Zhongjin: Short-term allocation choices select assets expected to be included in pessimistic asset Medium-term follows the direction of credit expansion.

Over the past week, the situation in Iran has rapidly evolved in a direction that is no longer escalating, which is also the default expectation for most assets. Otherwise, the market would have started to intensify its volatility weeks ago. This judgment is not difficult to make, after all, Trump still has to consider the midterm elections at the end of the year and cannot continue to endure high oil prices, high inflation, and financial market turmoil. The difficulty lies in grasping the pace, even now, the situation of negotiations is still unclear and the fragile balance may be disrupted again. This is generally consistent with our previous baseline assumption, that is: there will be fluctuations in the short term, April is key, but the situation will not evolve towards complete chaos in the medium term. In this scenario, compared to simply betting on the direction based on luck, we believe that a more graspable "certainty" is the degree to which assets factor in expectations. This can help us decide on allocation strategies and provide three levels of allocation suggestions: 1) Light positioning, can add pessimistic assets to the left side into expectations, such as gold, US bonds, Hengkang, innovative drugs, etc; 2) Heavy positioning, can partially adjust to low-volatility dividends or reduce positions to wait for opportunities; 3) Hold benefiting assets such as energy storage, green electricity, and coal, but because it is highly consensual, chasing prices excessively is not advisable. The market performance in recent times has largely followed this pattern. In this article, we explore another interesting phenomenon: why, in the face of the Iran situation and high oil prices, have the profit adjustments in the US, A-share, and Hong Kong markets taken such different directions over the past month? US stocks have risen, A shares have remained steady, and Hong Kong stocks have declined. Is it that US stocks are too optimistic, or Hong Kong stocks are too pessimistic? Answering this question involves not only the extent to which short-term profits are priced in relation to geopolitical risks but also the fundamental strengths and prospects of the three markets after geopolitical risks temporarily ease. Consideration of profit changes in the three markets: US stocks have seen increases, A shares remain steady, while Hong Kong stocks are under pressure. Since the Iran situation, the profit expectations of the US, A-share, and Hong Kong markets have diverged: US stocks have seen increases, A shares have remained steady, and Hong Kong stocks have declined. From the end of February to now, according to FactSet's consensus expectations: 1) US stocks have seen increases: 12-month forward EPS expectations for the Nasdaq, S&P 500, and Dow Jones Index have been raised by 5.6%, 5.0%, and 2.2% respectively, seemingly ignoring the impact of the geopolitical situation and actually benefiting from it. 2) A shares have remained steady: the Shanghai and Shenzhen 300 index has been raised by 1.6%, and the MSCI China A-share index 12-month forward EPS has only been slightly reduced by 0.1%, with benefits in the upstream offsetting the pressure in the middle and downstream. 3) Hong Kong stocks are under pressure: the Hang Seng Index, MSCI China excluding A shares, and MSCI China index 12-month forward EPS have been reduced by 1.3%, 1.9%, and 3.0% respectively, making it the weakest among the three markets. Looking at the internal structure, the profit expectations for the upstream sectors in the three markets have been raised, but more so in US stocks, with A shares and particularly Hong Kong stocks seeing greater reductions in the middle and downstream sectors. 1) Energy and raw materials profit expectations are rising. According to FactSet's consensus expectations, the energy sector's 12-month forward EPS in the US has been raised by 35.2%, significantly higher than the 13.1% in A shares and 10.1% in Hong Kong stocks; the raw materials sector has seen profit increases in A shares, Hong Kong stocks, and US stocks by 12.5%, 7.9%, and 5.4% respectively. 2) Some middle and downstream sectors in A shares and Hong Kong stocks have seen profit reductions. In Hong Kong stocks, the technology sector and consumer sector have seen the most significant profit reductions, with industries such as consumer services, semiconductors, technology hardware, telecommunications services, and optional retail experiencing reductions of 15.1%, 14.1%, 13.7%, 10.1%, and 7.6% respectively; for A shares, the real estate (-88.4%), automotive and parts (-10.6%), telecommunications services (-7.4%), and medical equipment and services (-6.9%) sectors have seen reductions. US stocks have had fewer downward revisions, with only transportation and durable consumer goods seeing reductions of -2.9% and -2.2% respectively. Even in the same sector, profit adjustments and directions vary significantly in different markets. In the semiconductor sector, 12-month forward EPS has been raised by 18.4% in US stocks, reduced by 1.8% in A shares, and significantly reduced by 14.1% in Hong Kong stocks; in the technology hardware sector, profit expectations have been raised by 1.9% and 1.1% in US and A shares respectively, while they have been reduced by 13.7% in Hong Kong stocks; in the consumer services sector, profit expectations have been raised by 2.5% and 0.5% in A shares and US stocks respectively, but reduced by 15.1% in Hong Kong stocks. Overall, the key to the overall increase in profit lies in the significant upward revisions in the energy sector in US stocks and the smaller downward revisions in the middle and downstream sectors. Contrasted with this, significant downward revisions in the technology and other downstream sectors in Hong Kong have dragged down overall profits. The reason behind this and whether this trend is reasonable is a complex issue that involves the pricing of geopolitical risks and the fundamental strength and prospects of the markets in the three regions. The profit prospects in the three regions: In the baseline scenario, US stocks are expected to have higher growth than A shares and Hong Kong