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BOCOM Int'l Research Economics & Strategy

20 November 2020

China Market Strategy Outlook 2021: Value Strikes Back We continue to advocate value investing in 2021. China’s value sectors have

started to outperform since our 2H20 outlook report in June. But what on earth is “value”? It is confusing, as value is a relative term defined when compared with growth and price – unlike the GICS sector with an absolute definition about earnings sensitivity to economic cycles. At the current cyclical phase, the value sectors are the long-forgotten traditional and cyclical sectors with low valuation.

Cyclical recovery continues; inflation upside surprise. Our proprietary cycle indicator has been heralding a recovery since June. As credit growth continues at a measured pace in tandem with M2, and property investment heals after digesting the “three-red-line” policy, the recovery should continue. Other indicators, such as the copper cycle and gold, as well as the PBoC’s three-year monetary cycle, are all auguring well for the recovery. With demand improving as consumer confidence bounces back from historic lows, inflation pressure will creep up. Our model allocates towards traditional sectors such as financials, industrials, materials, energy and consumer discretionary, and keeps some exposure to IT.

“Valuation Investing” vs. “Value Investing”; industrial modernization within China’s 14th Five-year Plan (FYP). Companies that create value over the long run may not offer good valuation in the short term. The term “value” has the intangible quality of management, strategy and resources at company’s command. It is different from the consensus understanding of “value investing”, which is more about a quantitative valuation number. The difference between valuation and value is often like Christmas tree and Christmas.

That said, China’s 14th FYP emphasizes industrial modernization and the real economy, as well as how best to share the fruits of economic development among companies big and small, and people rich and poor. The crackdown on online lending and the anti-monopoly guideline for the platform economy are important signposts. The 14th FYP will be conducive to the traditional sectors with low valuation to create value. As such, valuation and value investing have large intersection.

SHCOMP ~2,900 - 3,600; USD entering weak cycle bodes well for China and RMB-denominated assets; HK, EM, gold, commodities and Bitcoin. The top end of our forecast range implies ~10% upside for SHCOMP, with ~2,900 being the likely bottom. But what is more important is the structural change within a broader market. Besides the cheap traditional and cyclical sectors, SSE50, CSI300 and HSCEI are all inexpensive with the tailwind from a strengthening RMB. Rising real yield concurrent with a cyclical upswing augurs well for these assets – till around end of 1Q21. We will re-examine our trading positions then.

Hao Hong, [email protected](852) 3766 1802

Head of Research

Karen [email protected](852) 3766 1825

Hanna [email protected](852) 3766 1805

20 November 2020China Market Strategy

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Outlook 2021: Value Strikes Back

What is value?

We have been advocating the return of “value investing” since our 2H20 outlook published on 10 June 2020. We have followed up consistently on this then non-consensus call on value amid a chorus of growth with our speeches at various summits and forums. On 9 November, there was a sudden and violent sector rotation from growth to value in the US market, with the news about Pfizer’s COVID-19 vaccine proven to be 90% effective.

Indeed, it was the largest single-day value outperformance relative to growth since 2009, a time when funds started to rotate into growth from value. Such outsized value performance is heralding the inception of the return of value investing. It offers a glimpse of what is to come. Investors should take note.

But still, what on earth is “value”? It has been baffling to my readers since we made this call. Unlike sectors and industries that are clearly defined in absolute terms by Global Industry Classification Standards (GICS) according to their earnings sensitivity to economic cycles, “value” is a relative term.

Value is defined by comparing underlying valuation with price. As such, the definition of value internalized growth, as valuation is derived from growth. Value is relative to growth, at a low price. Therefore, unlike the GICS-defined sectors, “value” can mean different sectors under different macro scenarios. From 2001 to late 2007 was a prolonged period of value rotation and value outperformance, and then followed by rotation back to growth since 2008 till recently (Figure 1).

Figure 1: Value underperformance relative to growth is beyond extreme

Source: Bloomberg, BOCOM Int'l



In our quantitative analysis, we define value by ranking stocks according to their valuation and growth. We then screen out value stocks with low valuation and reasonable growth. That said, we note that such a quantitative definition of “value” is different from the “value” created by good companies. The quantitative definition of “value” is more about valuation, a numeric number. Many even call “value investing” as understood by consensus “valuation investing”. But the “value” created by good companies has some intangible quality, because of company management’s vision and integrity, as well as strategic positioning within a growing industry.

