This article was compiled from Huaan Securities “How to Grasp the Rhythm of Cyclic Markets”

The economy is recovering, and the cyclical market cannot be ignored

As time continues to evolve as economic recovery continues to evolve, the advantages of the cyclical style have become more obvious:

① Since March 23, A-shares have bottomed out due to fears about the sharp decline in US stocks, the cyclical style has ranked second with an increase of 24.53% and growth, second only to the consumption style of extreme groups;

② Since the economy gradually confirmed its recovery trend at the end of May, the cyclical style gradually narrowed the gap between consumption growth and consumption growth with an increase of 24.32%;

③ The continuous surge in the financial sector at the beginning of July triggered market sentiment. The financial sector at this time was very remarkable, but unexpectedly, as of September 23, the cyclical sector ranked first with an increase of 16.52%, and gradually widened the gap in growth with other styles.

The “syllogism” of cyclical stock market

The pace of change in the economic growth rate this year and next will follow a V-shaped trend, similar to 2009-2010.At the time, there were abnormal fluctuations in the economy and markets due to the impact of external factors such as the US subprime mortgage crisis and the global financial turmoil, which was essentially similar to the current epidemic.

The 2009-2010 cycle style also showed a period of astonishing market growth.From the introduction of the $4 trillion infrastructure stimulus plan in early November 2008, a reversal in market conditions began, and ended after the two sessions in April 2011, when it was confirmed that the economic stimulus plan had been withdrawn and disruptions began to focus on adjusting the economic structure. Over a period of nearly 2.5 years, the cyclical style nearly doubled, ranking second among all styles. This is far higher than the 78% increase in Shanghai and the 136% increase in Wande Quan A over the same period.

The interpretation of a full cycle market under this macro-general trend is divided according to driving force characteristics. In total, it has gone through three stages: estimation improvement, weak performance (valuation drive) → → digestion of valuation, performance recovery (valuation decline) → strong performance, valuation recovery (dual driver of performance valuation).

Take the construction materials market as an example:

The first stage: from the beginning of 2008.11 to the beginning of 2009.08, valuation performance was driven by both.

At this stage, the cyclical style index rose 225%. Of these, 98% of the increase was contributed by valuation increases, 64% was contributed by performance, and 63% was contributed jointly by valuation performance. Overall, the contribution of valuation and performance was 6-4 points. What is different about the building materials market at this stage from the cyclical sector and other cyclical industries is that performance has become an important driving force, mainly because the building materials industry's profit recovery is faster and ahead of schedule compared to other industries.

Second stage: From the beginning of 2009.08 to the beginning of 2010.07, valuation digestion is the core factor in market performance.

At this stage, the cyclical style index fell by nearly 25%. Among them, valuation contributed a decline of nearly 57%, performance contributed a 73% increase, and valuation performance also contributed a 14% decline. Overall, all of the market declines at this stage were due to valuation digestion. Valuation is mainly digested through two dimensions: first, valuations are digested through positive performance contributions; second, there is also a pure valuation effect caused by deviating too much from the center after the valuation is elevated.

The third stage: from the beginning of 2010.07 to the beginning of 2011.04, valuation performance is driven by both.

At this stage, the cyclical style index rose 94%. Of these, 48% of the increase was contributed by rising valuations, 31% was contributed by performance, and 15% was contributed jointly by valuation performance. Overall, the driving contribution rate of valuation and performance was 6-4 points.

When procyclical opportunities are ongoing

According to the rhythm and driving relay of the 2009-2010 cyclical market, the characteristics of the first phase of the current cyclical style market, that is, when underestimating procyclical opportunities are ongoing:

The increase in valuations is driving the current cyclical market rise.Since the economy gradually recovered slowly at the end of March, as of September 23, the cyclical sector had risen 29%. Of these, the increase in valuation contributed to an increase of 82%, performance dragged down a 29% decline, and valuation performance combined to drag down a 24% decline. Overall, all of the cyclical market increases in the previous period were explained by higher valuations, while the performance aspect played a dragging role.

Despite a sharp marginal narrowing in the performance of the cyclical sector in the 2nd quarter of 2020, growth was negative.The performance of the cyclical sector also showed marginal improvement along with the economic recovery process exceeding expectations in the second quarter. The net profit growth rate for the second quarter was -38%, a significant improvement from -97% in the first quarter, but it is still negative growth, that is, it is not yet able to contribute to the cyclical market.

Investors should also note that the policy is already in the process of gradually returning from full easing to normal operation. Once the profit growth rate of the cyclical sector is confirmed to be correct, valuations are expected to reach the top position and enter a second-stage decline channel.