stocks, but pricing for the escalation of the situation is not fully factored in Looking ahead, the medium-term profit prospects in the three regions will be affected by credit cycles, industry structure, and the evolution of the Iran situation. Based on the analysis above, in a pessimistic scenario, pricing in the three regions for the escalation of the situation is not fully sufficient. If the central oil price remains at a high level of $100 until the third or fourth quarter, the profits of US companies are estimated to decline by about 9% to 3-4%, and Chinese company profits are estimated to decline by 12% and be negative growth, much higher than what is currently reflected in consensus expectations. This is one of the reasons why we previously concluded that some equity markets have not fully priced in pessimistic expectations: the impact of high oil prices and geopolitical shocks on profits takes time to manifest, and the market still holds high expectations for the "TACO" logic, believing that Trump may still compromise under pressure from the mid-term elections in the second half of the year. If the situation continues to escalate, combined with the fact that some valuations still include expectations of interest rate cuts, US stocks may face a 10-15% correction pressure; for the Chinese market, assuming the Fed does not cut interest rates this year, year-end US bond rates reach 4.2%, and referencing the extent to which risk premiums rise from the Russia-Ukraine conflict to the normalization of the conflict, the Hang Seng Tech Index may face a reduction of about 6% to 4500-4600 points, and the Hang Seng Index may fall by about 10% to around 23000 points; different indices in the A-share market may face different pressures due to variations in valuations and profit exposure. Of course, if the situation eases, this pressure will naturally dissipate, as seen in recent market performance. In terms of allocation strategy, investors can take different layered strategies to deal with the current situation and future uncertainties: 1) For low positions, assets such as Hengsen Technology, gold, and innovative drugs that have already fully reflected pessimistic expectations, are highly correlated with interest rates and risk preferences, and have low valuations after deep corrections can be considered for investment on the left side. Once the situation eases or extreme scenarios do not materialize, they are likely to recover first and are suitable for left-side placements. In the medium term, focusing on sectors that benefit from the clear expansion of the credit cycle like technology and cyclical sectors is advisable, and one can choose to enter at appropriate positions in the future. 2) For high positions, partial reallocation to low-volatility dividend stocks or reducing positions to wait for opportunities is recommended. The second quarter is a weak period in the credit cycle, coupled with external geopolitical shocks and uncertain external demand, and with the overall market not factoring in too many pessimistic expectations, moderate position reductions can help to avoid potential volatility without missing out significantly. Banks, utilities, and other dividend-paying assets with stable cash flows and dividend certainty can serve as defensive positions. While these assets may not provide high elasticity, they can help reduce volatility and control drawdowns when the market fails to form a consensus direction. 3) Holding assets that benefit from supply shocks and energy security logic, such as energy storage and green electricity, is another option. This strategy is based on consensus in the market and may be crowded with trading activities, so it is not advisable to chase prices excessively. If high oil prices lead to increases in fertilizer and food prices, Shenzhen Agricultural Power Group can gradually be considered for investment. In conclusion, based on several key assumptions: 1) the situation escalating into full control is not the baseline scenario, 2) but there may still be fluctuations during the process, 3) even without considering the Iran situation, the second quarter is already a period of weak credit cycle in China. We recommend that different investors adopt layered strategies to deal with the current situation: 1) Light positions: assets that have already fully factored in pessimistic expectations, are highly correlated with interest rates and risk preferences, and have low valuations after deep corrections, such as Hengsen Technology, gold, and innovative drugs, can be considered for investment on the left side. These assets have already priced in sufficiently low expectations, and further downside is relatively limited. In the event of a situation easing or the extreme scenario not materializing, they are likely to recover first and are suitable for left-side placements. In the medium term, focusing on sectors that benefit from the clear expansion of the credit cycle like technology and cyclical sectors is advisable, and one can choose to enter at appropriate positions in the future. 2) Heavy positions: partial reallocation to low-volatility dividend stocks or reducing positions to wait for opportunities is recommended. The second quarter is a weak period in the credit cycle, coupled with external geopolitical shocks and uncertain external demand, and with the overall market not factoring in too many pessimistic expectations, moderate position reductions can help to avoid potential volatility without missing out significantly. Banks, utilities, and other dividend-paying assets with stable cash flows and dividend certainty can serve as defensive positions. While these assets may not provide high elasticity, they can help reduce volatility and control drawdowns when the market fails to form a consensus direction. 3) Holding assets that benefit from supply shocks and energy security logic, such as energy storage and green electricity. This strategy is based on consensus in the market and may be crowded with trading activities, so it is not advisable to chase prices excessively. If high oil prices lead to increases in fertilizer and food prices, Shenzhen Agricultural Power Group can gradually be considered for investment. This article is translated from the "Zhongjin Dianqing" official account. Editor: Li Fo.