CICC Strategy: How to Allocate the Market in the First Quarter?

1. Grasping the rhythm of expectations and reality, layout during short-term volatility Recent market fluctuations are partly due to the pressure of meeting previous expectations and also due to the anticipation of future uncertainties. Firstly, with political meetings and economic work conferences being held one after another, the window of accommodating loose policies and rising risk preferences has passed, waiting for the effects of previous policies to gradually take hold will take time. Additionally, recent macroeconomic data indicating a weak underlying momentum in the fundamentals, delayed implementation of reserve requirements and interest rate cuts, etc., have led to the short-term market entering a phase of "lack of continuity." At the same time, with Trump taking office on January 20th, and the deadline for annual performance forecasts approaching, disruptions to market risk preferences and anticipation of future uncertainties have led to market adjustments at the beginning of the year. However, looking ahead, within the overall framework of reversing logic, what we need to focus on is how long this trend will last. In the face of temporary oscillations, the key is to grasp the rhythm between expectations and reality, and layout during short-term periods of volatility. We have repeatedly emphasized that around the logic of reversal, in order for the capital market and balance sheets of assets to form a virtuous positive cycle, a longer-lasting trend is needed, rather than short-term profits. The turnaround of the Chinese economy won't happen overnight, therefore this current upward trend may consist of multiple stages of "rapid rises and large fluctuations", gradually raising the bottom and moving upwards. Furthermore, each oscillation and consolidation serves the purpose of not only digesting previous gains but also creating more space for the subsequent rise, clarifying the market's train of thought and gradually unveiling the main long-term trends in the midst of fluctuations, which is beneficial for the long-term development of the market. In terms of structure, in the short term, as both the fundamentals and policies are yet to be confirmed before the two sessions, the market is still primarily driven by expectations. The market is expected to display a configuration of "dumbbell" style, where the leading stocks show strong performance while the small-cap themes lag behind. Since the end of regulations in September 2024, as the policy and fundamentals reverse, but are yet to be validated, the market is mainly driven by the logic of liquidity and valuation repair, leading to a low correlation between the performance of the index and industries with the fundamentals. At present, the market still focuses mainly on small caps and dividend styles. Looking ahead, in January and February, the market will be in a period of data and policy vacuum, with expectations of fundamental improvements yet to be validated, indicating that the short-term situation may continue to maintain the "dumbbell" configuration. However, it is important to note that the process driven by expectations is also intertwined with real disturbances, which means that there may be some differences in tempo between the two ends of the "dumbbell": In January (from the beginning of the year to before the Spring Festival), the "dumbbell" may lean towards the large-cap and dividend end. On one hand, January is the period of disclosure for annual performance forecasts, and the market usually shows risk aversion towards small and micro-cap stocks whose performances may fall below expectations. On the other hand, the main incremental funds, such as insurance funds, are more inclined towards large-cap and dividend stocks at the beginning of the year. Furthermore, the implementation of new delisting rules at the beginning of the year, and potential risks posed by Trump's inauguration on January 20th, may also lead to a more defensive market sentiment. In February (especially from after the Spring Festival to before the two sessions), the "dumbbell" may lean towards the growth and thematic end. After January, the disturbances caused by Trump's inauguration and the disclosure of annual performance forecasts come to a temporary halt, and more importantly, with the disclosure of Spring Festival data and local two sessions confirming the GDP targets and key work directions, the market will have a new "anchor" for expectations, which may lead to an improvement in risk preference. During this period, due to the relatively loose monetary environment and expectations for the two sessions, small-cap styles tend to perform better. Over the past ten years, the small-cap style has had a relative success rate of 100% in February. 