It's Time to Start Considering 'Small and Beautiful'

Weekly Reflections

In the first week of trading in 2021, the two markets recorded a good start, and the prices of stocks huddled by institutions continued to hit new highs, but the “two-eight differentiation” (20% stocks rising, 80% falling) was also very serious, with as many as 1,000 stocks falling in the whole city every day. Regarding the positive cycle logic of institutional investors huddling, Chen Jiahe elaborated on it in the article “There is No Perpetual Motion Machine in the Capital Market”. Some institutional investors centrally buy stocks of some high-quality companies. The stocks of these companies rise sharply due to large buying, and valuations reach the level of 60 or 70 times PE (Price-to-Earnings ratio), or even hundreds of times PE. Because this buying leads to rising stock prices, the performance of institutional investors significantly outperforms the market. And as performance rises, products such as new funds issued by these fund managers are also hotly sought after by the market. Therefore, more new funds flow into the market, and these funds are again invested in the stocks of the same batch of high-quality companies, causing the stock prices of these companies to continue to rise. At the same time, because the circulating shares on the market have been slowly locked up by previous holdings, the funds required for each new rise become less and less.

Thus, the capital market has formed a perfect positive cycle: huddled institutional investors constantly make money and outperform the vast majority of other stocks in the market that are not held in huddles, investors who buy these funds make a lot of money, and listed companies are also happy to see their stock prices rise.

Chen Jiahe believes: Compared with 2015, this fund huddling is actually not that serious. The quality of stocks this time is relatively high, and the market capitalization is also relatively large. At the same time, some fund managers expressed helplessness towards this huddling phenomenon at present. If they chase in, they are afraid that the valuation is too high, and if they don’t chase in, they are afraid that the performance will lag behind. Therefore, this is a typical positive cycle process now, and we cannot currently estimate when this positive cycle process will be broken. Due to the mixture of various factors, it is difficult for us to specifically predict when the turning point to a reverse cycle will appear in the future, but we will definitely see this point. Otherwise, the capital market would be too simple and one-sided, and a negative cycle will definitely appear in the market.

Regarding whether the huddling phenomenon can continue, there were sharp divergences in the views of brokerage strategies over the weekend: on the one hand, some institutions believe that huddling is an inevitable trend of institutionalization, “the leaders may change, but the bubble of leaders will not change”; on the other hand, some institutions also indicated that the market is looming with a structural bubble and faces the risk of going from “huddling” to “breaking up”.

The current situation of A-share funds huddling in segmented leading stocks is consistent with the “Nifty Fifty” market of US stocks in the late 1960s.

“Nifty Fifty” are 50 blue-chip stocks that were widely sought after by market investors in the late 1960s and early 1970s. Coca-Cola, Disney, McDonald’s, American Express, Gillette, General Electric, Citibank, Pfizer, etc. were all within the scope of the Nifty Fifty.

At that time, a view was prevalent in the US investment community: these blue-chip stocks with excellent earnings growth should be held for a long time and not sold. At any time investing in these Nifty Fifty stocks, as long as you hold on, you can get very good returns. Most people believed this view, and the valuations of the Nifty Fifty rose all the way. By the peak of the US bull market in 1972, the average PE of the Nifty Fifty reached 42 times, and the PE of some stocks was as high as 80 or 90 times.

The oil crisis in the early 1970s superimposed on the food crisis in 1972 promoted a rapid rise in the domestic inflation level in the United States, and market interest rates rose all the way. The rapid rise in interest rates first impacted the “Nifty Fifty” targets whose valuations were already very high at that time. With the US economy falling into recession at that time, the high growth logic of the “Nifty Fifty” no longer existed. The “Nifty Fifty” walked out of a wave of “valuation killing”. At the end of 1974, the PE valuation of the “Nifty Fifty” went down to 17 times.

Charlie Munger lost heavily in this Nifty Fifty crash. He lost 31.9% in 1973 and another 31.5% in 1974.

A PE of 40 or 50 times requires the compound annual growth rate of the net profit of the underlying company to maintain above 30%. This may be achievable by the Nifty Fifty within a few years, but it is difficult to sustain for a long time. Corresponding to A-shares, in 2018, the China Listed Companies Research Institute made a “2018 A-share Listed Company Growth List”, and the list was for the top 100 companies in terms of compound annual growth rate of net profit. The list showed that the compound growth rate of net profit of the top 100 companies on the list in the past five years was all above 30%. The report concluded that under the complex macroeconomic environment, the ability of listed companies on the list to maintain high growth in performance is related to their own scale. To summarize in one sentence: this is a batch of “small and beautiful” companies, not “Nifty Fifty”.

