Finding Value in A-Shares as Investors Look for July Rebound

There's increasing talk of the market bottoming in China following last week's decline. One saying going around is "May lose money, June capitulate, July rebound." Even if the bear market hasn't ended, a counter-rally is expected. One area worth investigating is the blue chip stocks. Similar to what has happened in the United States, the worst stocks in the market by valuation measures have led the market in recent years. The blue-chip A-shares are undervalued relative to the market and to U.S. blue-chip stocks that trade at a premium.
iFeng: A股情报:五穷了,六绝了,七月能翻身吗?
From the perspective of the Japanese K-line graph, the Shanghai Composite Index, Shenzhen Component Index, and the Growth Enterprise Market Index have fallen by 5.07%, 6.69%, and 7.39% in short days since the Powei declined on June 15, and short-term short-term kinetic energy began to weaken. The intention to enter the market for bargain-hunting was gradually strengthened. In the intraday trading session, high-sending transfer, intellectual property rights, software, semiconductors, and internet and other concept stocks rose sharply, indicating that the market’s most sensitive sense of hot money has been fully ignited. It also means that After the release of concentrated emotions and risks, the pessimism in the market has improved significantly and the overall risk has been digested.

There are stock market rumors that "May poor and June capitulate," and this year the stock index barely closed in May, with individual stocks plunging up and down. It is in a downturn, and the probability of closing lower in June is extremely high. Then can the "July rebound" really be realized? How can we upgrade the strategic perspective to meet "seven times"?

...Xiangcai Securities proposes to learn to enhance the strategic pattern after a continuous downturn, because even in a bear market, after each major sell-off, there is a very obvious staged rally, and in such a rebound, it will A lot of cattle stocks have emerged.

Huaxun Investment said that if we lengthen the analysis cycle, we can clearly see that the Shanghai Composite Index has come to around 2850, which is just the rising point of the rising prices in June 2016, and has experienced repeated bottoming. The process began after a round of mid-level uptick. Therefore, the current index has fallen to the pre-intensive trading area, the market outlook is expected to build a phased bottom near 2850.
A-shares also appear relatively cheap by some measures:
The famous economist Li Xunlei published a long article, saying that the historically tested blue chip stocks in the A shares have been undervalued compared to US stocks: By comprehensively comparing the valuations of Chinese and US listed companies under various performance levels, only ROE has been found for 10 consecutive years. In 10% or more companies, PE and PB are lower than those in the United States. Among the companies with poor performance, the valuation of A shares is still higher than that of US stocks.
East Money: 李迅雷:大跌之后谁将胜出 依据确定性溢价寻找投资标的
 Judging from the US stock market, the deterministic premium of the mature market is obvious

Large companies in the U.S. stock market have relatively high valuation advantages relative to small companies. Firms with stable performance have higher valuations compared to companies with large fluctuations in performance. The valuation premium of the US stock market is highly effective: From the two time nodes in 2005 and 2010, the high-valuation and low-valuation companies at that time scored distinctly in the subsequent five-year performance, and the valuation level reasonably reflected The company's future performance changes.

From the past history, A-shares are not clear about the definitive premium

In the past, A shares had a long-term existence of higher valuations of small-cap stocks and premium stocks did not receive discounts. However, from the two time points in 2005 and 2010, valuation premiums of CSI 300 constituent stocks reflected to a certain degree. The company's future performance changes, but it is significantly weaker than US stocks. The deterministic premium of A-shares in the past was not obvious, mainly because “shell value” became the largest certainty of small-cap stocks.

