After global stock markets crashed in Mar and then recovered most of the losses, we observed several divergences in the market and economy: recession is deep but stock prices are strong, China’s domestic demand is recovering but external headwinds remain, investors are buying while insiders are selling, etc.
- Divergence 1: Wall Street & Main Street. S&P 500 surged 42% in 50 days, due not to cheap valuation or upbeat economic data, but Fed's unlimited QE. We are wary of stretched valuations of stocks and the current market consensus of earnings which seemingly priced in an ideal recovery.
- Divergence 2: COVID-19 in China & Overseas. COVID-19 outbreak occurred in China earlier than in Europe and the U.S., and became under control in China much earlier than in the West. For China’s economy, therefore, external demand is likely to stay weak due to the pandemic, while domestic demand is more resilient, especially with policy support.
- Divergence 3: China’s Domestic & External demand. China’s domestic demand is enjoying a better recovery than that of external demand, as illustrated by recent economic data. Manufacturing PMI dropped for two months in a row, while the non-manufacturing PMI rose further. Construction sector’s sub-index rose for three consecutive months to 60.8, while new export orders sub-index dropped back to 35.3.
- Divergence 4: Investors Buying & Insiders Selling. U.S. public companies have sold a record value of shares in May (>US$60bn). In HK, there have been a mini wave of share placement in the past week, with at least six companies issuing new shares to raise a total of HK$20bn. This gives a signal to investors that their shares are not cheap and that management are cautious about business outlook.
- Divergence 5: Growth & Value stocks. Growth stocks such as internet significantly outperformed value stocks such as financial and energy YTD. Valuation gap between them widened to the biggest in at least a decade. However, as investors bet on economic recovery, sectors that were the hardest hit, i.e. cyclical value stocks, could well play catch-up in near future. Growth stocks that have outperformed much may face profit-taking.
- Strategy: Switch to laggards in Consumer & Machinery. 1) Buy on dips instead of chasing the rally; 2) OW domestic consumption sectors, UW external-driven ones; 3) Play catch-up in some laggards with sound fundamentals in domestic consumption sectors, plus a few value stocks.
