One more rout: How much faith remains in China Assets to withstand another test?

Hello everyone, here is Dolphin Research's summary of the core information on this week's portfolio strategy:

1) The US retail sales data still reflects a thriving consumer demand: Under the festive atmosphere, categories related to the holidays such as food and beverage stores, daily necessities stores, clothing stores, department stores, and online retail have experienced a surge, driving a significant rebound in core retail.

2) Behind the support for consumer spending is the expansionary fiscal policy in the United States during the economic upswing: The fiscal outlook for the United States in 2023 shows that the government is reducing taxes for residents while increasing feedback to residents through social and retirement security networks. At the same time, industry stimulus policies are being implemented to boost specific sectors, leading to sustained high economic growth. The expansionary fiscal policy during the upswing ensures high economic growth in a high-interest rate environment.

3) In the context of last year's environment of high nominal interest rates (low real interest rates) and high growth in equity assets, assets with dividends and growth potential have performed well.

In comparison, the China market in 2024 seems to be indicating a year of low stimulus, high real interest rates (negative inflation), and a further step-down in GDP growth, with no strong stimulus measures and stable MLF operations.

Under this macroeconomic combination, Chinese assets are more suitable for individual stocks with good fundamentals, stable competitive landscapes, and good dividend returns.

Based on this logic, Dolphin Research made overall adjustments to the portfolio last week, as detailed in the main text.

4) This week marks the beginning of the earnings season, with Intel in the semiconductor sector, Netflix in the internet sector, and Tesla in the new energy sector all releasing their earnings reports.

Key areas of focus include Intel's AI PC strategy and the potential for incremental growth, improvements in the industry competitive landscape for Netflix and the opportunity for additional users amid crackdowns on account sharing, as well as Tesla's description of the competitive landscape and strategy for the year 2024.

Here are the details:

As a domestically driven economy fueled by current cash flow, the most important monthly indicators for the US economy, in addition to employment/wage data at the beginning of the month and CPI data in the first half of the month, are retail sales and household income and expenditure data in the second half of the year. Last week, the most important indicator was retail sales.

I. Strong Consumer Confidence

US retail sales, similar to China's retail sales, mainly consist of physical retail and food and beverage consumption. They represent the sales revenue obtained by retailers. Of course, their sales revenue can come from ordinary consumers as well as government and corporate clients, but overall, retail sales are mainly driven by household customers. Therefore, retail sales mainly reflect the situation of physical retail and food and beverage consumption in household spending.

Originally, due to the fact that the household savings rate had once again reached a historical low, the market generally expected a cooling down of consumer spending in the US during this cycle.

However, due to strong December employment and holiday demand, US retail sales remain robust. Looking at the seasonally adjusted data:

a. US retail sales in December increased by 0.55% MoM, equivalent to a 7% YoY growth rate, showing a rebound in growth. Meanwhile, the nominal YoY growth rate for the same period was still at 5.6% ([compared to China's non-seasonally adjusted YoY growth of 7% in December](https://longportapp.cn/zh-CN/topics/11165492? In terms of the specific categories, after the return of the strike for the second month, automotive consumption further rebounded. Moreover, driven by the demand during the Chinese New Year, high-weight categories such as grocery stores, daily necessities stores, clothing stores, department stores, and online retailing have experienced a surge, leading to a significant recovery in core retail.

Basically, as we approach the end of 2023, a clear support is that as long as employment remains stable, corporate layoffs are only limited to partial and small-scale optimization, and employee salaries continue to grow, the maximum impact on US domestic demand is only a rhythm adjustment, without a downward trend.

Ultimately, the market's expectation of changes in interest rates only results in noise that causes fluctuations in the stock market. However, the economic fundamentals remain robust, and overall equity assets are on an upward trajectory. The decline in valuation only brings opportunities for entry.

II. The sustainability of US fiscal support is crucial

Therefore, as we enter 2024, the potential changes within this cycle mainly depend on how long the expansionary fiscal policy within the US cyclical upturn can continue. By the end of this quarter, which is also the first quarter of the new fiscal year in the US, the US government is still in the process of deficit expansion.