Whether a target is worth buying or not, first depends on whether the target is high-quality and has long-term investment value, and also depends on whether the price is cheap. The segmented leading stocks huddled by institutional investment are undoubtedly good targets, but the current price is indeed high. The PE of the wind brand leading concept (8841136) has reached 51.35 times. It is time to consider excessive risks. At this time, sub-optimal, “small and beautiful” companies in industries such as banking, real estate, coal, food and beverage, and military industry with relatively low valuations may be safer and more growth-oriented targets. In addition, high-growth enterprise technology and carbon neutrality enterprises are also worth attention. There are talented people in every generation, and each leads the way for hundreds of years. Assessing the situation, no matter when, discovering those who lead the way is the right path.

Weekly Events

Trump incited supporters to storm the US Capitol when the two houses confirmed the new president. Subsequently, some lawmakers proposed to impeach Trump, who has only 10 days left in his term, and major social platforms also removed Trump’s social accounts.

Of course, there are also those who rub off on hot spots and are not afraid of Trump being sad.

Weekly Market

Period: 2021-01-04 ——— 2021-01-10

Last Week Review: The three major indices all rose, with two consecutive rises; Stock Connect continued to flow in for three weeks; Wind industry sectors top 3 gainers were shipping, precious metals, papermaking, top 3 losers were office supplies, education, motorcycles; Wind concept sectors top 3 gainers were financial participation, Chengdu-Chongqing Special Zone, smart grid, top 3 losers were lithium batteries, CAR-T, stock trading software.

This Week Summary: A-shares welcomed a good start with three consecutive rises, and the turnover of the two markets exceeded 1 trillion yuan for five consecutive days. However, from the market perspective, individual stocks show extreme “two-eight differentiation”. Leading stocks huddled by funds continued to rise, and the PE of some industry leading stocks even exceeded 100 times, while most small and medium-sized stocks fell. Wind industry sectors top 3 gainers were energy equipment, oil and natural gas, chemical raw materials; top 3 losers were office, education, motorcycles. Wind concept sectors top 3 gainers were yellow wine, bicycles, titanium dioxide; top 3 losers were lithium batteries, battery electrolyte, CAR-T.

Market (%)	Index	This Week	1 Week Ago	2 Weeks Ago	3 Weeks Ago
Shanghai Composite	3570.11	2.79	3.27	0.99	-0.29
Shenzhen Component	15319.29	5.86	3.99	0.73	-0.26
ChiNext Index	3150.78	6.22	5.16	0.71	-0.18
Hang Seng Index	27878.22	1.2	3.37	0.16	-0.67
HSCEI	1009.55	-0.43	-0.43	1.24	0.67
Hang Seng HK Chinese Enterprises	3890.77	2.4	3.48	1.03	0.02
Dow Jones	31097.97	1.61	1.58	0.23	-0.41
Nasdaq	13201.98	2.43	0.92	0.26	-0.07
S&P 500	3824.68	1.83	1.79	0.35	-0.35

Market (CNY, Billion)	This Week	Previous Week	2 Weeks Ago	3 Weeks Ago
Shanghai Connect	105.37	27.26	48.44	79.13
Shenzhen Connect	85.91	108.56	37.7	5.71
Hong Kong Connect	546.41	229.45	62.00	9.77

Positions

Code	Name	Current Period Dynamic
SZ000889	Zhongjia Bochuang	Flat
LU	Lufax	Flat
F260104	Invesco Great Wall Domestic Demand Growth Mixed	Reduce
F001668	Hwabao Global Internet Mixed	Clear
F163406	Xingquan Herun Graded	Reduce
F008238	Zhongtai CSI 300 Enhanced A	Clear
F166301	Huashang Trend Flexible	Increase
F004997	GF High-End Manufacturing	Clear
F005449	Huaxia Industry Leader Mixed	Increase
F002083	Xinhua Xin Dongli Flexible Allocation Mixed	Increase
F005827	E Fund Blue Chip Selected Mixed	Increase