning of the portfolio test to last weekend, the absolute return of the portfolio was 7.9%, and the excess return compared with MSCI China was 18.5%.

VI. Individual Stock Profit and Loss Contribution

From the performance of the stocks covered by Dolphin Analyst in the past two weeks, the main contribution comes from US semiconductor stocks, such as Nvidia and TSMC; in addition, the newly added Pinduoduo also performed well. The main drag on performance comes from Hong Kong consumer stocks, which have been continuously undervalued.

Specifically, Dolphin Analyst has sorted out the reasons for the rise and fall of the top companies as follows:

7. Distribution of portfolio assets

There was no adjustment in the portfolio this week, with a total of 21 stocks or ETFs being allocated, including 7 standard-rated stocks and 19 low-rated stocks, as well as gold, US bonds, and US dollar cash.

As of the end of last week, the allocation and equity asset holding weights of Alpha Dolphin's assets were as follows: