Three major new low sectors

I used to think that the plot of the Chinese capital market this year would be a low opening and a high rise, a turnaround for the salted fish. Now it seems that I was too optimistic. Half of the year has passed, and the Shanghai Composite Index has fallen below 3000 points. The sharp drop at the beginning of the year was not a show of strength, but rather set the tone for the whole year. All of the above is a joke. There is still half a year to go, and the final performance of the Chinese stock market for the whole year is still unknown. If you bought into the concept of "Zhongtegu," this year is still a bull market. However, with so many large stocks hitting new highs every day while the index continues to decline, it is clear that behind the peaceful days of "Zhongtegu," there are many sectors struggling under heavy pressure. There are several sectors worth mentioning. Although the index has not hit a new low, it has already hit new lows in years: consumer, securities, and pharmaceuticals. These sectors have all had their moments of glory in the past. After falling for so long, the P/E ratios have already come down. However, the phenomenon of water flowing to a lower level has not occurred. Is it not wise to bottom fish in these sectors now? I. Causes of the decline and representative stocks Currently, the CSI Healthcare, CSI Consumer, and CSI Securities indices have hit new lows in many years. The healthcare index is at a 10-year low, the consumer index is at a 5-year low, and the securities index is at a 6-year low. Many representative healthcare stocks such as WuXi AppTec, Aier Eye Hospital, East Money Information, Haitian Flavouring & Food, and Luzhou Laojiao have all hit new lows. Each declining sector and company has its own fundamental and valuation factors at play, but they also share a common point, which is that they are heavily held by funds. At this point, the market value of fund holdings in the food and beverage, healthcare, and non-banking financial sectors still ranks high, while the coal and oil sectors have risen significantly but have not yet reached the top 10 in terms of market value held. Despite having trillions of shares, the banking sector only ranks sixth, and most of the top five sectors have the problem of being overweight. It is evident that the core reason for the poor performance of these sectors lies in the fact that they are heavily held by funds. The fund industry is currently in a deadlock, underperforming the market. Instead of increasing capital at the bottom, investors are withdrawing, further increasing the selling pressure. Otherwise, such a sharp decline would not have been possible. The most absurd situation is in the healthcare sector, where there are currently only three healthcare stocks with a market value of over a hundred billion: Hengrui, Mindray, and WuXi AppTec The overall profit is not high, but the total market value of holdings is as high as 270 billion. For the food and beverage sector, giants like Wuliangye and Maotai have a market value of 300 billion, which is acceptable. The unreasonably high holdings have doomed the pharmaceutical index to perform the worst among these three new low sectors. Therefore, in which sector the fund's holdings ratio is higher, the worse the performance, it is a rule. The structural market for funds is very cruel. The holding market value of electronic stocks is also unreasonably high. Similar to pharmaceuticals, there are no particularly large companies in this sector, but they are supported by the chip bull market in the US, so there are no new lows, but they are also struggling. It can also be seen that another factor affecting the decline is economic resonance. The electronics sector has economic expectations, while pharmaceuticals and consumption, these two sectors are also quite weak in the US stock market. Excluding companies like Novo Nordisk and Eli Lilly, the entire large pharmaceutical sector in the US has been underperforming the market for a long time. The overall consumer sector in the US is also weak, with Nike recently faltering. If these sectors in the US can rise, A-shares probably wouldn't be performing so poorly. Therefore, the decline in these sectors is closely related to external factors. Overall, the collapse of the fund industry and the global industry's economic conditions determine the underperformance of these industries. However, investment value cannot solely rely on the overall environment. Starting from the fundamentals, have they really been misjudged? Second, cheap consumption can be compared to utilities. Currently, the entire consumer industry is quite sluggish. Even previously touted stable demand for condiments and beer are experiencing negative growth in performance, despite GDP still being positive. An astonishing data point is that the total retail sales in society in the first five months of this year grew at a rate lower than GDP growth for the first time, at only 4.1%, while GDP growth is still at 5%. The sign of economic transformation towards the development of high-end industries is that consumption growth gradually surpasses investment and exports to become the main driving force of the economy. After maintaining this trend for several years, it will come to an end in 2024. Currently, the driving force is the vigorous development of domestic new energy vehicles. With large volume and rapid growth, the overall growth rate is only 4.1%, so it is not surprising that other consumer sectors are experiencing negative growth. The liquor industry is currently in turmoil, with Maotai prices on the brink of collapse. However, upon closer inspection, the performance of second-tier liquor brands has also deteriorated significantly. Even the former liquor beta champion Jiugui Liquor has fallen by 85%, with a similar decline in performance. Isn't Maotai also struggling? With such a decline, its valuation must be very low, right? Calculating Jiugui Liquor still has a PE ratio of over 20, coupled with low dividend attributes, it still lacks investment value. The stock market has a memory. In the past, overvaluation was due to high growth, and then everyone expected that with the development of the Chinese economy, demand would increase again, performance would rise, digesting the valuation, it was fine to give a higher valuation. But now it is reverse digestion of valuation, the stock price has fallen but cannot be digested, it can only be said that the market's judgment on the demand for these industries is completely wrong. Previously, a similar mistake was made in real estate, do not use high-profit levels for optimistic valuations, but the market has not learned its lesson The current consumption pressure may last for a while, but consumption in areas such as automobiles and travel remains strong. People still have money to spend, just in different ways. The advantage of stable demand for non-durable consumer goods has not disappeared. The problem lies in the fact that past performance increments did not come from increased consumer demand, but from irrational sporadic demand. For example, hoarding of liquor and the trend of starting seasoning businesses. Removing this part of the performance, what remains is the performance brought by consumers' actual consumption each year, which still has long-term sustainable value. No matter how bad the economy is or how the population declines, the demand for three meals a day and basic necessities will not fluctuate significantly. The performance generated by stable consumption of all goods will not be inferior to the currently popular public utilities. By optimizing products, maintaining market share, optimizing profit margins through internal controls, and even achieving long-term growth. Food and beverage stocks that have already made adjustments, if they can maximize shareholder returns and fully demonstrate the advantages of their business models, will inevitably be able to restart and move towards a long bull market in the long run. Currently, there are major issues with liquor stocks because it is uncertain how much actual demand corresponds to performance. However, for stocks such as beverages, snacks, and seasonings that are difficult to hoard, when the dividend yield is up, it's time to take action.