2. March and April will be important observation windows for whether the market can transition to profit-driven In the medium to long term, for the market to continue, it still needs to have profit support, and by then market aesthetics will shift from valuation-driven to profit-driven. Referring to historical experiences, apart from the bull market in 2015, most bull markets in history have required resonance between profits and valuations for the market to sustain. Furthermore, following the initial rebound of a bull market, assets with high win rates characterized by high return on equity, high return on assets, high return on invested capital, high cash flow per share, high net profit growth rate/revenue growth rate, etc., have emerged as the consensus direction in the new medium to long-term dimension of the market. Currently, March and April may be important observation windows for whether the market can transition to being profit-driven. During this period, it will be crucial for the market to realign itself with policy signals, validate fundamentals, and choose new directions, as well as to evaluate whether domestic cyclical assets or distressed assets can take advantage of the situation: Firstly, the two sessions held in early March will further clarify economic goals and incremental policy measures including deficit rates within the context of the Central Economic Work Conference and accelerate policy implementation. If policy efforts can lead to clear expectations of fundamental improvements in the market, it may provide a "booster shot" to the market and indicate that domestic cyclical assets are expected to have positive pricing. Secondly, listed companies will disclose their annual reports for 2024 and first quarter reports for 2025 in April. After experiencing two quarters of countercyclical policy efforts, with some industries undergoing further consolidation, the financial reports are expected to gradually validate improvements in corporate fundamentals. Moreover, the financial reports will provide investors with more structural clues, helping the market rally around a main theme. Thirdly, external disturbances from sources such as US-China trade are gradually being resolved, indicating that the market may further focus on internal recovery signals. 3. Along the rhythm of expectations and reality, how should the structure be configured? In the first quarter, overall, it still leans towards a "dumbbell" style 1. One end of the "dumbbell": focusing on new quality productivity and mergers and acquisitions The new quality productivity sector is the point where long-term economic momentum shift and short-term supportive policies intersect. Especially since Trump took office, the uncertainty brought about by his policies towards China has once again emphasized the necessity for self-controllable technologies, which are also coupled with the development of new quality productivity domestically. The fiscal budget is expected to further lean towards the "safe" theme. On one hand, the development of new quality productivity domestically requires upgrading of the industrial supply chain, development of emerging industries, and future industry directions, which align perfectly with the critical sectors of domestic technology, making self-controllability not only a strategic tool under the backdrop of great power competition but also an inherent requirement for developing new quality productivity. On the other hand, with the clear signal of increased fiscal budget in 2025, the subsequent tendencies are expected to continue towards the "safe" theme. Overall, it leans towards a "dumbbell" style in the first quarter.Issue ultra-long-term special national bonds to support strategic directions with high importance such as technological innovation and industrial chain security, to help achieve high-quality, independent and controllable development.Focus on AI, semiconductors, creative industries, Siasun Robot & Automation, and low-altitude economy. In terms of mergers and acquisitions, as a resource allocation method supported by this round of policies, new investment opportunities are constantly emerging. By reviewing representative cases of mergers and acquisitions so far this year, and combining them with the latest policies of local governments and the State-owned Assets Supervision and Administration Commission of the State Council on improving and strengthening the market value management of centrally-controlled listed companies, we believe that future mergers and acquisitions should focus on three stock selection strategies: injection of high-quality assets not yet listed, integration of resources in the same industry, and cultivation of new productive forces. 2. On the other end of the "dumbbell": positioning dividend-like bond assets, enhancing allocations to consumption and cyclical dividend fundamentals We classify dividend assets into bond-like dividends (power, transportation, operators, banks, etc.), cyclical dividends (coal, steel, etc.), and consumption dividends (textiles, automobiles, home appliances, etc.). Cyclical and consumption dividends have both dividend and pro-cyclical properties, with industry prosperity level and fundamentals having a relatively significant impact on stock prices, while bond-like dividends have stronger fundamental stability and lower volatility, making them more suitable as core asset allocations. Therefore, in the short term, bond-like dividends are still the main direction of dividend allocations. As fundamental clues become clearer in March and April, there can be opportune enhancements in allocations to consumption and cyclical dividends, considering the potential incremental policies related to domestic demand, consumption dividends may be a direction that deserves more attention. The screening criteria for bond-like dividend assets: 1) correlation coefficient between stock price and 30-year treasury bond yield maturity in the past three years is less than -0.8; 2) total market value is over 100 billion; 3) dividend yield is greater than 2%; 4) maximum drawdown in the past five years is less than 30%. Mainly concentrated in industries such as