Minority AM Liam Zhou: Minds are changing, not principles

Liam Zhou   2020-03-20 本文章567阅读

The Covid-19 has become a global pandemic. Price war on oil erupted, and the U.S. and Europe stock markets were near 10-year high. All of a sudden, the stock, oil and currency markets all went extreme volatile and investors are panicing. Economists even start to foresee a depression similar to the one in 1930s. 


Foreign capitals have flowed out of China A share, and the blue-chips are under pressure. Value stocks getting weaker while small-mid-cap and tech stocks remain active, making investors even more anxious.


Would global economy go into a crisis?


Do not worry about this question.


We don’t think recession can be predicted. If asking 100 economists, you getting 100 different answers. Was the 1930s Great Depression predicted? Was the 2008 financial crisis predicted? Was the recent crash in U.S. and Europe stock markets predicted?


People having different expectations at different time, and different measures are taken in various economic environment, which leads to distinct outcomes. We need to remember that stock prices already reflect majority’s pessimistic expectations and concerns.


Howard Marks, the American investment master, at 74 years old, released his latest memo “Nobody Knows”, which I would highly recommend. 


Following the herd can’t make profit.


People may realize a fact that most stock investors would not making much profit in the long term.


We need to see the stock market as its alive. The fluctuation of share prices reflects investors’ expectation of future, or investors’ minds. When investors are optimistic, share prices has already been high. In contrast, when investors are pessimistic, share prices has already been low.


If your expectation is roughly the same as most people, your behavior would be similar to them, and the investment result would make no much difference.


Would majority investors make excessive return? Maybe by chance, but impossible in long run. That’s why we need to be minority when investing. 

We are not buying hot stocks in the market, but stocks with great risk-return ratio.


People normally buy stocks that draw most attention. The stocks recommended by friends or covered by the media are most likely linked to a hot topics or themes. Small-Mid-cap, tech stocks and stocks with unique stories are easier to draw attention. But these stocks are not what we would invest.


Would it be easy to make profit in stock that most people think is good? No, it’s not easy. If everyone has high expectation on a stock, the price would have been high. Once the reality doesn’t meet the expectation, the risk is huge. Maybe those stocks are actively traded with big rise, but consider the downside risk, the risk-return ratio is not good. Most time, the high risk-return ratio opportunities exist in stocks that majority investors have neglected.


The risk associated with hot stocks are much higher than most people imagine.


SWS Research compiled an “active traded stocks index”, which select 100 stocks with highest turnover rate each week. The index started from 1000 points in 2000, and turned into 10 points in 2017, 99% lost! And it didn’t take account of transaction cost. If investors bought these stocks, what are the odds to achieve long term profit? We should not pursue short-term profits and underestimate the risks embedded.


Bias toward blue-chips is still in the market, and the risk-return ratio is still good.


1.     Supply and Demand


People are worried about recent foreign capital outflow. Approximately 80 billion RMB has flowed out of China A share via Hong Kong connect during the crash of U.S. and Europe stocks market. However, we believe that this is only an extreme situation that will not last long. Foreign capitals have accumulated one trillion RMB net inflow via Hong Kong connect in the past 5 years. The temporary outflow will not change the long-term trend of inflow. Let’s continue observe the Hong Kong connect flow.


2.     Counterparty Behavior


In Q4 2019, domestic institutions cut their blue-chip position, which leads to a lower blue-chips allocation ratio for mutual fund. Actually, the risk is reduced when big institutional investors have less allocations for blue-chips. In contrary, risk is accumulated if everyone arrives at a unanimous opinion, and stock holdings are concentrated.  


3.     Valuation


Despite the recent corrections in global stock markets, the valuation of China blue-chips is still very attractive. The stock indices of U.S. and Europe dropped about 30%, but China CSI 300 index and Hong Kong HSI Index are still the lowest in valuation among major indices.


4.     Market Sentiment


Our inhouse market sentiment model shows that investors’ sentiment drops to the lowest level of the past 12 months. The lower the market sentiment, the lower the risk.


The movement of share prices is difficult to predict, but we can evaluate potential returns and risks. Our goal is to accumulate return in the long term. Short-term fluctuations are meaningless. We need to understand the essence and hold our investment principles, so that we can go through market chaos with a peaceful mind.