As such, a company that creates value over the long haul may not fall into the quantitative value definition at all times during its life cycle. That is, a company that creates value may not have low valuation. Indeed, we would argue that good companies creating value will rarely be cheap.

Figure 2: Historical and current sector allocation based on value

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Financials, 36%

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Real Estate, 4%Utilities, 4%

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Telecom, 1% FinancialsIndustrialsEnergyMaterialsCons. Discr.ITUtilitiesReal EstateCons. Stap.Health CareTelecom

Sector distribution of the portfolio (Market Cap)

Source: FactSet, BOCOM Int'l



In our quest for value, we find that at the current stage of the economic cycle, sectors that fit the quantitative definition of value are mostly traditional and cyclical – the old economy that seems to have been neglected by investors for a long time. The value sectors include industrials, financials, staples, materials, and real estate (Figure 2). And this part of the Chinese market that we call “value” has substantially underperformed growth for some time (Figure 3). In other words, the technology sector, which has created value and will likely continue to do so for shareholders in the long run, is not selling at a good valuation for now.

Figure 3: Value has also substantially underperformed growth in China

Source: FactSet, BOCOM Int’l

As discussed above, valuation and value are often apart like Christmas vs. Christmas tree. But we would argue that the traditional, cyclical sectors that are selling at a low valuation can indeed create long-term value for investors. Recent dramatic shift of regulators’ attitude towards China’s internet giants, following the sudden halt of the Ant IPO, is a telltale sign of what is to come. With policy support, the likelihood of the traditional sectors to offer value has increased.

After all, China has been promoting directing fund flows “from the virtual economy to the real economy” for some time. And the 14th FYP has outlined some key industries to develop, including the upgrade of manufacturing industries and the modernization of their industrial chains, new energy and its auxiliary and associated industries, and technology hardware such as semiconductor. With policy support and continuing “reform-and-open”, traditional cyclical industries now selling at low valuation will likely start to create long-term value for shareholders. As such, at this stage of the economic cycle, the scopes of valuation and value investing coincide. Valuation investing is now value investing



Value to outperform during a cyclical upswing

Where are we at in this cycle? And what does it mean for value versus growth investing?

We believe we are in a cyclical upswing within a short economic cycle. And China is leading the way. In our previous research papers on China and the world’s economic cycles, we have demonstrated quantitatively that the duration of these short economic cycles runs about 3-3.5 years, closely correlated with the central bank’s monetary cycle (Figure 4). And the short cycles interweave into medium and long-term cycles. While the world economic cycle is in a secular decline, it can still have cyclical upswing in the short term, as seen in its short-term recovery in growth rate.

When cycle turns, arrays of macroeconomic variables across the spectrum rhythmically move in tandem, with a well-defined regularity but varying time leads and lags. We can detect these movements in economic variables in both value and volume data, as well as in survey and sentiment data. Since the variables are closely correlated within a cycle, we can measure just a few variables from different parts of the economy to verify the stage of the current cycle.

Figure 4: The PBoC’s three-year monetary cycle; monetary expansion to continue at modest pace

Source: Bloomberg, BOCOM Int’l

While the PBoC has been easing its monetary policy with restraints, M2 growth has started to accelerate (Figure 4), and credit growth is keeping pace with broad money growth. We have long argued that the PBoC did not have to be as aggressive as its Western counterparts (Figure 5), as the COVID-19 outbreak has been well managed in China, and the Chinese have abundant savings. Further, given the imbalance between large and small firms within the economic system, targeted easing towards SMEs and the lower-income population, instead of wholesale monetary easing like the Fed and the ECB, will be more effective.



Figure 5: The Fed and the ECB are rapidly expanding their balance sheets; the PBoC keeps its restraints


Meanwhile, Chinese consumer confidence is starting to recover from its historic lows seen during the COVID-19 outbreak. And long-bond yield is rising. All these observations are auguring well for a cyclical upswing (Figure 6).