Moreover, from a structural perspective, there are three major areas of high expenditure growth:

a. Industry-stimulating expenditure, corresponding to business and housing credit. Apart from the bipartisan disagreement on anti-inflation bills, both the infrastructure bill and the semiconductor bill have achieved bipartisan consensus. If the Republican Party takes office in the future, the IRA may be adjusted, but it is likely to be completed by 2025.

b. Social security and pension expenditure: In addition to the increase in the number of people covered by social security, the main factor is the cost perspective. The cost of individual payments naturally increases with the rise in living costs in an inflationary environment. Pension and medical insurance expenditures are mainly related to aging and early retirement. c. The interest payment on government bonds currently accounts for 11% of total expenditure, showing a trend of catching up with defense spending.

On the expenditure side, in years of very good economic growth, the US government's revenue has still declined or had negative growth due to the decrease in personal income tax, partly due to the poor performance of equity assets in 2022 and the previous Trump tax reduction law that lowered residents' taxes.

The picture depicted by this revenue and expenditure is: In 2023, a year with a strong economic foundation, the US government is actually reducing taxes on residents while increasing feedback to residents through social and retirement security networks. At the same time, through industry stimulus policies, it is increasing feedback to specific industries, driving sustained high economic growth.

A rare pro-cyclical combination of fiscal stimulus, in which not only the government is moving forward with a heavy load, but also residents and businesses are living very well.

As the US economy, where residents contribute nearly 70% of domestic demand, under the high-support fiscal policy of "taking less and giving more, and financing to make up for it," the actual domestic demand of US residents is not bad, and the demand for recruitment by enterprises continues, providing a stable foundation for GDP growth.

III. portfolio adjustment

Corresponding to the environment of US equity assets last year, it was a macro combination of high nominal interest rates (low real interest rates) and high growth, which was good for assets with dividends and growth.

In contrast, China's policy thinking does not involve strong stimulus, coupled with the recent unchanged implementation of the MLF, which may mean that 2024 will also be a year of low stimulus, and the corresponding macro picture may still be one of high real interest rates and low growth under the transformation of economic momentum. Under this macro combination, stocks with good fundamentals, stable competitive patterns, and a focus on dividend returns are preferred.

In this macro combination, it is not conducive to businesses that rely on financing to drive growth, especially if the return on assets brought by financing is not high. Based on this logic, Dolphin Research last week made a unified adjustment to overvalued consumer stocks (growth stepping down, valuation not matching growth prospects) and growth-oriented Chinese assets.

However, Dolphin Research also noticed that some undervalued Chinese internet assets have recently entered the extremely undervalued range again. While adjusting out, Dolphin Research closely monitors high-quality assets, such as those with stable fundamentals and a higher proportion of cash in valuation, which present extremely undervalued opportunities.

The specific stocks adjusted out and their logic are as follows:

IV. portfolio returns

On the week of January 19th, the Alpha Dolphin virtual portfolio's returns declined significantly by 2.1%, underperforming the S&P 500 (+1.2%) and the CSI 300 (-0.4%), but slightly outperforming the Hang Seng Tech Index (-10%) and MSCI China (-5.8%).

Since the start of the self-combination test until last weekend, the portfolio has achieved an absolute return of 21%, with an excess return of 52.5% compared to MSCI China. From the perspective of asset net value, Dolphin Research's initial virtual assets were $100 million, and it is currently $123 million.

V. Contribution of Individual Stocks' Profits and Losses

Last week, Dolphin Research observed that the rise in the portfolio and the holding pool was still driven by AI logic, with the AI logic line moving from the cloud to the local direction - AI PC and AI mobile phone direction.

Throughout this process, the entire industry chain - from CPU, GPU, to chip manufacturing, and then to storage - is on the rise. The latest performance of TSMC does not break this logic.

As for Chinese concept stocks, from the perspective of the magnitude of the decline: the stocks with larger declines are those that suffered from the disappointment of interest rate cuts (including no interest rate cuts in China and the reversal of interest rate cut expectations in the United States), and the stocks with poor industry competition and excess capacity. They experienced larger declines.

Regarding the major companies with significant increases and declines in Dolphin Research's holding pool and watchlist last week, Dolphin Research's analysis is as follows:

VI. Portfolio Asset Allocation

After the Alpha Dolphin virtual portfolio was adjusted this week, a total of 18 stocks were held, including three standard stocks, and the remaining equity assets were underweighted, with the rest being gold and US dollars.

As of last weekend, the asset allocation and equity asset weightings of Alpha Dolphin were as follows:

VII. Key Events this Week:

After a small warm-up, this week the US stock market officially enters the earnings season for major companies. Pay close attention to Netflix, Tesla, and Intel. Especially Tesla, which is the leading company in this wave of decline in new energy, pay attention to its outlook for the fourth quarter and the full year of 2024.