The deterministic premium of A-shares is fully regressing since 2017

Under strict supervision, the "shell value" subsided, and the risk premium for small-cap stocks was significantly increased. The valuation of companies with large fluctuations in performance was significantly reduced. In addition, the expansion of credit spreads is also a manifestation of the rise in uncertainty risk premiums. Judging from the current valuation of the CSI 300 constituent stocks and the changes over the past year, the effectiveness of the A-share market valuation premium is increasing.
Large-cap A-shares are cheaper than U.S. large-caps:
China and the United States contrast and combine the domestic environment to find certainty and uncertainty of the A-share market

1) The valuation of historically tested blue chip stocks in A-shares has fallen below US stocks: By comprehensively comparing the valuations of Chinese and US listed companies under various performance levels, it has been found that only companies with ROE of 10% to 15% or higher for 10 consecutive years, have P/E and P/B that are both lower than the United States. Among the companies with poor performance, A shares still have higher valuations than US stocks.
 2) The deterministic premium of the leading companies in the stock economy is expected to continue to increase: Although over a year of leading stocks, the valuation of the A-share leading portfolio is still significantly lower than the non-leading portfolio, which is in line with the leading companies in mature markets. There is a regular opposite of the valuation premium.
 3) Focus on cash flow in the context of financial deleveraging: A more stable cash flow can obtain a deterministic valuation premium while a deteriorating cash flow status implies a higher risk premium. In this article, we review the changes in the recent performance and cash flow of various industries.
There may not be much direct exposure to a Sino-American trade war in the A-share market.
4) Concern over the uncertainty of export business under external environmental factors: We conducted statistical analysis of the overseas business income data published in the annual report of listed companies in 2017, and announced that there were 2,068 overseas business income companies, of which the overseas business accounted for more than 20% of companies have 819, more than 50% of 299, mainly in electronic components, machinery, automobiles, textiles and clothing. In the annual report, there were 29 companies with North American business income, of which 21 companies accounted for more than 10% of North American business income and 14 companies exceeded 20%.
In recent years, the process of internationalization of A-shares has been accelerating, and the opening of the capital market to the outside world has been further opened. The A-share valuation system has also gradually moved closer to mature markets such as the United States. In the context of the stock economy, the pricing logic of mature markets is used as a mirror to reflect the differences and trends in the investment value of the domestic market.

This article stands on the valuation point of view and quantifies the Chinese and US stock markets and finds that over the past 10 years, US stocks tend to give firms with high certainty valuation premiums, while A-shares prefer smaller firms and “shell value”. Now that tight financial supervision has become the main theme, the valuation of A-shares has fully returned, the “certainty” value of leading companies and long-term performance stars has not been fully explored, and cash flow deterioration and “uncertainty” in export business should be more cautious.
This chart shows the worst performing 10 percent of each industry (red) versus the WIND Total A-Share Index.
Return on equity is higher for large firms (red) and recently started moving higher:
P/E ratios of large (red) and small-cap stocks:
On the other hand, the turnover of small-cap stocks has dropped sharply, and the market’s concern has weakened significantly and liquidity risks have emerged. With the small-cap stocks index accounting for 1,000% of the total turnover of the market, the continued popularity of small-cap stocks for many years turned down in 2017, and the proportion of small-cap stocks dropped significantly. On the other hand, the number of stocks with a daily average turnover rate of less than 1% and one stock rose significantly, and it seems that there is a trend of convergence to the status quo of small-cap stocks with poor performance in mature markets.
Mature markets, but also bear markets.
Exhibit 15 : The number of stocks with a daily average turnover rate of less than 1% and 1‰
The valuation of high (red) and low volatility stocks:
 3.3 The expansion of credit spreads is a reflection of the return of risk premiums

Credit spreads are a measure of the risk premium for low-grade credit debt. For a long time, the domestic bond market AA grade credit spreads have changed in the same direction as the 10-year Treasury bond rate (except for a short period of 2012), which is mainly due to liquidity. In theory, when the economy is goodRisk-free gains rise, but credit risk is reduced, and credit spreads should be narrowed, and vice versa. When credit spreads and Treasury yields are higher, they should change in the opposite direction. This shows that credit spreads have not effectively reflected credit risks in the past, and the risk premiums of domestic bond markets for low-grade credit bonds are not sufficient.