Figure 6: China consumer confidence recovering from historic lows, suggesting higher yields


Metal prices are also portending an emerging cyclical upturn. The copper price in Shanghai that is closely correlated with the ISM is rising, and has recently broken out of a prolonged rectangle consolidation pattern formed in the past few months. And so is one of the best cyclical indicators – the Shanghai Composite (Figure 7).



Figure 7: ISM and copper price continue to recover


Gold price is also rising, heralding emerging inflationary pressure, if history is a guide. Already, the inflation expectation in the US is surging (Figure 8). It is difficult to fathom how inflation expectation could stay dormant, when the Fed’s balance sheet expanded close to four trillion dollars and broad money supply in the US surged more than 20%. Surging inflation expectation is consistent with a cyclical upswing.

Figure 8: Rising gold price implies rising inflation expectation


The forecast of an emerging cyclical upturn has been confirmed by our proprietary US economic cycle indicator (Figure 9). Our indicator is rebounding strongly from its historical low. Although this indicator is still showing contraction YoY, but the growth rate is improving on the margin. Semi shipments, an important cyclical indicator for the US, is



surging concurrently. While growth is recovering and is now rapidly being priced in by consensus, the inflation pressure in the US is likely to surprise on the upside in the coming quarters, given the US’ aggressive monetary and fiscal responses to COVID-19.

Figure 9: Global economic cycle is recovering from the COVID-19 abyss


If inflation is likely to offer upside surprises in the coming quarters, cyclical sectors that fall into the scope of value investing will likely outperform. This is because the earnings of the upstream sectors are more sensitive to the turn of economic cycle, and thus can benefit more from a rise in commodity prices. Our decision tree analysis, which is updated from our 2H20 outlook (“Outlook 2H20: The Dragon Awaits”, 20200610), continues to show the likelihood of an outperformance by the value sectors (Figure 10). Simply put, these cyclical sectors are likely to ride the upcoming cyclical upswing, and thus offer more value to investors.

Figure 10: Value will likely outperform growth in a recovery scenario, with ~80% chances

Source: BOCOM Int'l



US dollar entering secular decline; buy commodities, EM and China.

While the global economy will see a cyclical upswing in the short economic cycle, the long economic cycle is in secular decline. Such decline is evidenced by the falling growth rate in the US over the past six decades. Importantly, the US dollar runs a distinct 17-year cycle, and leads the US economic growth (Figure 11). The dollar has clearly peaked in the current cycle. The US economic growth will likely decline again, after a few quarters of upturn in the near term, if history is a guide.

A weakening dollar augurs well for most assets that are priced in it. Traditionally, commodities, EM and Chinese assets have performed well in a weak dollar cycle. Already, this year we have seen a rapidly-strengthening yuan, as the mirror image of a weakening dollar. The rising yuan, when breaking through a certain threshold, may induce a wave a revaluation of Chinese assets. A weak dollar cycle is conducive to such currency and asset revaluation.

I have discussed in detail the looming demise of the US dollar in my new book “Forecasting: Economy, Cycles and Market Bubbles”. While the looming collapse of the dollar’s hegemony has been a recurring theme after a period of dollar strength starting to wane into a depreciating cycle, we believe this time is different. Never before have we seen such brazen efforts of money printing. And the rise of central bank encrypted digital currencies will likely prove to be the death knell. This new form of currencies will challenge the dollar’s role as the measurement of price, the medium of exchange, and the storage of value. The PBoC is trailblazing in this field. Monetary debasing will eventually bear its own consequences.

Figure 11: USD strength in the current cycle has peaked, and it heralds lower secular US growth




Market outlook

Every year this time when we publish our market outlook for next year, we apply our earning-yield-bond-yield model (EYBY) to the challenge. EYBY has a long and distinguished forecasting track record. In our outlook report titled “Outlook 2020: Going the Distance” on 11 November 2019, we forecast the model trading range for the Shanghai Composite in the following 12 months to be between 2,500 and 3,500, with the most likely range between 2,700 and 3,200, and 2,700 being the most likely bottom.

2020 has turned out to be a year of epic market volatility. Even so, during the darkest hours of the epic plunge on the first trading day after Chinese New Year when COVID-19 was still ravaging the country, the SHCOMP stopped falling and found support at 2,685. During the unprecedented US market meltdown triggering circuit breaker a few times in March, the SHCOMP once again found support at 2,645, and had never made a new low. These two important lows during the epic market volatility are indeed very close to our forecast of the “most likely bottom” of 2,700.