III. Misjudgment in the Pharmaceutical Sector The issues in the pharmaceutical sector have been discussed in previous articles "Entering the Falsification Period of Innovative Drugs", and hitting a new low is not surprising. The biggest issue in the pharmaceutical industry as a whole is the post-pandemic base number issue, high valuations, and insufficient incremental supply from the domestic single market. Although the pharmaceutical model has essential needs and advantages such as aging population that seem to be long-term, it is inferior to the business models of consumer goods like food and beverages. In the era of innovation, standing still means falling behind. Relying solely on old formulas and products to make money for many years is not very realistic, as the input-output of research and development is an uncertain process. The long-term returns of the pharmaceutical index in the US are also not outstanding, with most major pharmaceutical stocks having average growth and shareholder returns not being high. They often have to maintain growth through significant research and development or large mergers and acquisitions to keep up, and only a few have seen significant stock price increases. In summary, over the past 10 years, the US pharmaceutical index has been suppressed by the semiconductor and internet sectors, making it not the preferred choice for tech growth stocks.

The pharmaceutical sector is overly optimistic, Ultimately, the mismatch between position and profit scale has caused the greatest losses for fund investors in the pharmaceutical sector in China. The biggest problem with bottom-fishing pharmaceutical stocks is the lack of growth. Let's take a look at dividend-paying stocks for stability. In the face of the rise of innovative drugs, the business model has changed. In the past 20 years, Chinese pharmaceutical companies were very similar to food and beverage companies, but that era is gone. When learning from the U.S. stock market, how should pharmaceutical companies with insufficient growth be valued? The common range is a PE ratio of 10-15 because of the research and development issues in pharmaceutical stocks, with the distribution ratio (dividends plus buybacks as a percentage of profit) only accounting for 50% of profits. Therefore, the overall return rate is around 3-5%, in line with current interest rates. Companies like AbbVie, Gilead, Pfizer, Johnson & Johnson, and GSK are all in a state of stagnant performance and fall within this valuation range. By the same standard, there are still many overvalued pharmaceutical companies in the A-share market. With no growth and unstable performance, should they still be valued at 20-30 times earnings? The biggest drop doesn't necessarily mean the most undervalued. However, companies that have successfully transformed or are innovative are not part of this discussion. IV. Difficulties in Finding Value in Brokerages Within the entire financial sector, brokerages have been lagging behind for many years. This new low is no exception, and it is a very ugly trend with the banking sector hitting new highs and lows at the same time. The conclusion is that this sector has little long-term value and doesn't require much attention. Despite the recent popularity of CICC, even with salary cuts, it still leads the country by a wide margin, with average compensation far exceeding average profits for many years, and the money earned is mostly distributed internally. Without making money, there will be a big collapse. It's a loss whether you imitate overseas every day, play the role of China's Goldman Sachs, or Morgan Stanley, and then compete with the real deal. Either lose in investment, get bottom-fished by foreign capital at low points, and cut at high points. Or lose in business capabilities, as Chinese companies prefer to have foreign investment banks handle their IPOs. Or lose in research, with 9 out of 10 judgments being wrong in a year. From the overseas experience, it is clear that the business model of Chinese brokerages does not support the industry as a whole. Even seemingly pure investment banks like Goldman Sachs and Morgan Stanley have banking as their core business, with investment banking and stock brokerage being minor. Even Morgan Stanley, which seems like a pure investment bank, has less than half of its revenue from investment banking, interest spreads, and commissions, which are the main income types for Chinese brokerages. In the past, the A-share market was characterized by a gambling ecosystem and speculation, with the nature of mass participation allowing many small companies in this industry to survive, creating a typical small industry with multiple companies and low profits. The brokerage industry does have good stocks, but they are not in the A-share market. Futu Holdings has been strengthening over the past two years. Only global comprehensive brokerages can achieve significant growth, but what about Futu's valuation? With a PE ratio of 17 times, over 70% buybacks, and still maintaining a 4% dividend yield, this is why U.S. stocks are not fond of Chinese companies, yet Futu can still rise Representative US stock financial companies such as JP Morgan, Goldman Sachs, and Morgan Stanley all have a dividend yield of over 3%. However, in terms of business stability and favorability among US stock investors, Futu cannot compare. Looking at the valuation of Chinese securities firms, there is naturally not much appeal, as those with high dividends are usually companies with significantly declining performance. With the introduction of the nine policies, the market is contracting towards Hong Kong stocks, and tough times are still ahead.

V. Conclusion

The three sectors with the worst short-term performance have all experienced justified declines, attributed to both the overall environment and their own shortcomings. However, from a long-term perspective, consumer stocks are the most optimistic. The long-term value of excellent consumer stocks will not be lower than that of utility stocks. The reversal of consumer stocks will not be very difficult. Perhaps once this round of fund collapse passes, they will rebound. On the other hand, other sectors will require more conditions to recover. The turning point lies in dividends. The reason why the business model of pharmaceutical companies is not considered good is due to the instability in research and development, resulting in insufficient shareholder returns and uncertain growth. The business model of consumer stocks should be better. Therefore, the only standard to verify this is the dividend payout ratio. It has often been discussed that the business model of China Mobile is very good, but with the company historically paying out 50%, it inevitably raises doubts about the true profit. As the dividend payout ratio gradually increased from 50% to the current 70%, the value regression became quite natural, making it the leader in market value among A-shares today. The influencing factors of many consumer stocks having insufficient dividend payout ratios are only due to management attitudes, not the overall environment, which can be controlled by people. Based on this, the attitude towards the entire consumer industry should be optimistic