However, in the past year or so, credit spreads have continued to widen, and even in the range of falling Treasury bond yields, credit spreads have continued to rise, showing that credit risk premiums are returning.

Exhibit 17 : Credit Risk Premium Regression: AA Grade Credit Spread vs 10 Year Treasury Rate
In which industries will you find the 50 cheapest blue chips? Banks, 21. Real estate 8. Construction 5. Railroads 3. Coal 3. Building materials 2. Transportation 2. Autos 2. Basic chemicals 2. Energy 1. Utilities 1.
The valuation of the banking industry has remained low for a long time. As early as 2012, when the banking industry ROE was more than 20%, PE was only 10 times or less. In hindsight, the market's valuation of banks is still valid. Since 2013, the banking industry's ROE began to decline continuously. Currently, under the background of financial deleveraging, the profitability and asset quality of the banking industry are subject to large uncertainties. Therefore, the current low valuation is precisely for this uncertainty. Risk premium.
P/E and ROE of the banking sector:
Coal and steel are typical strong-period industries. Performance fluctuations rank among the front ranks of all industries. The current static low PE is an effective reflection of its future performance fluctuations.

Real estate, construction and other industries also belong to cyclical industries. However, from historical data, ROE fluctuations in these industries are of medium level. Does the current low PE indicate that these industries are underestimated? Exhibit 20 and Exhibit 21 show the ROE and cash flow status of the real estate and construction industry. It is not difficult to find that ROE did increase in these two industries in the most recent year, but the cash flow situation deteriorated significantly. Therefore, the current low valuation may reflect the uncertainty of the quality of their earnings.
Real estate cash flow as a percentage of operating income (red) and ROE:
Same data, construction industry:
Consumer stocks look attractive:
 4.2 Definitive premium of leading companies in stock economy is expected to continue to increase

The Chinese economy has entered the dominant stage of stocks. Under the stock economy, the leading companies have obvious competitive advantages and their market share is expected to increase continuously. Therefore, the certainty is much higher than that of non-leading companies.

After more than a year of leading stocks, is the premium of A-share leading companies sufficient? We analyze the combination of leading stocks in the large consumer and cyclic sectors for analysis. The screening criteria are: 1) The market value is greater than 80 billion; 2) The ROE is located in the top 20% of the sector in the past two years; 3) The listing is for 2 years.

Exhibit 26 and Exhibit 27 show a comparison of the valuations of leading and non-leading combinations in the consumer and cyclic sectors, respectively, where the valuation of the consumer segment is measured in PE and the periodic segment is measured in PB. Although the leading stock company's stock price rose significantly more than the overall sector in the past year, the valuation of the leading combination is still significantly lower than the non-leading combination. This contradicts the rule that the valuation of large companies in the U.S. stocks industry is slightly higher than that of small companies. It can be seen that the deterministic premium of A-share leading companies is expected to continue to increase compared to non-leading companies.
Leading consumer companies trade at lower P/E ratios than non-leading companies:
Leaders in cyclical industries are also cheaper:
We further analyze the performance (ROE) and cash flow status (operating net cash flow/operating income) of each industry. The industry that has seen the largest increase in the past year is food and beverage, and its ROE and cash flow are both upward. Correspondingly, the industry's most falling media industry in the past year has seen its ROE decline and its cash flow significantly deteriorated. Other industries with large declines, such as construction and machinery, also have significant cash flow problems (the ROE has not dropped significantly).

Exhibit 31 : Both food and beverage ROE and cash flow rise
Media ROE and cash flow sinking:
Finally, here are the stocks most exposed to North America. First number is overseas profit share and second is North American share:
The top one is Yotrio Group, a maker of outdoor furniture and products. Next is Shifeng Cultural Development, a toy maker. Third is Shandong Liancheng Group. It makes "precision machinery parts and components; iron, aluminum, and other metal casting products used for passenger cars, commercial vehicles, compressors, agricultural and construction machinery, hydraulic systems, and more."

No comments:

Post a Comment