In the subsequent dramatic market recovery, the SHCOMP rallied to 3,459 – just slightly below the top of our forecast range of 3,500 – and then paused, despite the dramatic market upward thrusts. Further, 75% of the time in the 12 months after our forecast, the SHCOMP traded within 2,700-3,200. Such observation fits our forecast definition of the “most likely trading range”. In short, the EYBY market forecast model has been very robust in the past tumultuous 12 months.

We note that our EYBY model continues to be stuck in a neutral range that tended to linger for some time in history (Figure 12). This is a range where stocks are neither more nor less favorable than bonds. That said, we have discussed the rising inflation outlook in the near term in the previous section. Amid the recent credit events in the SOE and muni bond market, we believe that stocks are preferable to bonds going forward.

Figure 12: EYBY is stuck at neutral, given the credit vs. money supply conditions




We have plotted EYBY and its corresponding composite levels on logarithmic scale in Figure 13. To eliminate the distortion from extreme data as the result of an abnormal trading year, we have excluded the data from 2015 – the year of stock market bubble. Further, we have grouped the data into pre- and post-bubble years starting from 2010 – the watershed year for the SHCOMP when its 850-day moving average stopped making new high beyond 3,200.

Figure 13: The likely trading range in the next 12 months is ~2,900 to ~3,600

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We have explicitly based our 2021 forecast on the data points between 2016 and 2020 (Figure 13, black and red dots). We believe EYBY will be stuck in neutral, unless dramatic monetary policy would be induced by unforeseen economic difficulties. As the SHCOMP has an internal compound rate of return that equals the economic growth target implicitly embedded in China’s FYP, the composite has a rising bottom that doubled every decade since 1996 (“The Market Bottom: When and Where?” 20160606). As such, we believe the bottom of the trading range will continue to rise to ~2,900, and the top will be around 3,600.

The top of our forecast range implies about 10% upside from the market’s current level. It doesn’t seem a lot. But other market indicators paint a similar picture.

The time series of GDP capitalization rate, or the ratio between Market Cap to GDP, appears to have formed a giant rising triangle pattern. The triangle continues to narrow, and the ratio is now right at the upper end of the triangle (Figure 14). Unless there is a breakout of this giant rising triangle because of how the market values China’s GDP, this ratio seems to have run into strong resistance. Meanwhile, the ratio between market value and M2 seems to be surging. But this is the result of the IPO reform from an approval-based system to a registration-based system.



Figure 14: For GDP cap rate to improve, M2 allocation towards stocks needs to rise further


Historically, the range of the YoY change of the GDP cap ratio is between +7% and -20%. That is, if the speed of market cap increase is +7% faster than the concurrent GDP, then the market will peak out – except during market bubble when valuation measures such as this no longer count. And if it falls to -20%, then the market tends to bottom out. The YoY change in the GDP cap ratio between +7% and -20% coincides with the peak and trough in the SHCOMP during the non-bubble periods (Figure 15). This change in GDP cap ratio has also run into a level that suggests looming index resistance.

Figure 15: The change in GDP cap rate has run into strong resistance of 7%; market structure is set to change




Given the policy of “three bottom lines” to curb property developers’ leverage, as well as recent regulators’ stern attitude toward online lending, credit is unlikely to expand as fast as it has done in 2020. Property has been a powerful instrument for credit expansion. The curb on developers’ leverage will affect their land-grabbing activities, and, in turn, local government financing. As such, credit is more likely to expand in tandem with moderate money supply growth, as it has been since 2018. While we believe that broad money supply growth can accelerate slightly in 2021, both credit and money growth at such measured pace is unlikely to be a catalyst for market surge (a.k.a. bubble). But it is still market supportive (Figure 16).

Figure 16: Credit expansion is in tandem with M2; it is market supportive


We believe the opportunity next year will be more structural within an overall supportive market environment. Indeed, the market internal structure has started to change, and deep value cyclical sectors have started to outperform since our call in our 2H20 outlook (“Outlook 2H20: The Dragon Awaits”, 20200610). Fortune appears to favor the large-cap indices dominated by the traditional sectors, as rising real yield suggests an economic recovery and bonds becoming even less preferable (Figure 17). And the large-cap indices are cheap (Figure 18).