banks, transportation, operators, and power. (Post-2) After March and April, opportune enhancements to focus on the growth and turnaround industries related to domestic demand From an economic cycle perspective, the growth in domestic cyclical demand is one of the important directions for fundamental turnaround in this round. By 2025, with potential new tariff disturbances affecting external demand, economic growth will increasingly rely on domestic demand. As boosting domestic demand is a key focus of this round of policies, policy efforts are expected to be further clarified during the two sessions and is a direction that will benefit the most from policy adjustments and recovery expectations. Emphasizing the service sector consumption. From the statements of the economic work conference, service consumption, as a major direction in line with consumer upgrades and expansion, is expected to become an important driver of this round of consumption expansion and a major source of incremental consumption. In addition, service consumption also exists as a profitable sector with elasticity in consumption finesse this year. Inspecting the proportion of domestic revenue in various consumer industries in 2023 and the expected year-on-year growth in net profit in 2025, industries with considerable potential for profit recovery in 2025 mainly focus on service consumptions such as food and beverage, education, retail, and healthcare. External demand pressure is usually an important time window for domestic policies to exert influence, under potential incremental policy support, bases for profit recovery may provide assistance. Selected leading companies in traditional consumer sectors such as food and beverage and home appliances. As this round of policies focuses on the demand side, they are expected to benefit from economic fine-tuning and improved fundamentals, leading to a reevaluation of valuations. In addition, these industries have mostly entered the mature stage, with stable profits, a stronger emphasis on shareholder returns, dividend and buyback intentions are stronger, and with the stabilization and recovery of domestic demand, they will also provide increased dividends. Focus on leading companies in construction and real estate chains benefiting from the bond conversion policy. With the gradual implementation of local government bond conversion, and expectations of increased investment in projects after fiscal pressures are relieved, industries with high government involvement and higher accounts receivables are expected to see improvements in cash flow and balance sheets, mainly concentrated in construction and real estate chains such as decoration, professional engineering, infrastructure, construction, and engineering consulting services. From an industry cycle perspective, the advanced manufacturing industry with optimized supply patterns is another important direction for fundamental turnaround in this round. Identifying industries where capacity expansion has significantly slowed down in recent years, has been relatively cleared out, and has a high probability of reaching a turning point in capacity utilization rate by 2025, combined with mergers and acquisitions, industry competition is expected to accelerate optimization, and indicators of industrial reversal are expected to be further clarified in annual reports and first-quarter reports. Focus on leading companies in advanced manufacturing industries such as new energy and defense: In terms of defense, disturbances such as mid-term adjustments in the previous "Fourteenth Five-Year Plan", delayed order placement, etc., have subsided. By 2025, as the concluding year of the "Fourteenth Five-Year Plan" for military construction, the execution of the military construction plan has entered a critical phase of capability integration and delivery. The industry's backlog orders in 2024 Q3 have begun to rise, and the existing demand in the "Fourteenth Five-Year Plan" is expected to be released faster. Referencing historical experience, the five-year plan is usually an important factor affecting the evolution of the military industry's market sentiment, with the "Fifteenth Five-Year Plan" set to start in 2025, opening a new cycle of orders and is likely to drive the overall recovery of the industry. Furthermore, as market mergers and acquisitions enter an active phase, the pace of mergers and asset injections in the defense industry is expected to accelerate, potentially becoming a significant catalyst for the defense industry in 2025. In terms of new energy, the industry's supply has undergone accelerated clearing over the past two years, with signs of inventory replenishment appearing in segments such as batteries, wind power components, photovoltaic silicon materials, and inverters. The commencement rates in 2025 may reach a turning point first, with performance expected to stabilize and recover. At the same time, as supply is cleared, concentration in industries such as lithium batteries and wind power is gradually increasing, with policy support for mergers and acquisitions and the elimination of low-efficiency and excess capacity accelerating, the industry's competitive landscape is expected to further optimize, and industry consolidation will become an important focal point. Risk Warning Economic data fluctuation, policy easing lower than expected, and the Federal Reserve not cutting interest rates as expected. This article is from "Yaowang Houshi," GMTEight Editor: Li Fo.