Plunge, massive震荡! The Strait of Hormuz, engulfing the world! How should investors respond to this conflict?

Translated from: Securities Times Network

Recently, anxiety over the Strait of Hormuz has engulfed the global capital markets, with countries like South Korea and Japan experiencing some of the most severe fluctuations since the pandemic began. The A-shares have also seen increased volatility, with the Shanghai Composite Index briefly falling below 3,800 points.

We should rationally recognize that the fluctuations in A-shares are more driven by trading factors. The Shanghai Composite Index has not had significant adjustments since April last year, surging from 3,300 points to nearly 4,200 points. Profit-taking, along with crowded trading in overvalued sectors, margin trading, and automated stop-losses in quantitative trading, have all contributed to the increased market volatility.

In terms of the fundamentals of A-shares, the current valuation is at a historical low, with dividend yields far exceeding risk-free rates, and both buybacks and dividend payout ratios are on the rise. Meanwhile, hundreds of billions in time deposits are seeking alternative yields. Global capital is also in search of safer havens, and China stands as the “cornerstone of certainty” and a “harbor of stability” in the world. The gradual appreciation of the yuan means A-shares will likely become a refuge for global risk-averse funds.

Moreover, investments should not be held hostage by anxiety over the Strait of Hormuz. Currently, crude oil is generally in a state of oversupply, with no substantial supply shortages, and investments should avoid overreacting to geopolitical conflicts. It is worth mentioning that during the two oil embargoes in the 1970s, inflation and unemployment soared, and interest rates reached double digits, yet Buffett remained fully invested throughout such a harsh macro environment.

Buffett stated, “Every ten years or so, dark clouds will overshadow the economic sky, and at such times, a ‘golden rain’ will suddenly fall from the sky. When this happens, you must run out with a bathtub, not with a soup spoon.” For investors, this series of difficulties has led to extremely low valuations in the stock market, and these challenges will eventually become a thing of the past; however, the window for buying at extremely low valuations will not remain open indefinitely.

Panic is the greatest enemy of investment, and maintaining composure is essential. As seasoned investors firmly believe, the sky will not fall. If it were to fall, doing anything would be futile; therefore, one might as well take advantage of lower prices to buy stocks.

Four Factors Leading to Increased Volatility

The recent volatility in A-shares can be attributed to four main reasons:

First, the 2.6 trillion yuan of margin financing is extremely sensitive to market fluctuations. A drop in the stock market forces some margin accounts to sell, amplifying both upward and downward movements;

Second, the 2 trillion yuan of quantitative funds automatically execute stop-losses when volatility occurs, and the concentrated selling from automatic stop-loss orders intensifies the amplitude of fluctuations;

Third, some sector stocks have high valuations and crowded trading; once the market direction changes, selling can be swift, driving overall market volatility;

Fourth, it has been nearly ten years since the last peak in A-shares in 2015, and the market has gradually forgotten the pain of declines. New investors are eager to enter the market, but their tolerance for downturns is limited.

However, these are merely disturbances at the trading level and do not affect the investment value of A-shares. The valuations of A-shares are at historical lows, with many low-disruption sustainable heavy asset companies positioned at low valuations, providing a stable long-term dividend yield for China’s “hard assets.” Statistics show that as of March 27, the dynamic price-to-earnings ratio of the Shanghai Composite Index is 16.52 times, with a dividend yield of 2.54%; the dynamic price-to-earnings ratio of the dividend index is 8.86 times, with a dividend yield of 4.32%; and the dynamic price-to-earnings ratio of the Shanghai 180 Index is 11.92 times, with a dividend yield of 3.27%.

In terms of yield, major asset classes can be compared, and it is clear who is more attractive: the annualized return of the stock market is approximately equal to the dividend yield plus the economic growth rate, currently around 8%; the current yield on ten-year government bonds is 1.8%, while bank deposit rates are about 2%; the rental-to-sale ratio for homes in first-tier cities is around 2%. However, the annualized return of the stock market is realized over the long term and amid fluctuations.

Assets like gold and Bitcoin have recently shown weak performance because non-yielding assets are purely speculative; the peak of such assets may occur during the most intense conflicts. However, “hard assets” with stable dividend yields have intrinsic value; during heightened conflicts, the low point of stock prices may already be behind us, as price declines can make these already attractive companies even more appealing.

Against the backdrop of a stabilizing Chinese economy, the gradual appreciation of the yuan, and ample liquidity, investors’ anxiety over the Strait of Hormuz may have been overreactions. Yi Yingnan, a researcher at Renmin University’s Chongyang Institute for Financial Studies, recently wrote that America’s strategic dilemmas determine that the war will not escalate in the long term. Currently, crude oil is overall in a state of oversupply, and China has implemented a diversified strategy for its import sources for over a decade, continuously reducing reliance on a single source.

Cheap is the Hard Truth

Recently, the military conflict between the U.S. and Israel has sparked market associations with the two oil embargoes of the 1970s. The two oil embargoes indeed had a severe impact on the global economy at the time, leading to double-digit inflation, double-digit interest rates, and near double-digit unemployment rates in the U.S., resulting in stagflation.

However, Buffett remained fully invested in stocks during both oil embargo periods. Particularly during the first oil embargo that began in October 1973, Buffett had left the overvalued U.S. stock market in 1969, but he returned in 1973. He wanted to buy many stocks, but with limited funds, he even borrowed against Treasury bonds to increase his capital.

In 1973, he invested a total of $10.62 million to acquire 9.7% of The Washington Post’s shares. The intrinsic value of The Washington Post was around $400 million, but at that time, its market value was only $100 million. This investment became a classic success for Buffett, later yielding him returns of over a hundred times.

Investing is counterintuitive; when the stock market is cheap, a series of difficulties often deter investors from buying. However, looking back, cheap is indeed the hard truth.

Nevertheless, going against the tide during market panic requires immense courage. The book “Where Are the Customers’ Yachts?” published in 1940 describes Wall Street during the 1929 crash. At that time, the author observed that you cannot expect an experienced Wall Street trader to buy stocks when shipping volumes have just dipped below new lows, unemployment rates have peaked, steel production is less than half of normal, and a prominent figure confidently tells him that a large Midwestern underwriter is in crisis. “Unfortunately for everyone, this is exactly the time when stocks are most likely to fall.”

The market will eventually reward the courage and patience of contrarian buyers in the long term. “How can I buy stocks at extremely low prices?” The late global contrarian investing master John Templeton asked himself this key question at a very young age, and his answer was, “Unless someone is eager to sell, no other factor can drive a stock down to extremely low prices.” It was this answer that led him to borrow money to buy $10,000 worth of stocks during the toughest times of World War II, and after holding for four years, he sold for three times the return.