Figure 17: Real yield suggests SHSZ300 large-cap index has some further upside in the coming months




Figure 18: SSE50, CSI300 and HSCEI are cheap

Source: Wind, BOCOM Int'l



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BOCOM International10/F, Man Yee Building, 68 Des Voeux Road Central, Central, Hong KongMain: (852) 3766 1899 Fax: (852) 2107 4662

Rating SystemAnalyst Stock Rating: Analyst Industry Views:Buy: The stock's total return is expected to exceed that of thecorresponding industry over the next 12 months.

Neutral: The stock's total return is expected to be in line withthat of the corresponding industry over the next 12 months.

Sell: The stock's total return is expected to be below that of thecorresponding industry over the next 12 months.

Not-Rated: The analyst does not have conviction regarding theoutlook of the stock's total return relative to that of thecorresponding industry over the next 12 months.

Outperform: The analyst expects the industry coverage universeto be attractive relative to the relevant broad marketbenchmark over the next 12 months.

Market perform: The analyst expects the industry coverageuniverse to be in line with the relevant broad marketbenchmark over the next 12 months.

Underperform: The analyst expects the industry coverageuniverse to be unattractive relative to the relevant broadmarket benchmark over the next 12 months.

Broad market benchmark for Hong Kong is the Hang SengComposite Index, for China A-shares is the MSCI China A Index,for US-listed Chinese companies is S&P US Listed China 50(USD) Index.



Analyst certificationThe authors of this report, hereby declare that: (i) all of the views expressed in this report accurately reflect their personal views about any and all of thesubject securities or issuers; and (ii) no part of any of their compensation was, is, or will be directly or indirectly related to the specific recommendations orviews expressed in this report; (iii) no insider information/ non-public price-sensitive information in relation to the subject securities or issuers which mayinfluence the recommendations were being received by the authors.The authors of this report further confirm that (i) neither they nor their respective associates (as defined in the Code of Conduct issued by the Hong KongSecurities and Futures Commission) have dealt in or traded in the stock(s) covered in this research report within 30 calendar days prior to the date of issue ofthe report; (ii)) neither they nor their respective associates serve as an officer of any of the Hong Kong listed companies covered in this report; and (iii) neitherthey nor their respective associates have any financial interests in the stock(s) covered in this report except for one coverage analyst who is holding shares ofShimao Property Holdings Limited.

Disclosure of relevant business relationshipsBOCOM International Securities Limited, and/or its associated companies, has investment banking relationship with Bank of Communications, Guolian Securities Co. Ltd., Luzhou XingluWater (Group) Co., Ltd., BOCOM International Holdings Company Limited, Sichuan Energy Investment Development Co., Ltd, Light Year Holdings Limited, Analogue Holdings Limited,Zhejiang New Century Hotel Management Co., Ltd, Tai Hing Group Holdings Limited, Shanghai Kindly Medical Instruments Co, Ltd, China Bright Culture Group, Xinyuan PropertyManagement Service (Cayman) Ltd, Sinic Holdings (Group) Company Limited, Jinchuan Group International Resources Co. Ltd, China Tianbao Group Development Company Limited,JiaXing Gas Group Co., Ltd, Huali University Group Limited, Alibaba Group Holding Limited, Alphamab Oncology, Poly Property Development Co Ltd, Kwung's Holdings Limited, HonlivHealthcare Management Group Company Limited, Shanghai Gench Education Group Limited, Zhongguancun Science-tech Leasing Co., Ltd, Joy Spreader Interactive Technology. Ltd, FuShek Financial Holdings Limited, Xingye Wulian Service Group Co Ltd, Jiu Zun Digital Interactive Entertainment Group Holdings Limited, Cirtek Holdings Limited, Kidztech Holdings Limited,Akeso, Inc., JD.com, Inc, Qingdao Holdings International Limited, Immunotech Biopharm Ltd, Ganglong China Property Group Limited, Sino-Entertainment Technology Holdings Limited,Dashan Education Holdings Limited, Adtiger Corporations Limited, China Bohai Bank Co., Ltd., Fulu Holdings Limited, China Nature Energy Technology Holdings Limited, RemeGen Co., Ltd.and Shinsun Holdings (Group) Co., Ltd. within the preceding 12 months.BOCOM International Global Investment Limited currently holds more than 1% of the equity securities of Orient Securities Company Limited.BOCOM International Global Investment Limited currently holds more than 1% of the equity securities of Everbright Securities Company Limited.BOCOM International Global Investment Limited currently holds more than 1% of the equity securities of Guolian Securities Co., Ltd.BOCOM International Global Investment Limited currently holds more than 1% of the equity securities of Guotai Junan Securities Co., Ltd.

DisclaimerBy accepting this report (which includes any attachment hereto), the recipient hereof represents and warrants that he is entitled to receive such report inaccordance with the restrictions set forth below and agrees to be bound by the limitations contained herein. Any failure to comply with these limitations mayconstitute a violation of law.This report is strictly confidential and is for private circulation only to clients of BOCOM International Securities Ltd. This report is being supplied to you strictlyon the basis that it will remain confidential. No part of this report may be (i) copied, photocopied, duplicated, stored or reproduced in any form by any meansor (ii) redistributed or passed on, directly or indirectly, to any other person in whole or in part, for any purpose without the prior written consent of BOCOMInternational Securities Ltd.BOCOM International Securities Ltd, its affiliates and related companies, their directors, associates, connected parties and/or employees may own or havepositions in securities of the company(ies) covered in this report or any securities related thereto and may from time to time add to or dispose of, or may beinterested in, any such securities. Further, BOCOM International Securities Ltd, its affiliates and its related companies may do and seek to do business with thecompany(ies) covered in this report and may from time to time act as market maker or have assumed an underwriting commitment in securities of suchcompany(ies), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking, advisory,underwriting, financing or other services for or relating to such company(ies) as well as solicit such investment, advisory, financing or other services from anyentity mentioned in this report. In reviewing this report, an investor should be aware that any or all of the foregoing, among other things, may give rise to realor potential conflicts of interest.

The information contained in this report is prepared from data and sources believed to be correct and reliable at the time of issue of this report. This reportdoes not purport to contain all the information that a prospective investor may require and may be subject to late delivery, interruption and interception.BOCOM International Securities Ltd does not make any guarantee, representation or warranty, express or implied, as to the adequacy, accuracy, completeness,reliability or fairness of any such information and opinion contained in this report and accordingly, neither BOCOM International Securities Ltd nor any of itsaffiliates nor its related persons shall be liable in any manner whatsoever for any consequences (including but not limited to any direct, indirect orconsequential losses, loss of profits and damages) of any reliance thereon or usage thereof.

This report is general in nature and has been prepared for information purposes only. It is intended for circulation amongst BOCOM International SecuritiesLtd’s clients generally and does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person whomay receive this report. The information and opinions in this report are not and should not be construed or considered as an offer, recommendation orsolicitation to buy or sell the subject securities, related investments or other financial instruments thereof.

The views, recommendations, advice and opinions in this report may not necessarily reflect those of BOCOM International Securities Ltd or any of its affiliates,and are subject to change without notice. BOCOM International Securities Ltd has no obligation to update its opinion or the information in this report.

Investors are advised to make their own independent evaluation of the information contained in this research report, consider their own individual investmentobjectives, financial situation and particular needs and consult their own professional and financial advisers as to the legal, business, financial, tax and otheraspects before participating in any transaction in respect of the securities of company(ies) covered in this report. The securities of such company(ies) may notbe eligible for sale in all jurisdictions or to all categories of investors.

This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state,country or other jurisdiction where such distribution, publication, availability or use would be contrary to any law, regulation, rule or other registration orlicensing requirement.BOCOM International Securities Ltd is a subsidiary of Bank of Communications Co Ltd.

Outlook 2021: Value Strikes BackWhat is value?Value to outperform during a cyclical upswingUS dollar entering secular decline; buy commodities, EM and China.Market outlookDISC_PLACEHOLDERDISC_PLACEHOLDER0DISC_PLACEHOLDER1DISC_PLACEHOLDER2

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