Chinese concept stocks: Worth a serious "cognitive reassessment"!

Hello everyone!

I am Dolphin Jun. At the end of the year-end summary before the festival, Dolphin Jun mentioned:

"Regarding Chinese assets, I personally feel that there is no further need for pessimism. In 2024, the macro environment is downward, while stock prices are upward. After several years of revaluation, a 10X PE for Chinese internet assets is standard. Beyond the short-term economic cycle, many Chinese internet assets hold massive cash and have logic for market share improvement, making a long-term EPS growth of 10%+ absolutely feasible."

After several years of suppression, the undervalued Chinese assets only need a "favorable wind" for revaluation, whether it is a cognitive favorable wind or a macro favorable wind.

Since the Spring Festival, after continuous recovery of Chinese concept stocks, the first question everyone faces is: Can we still chase Chinese concept stocks? This strategy weekly report will focus more on discussing this question.

1. "Faith has been ground to dust"

From 2010 to now, the Chinese concept internet assets covered by Dolphin Jun have only encountered two major pitfalls in their annual growth: In 2018, trade disputes and economic downturns, coupled with the end of the mobile internet's second half, which means the growth logic broke down, led to a 40% drop in overseas Chinese assets that year, marking the first deep correction of Chinese concept stocks.

However, compared to the adjustment in 2018, the period from 2021 to 2024 is the time of complete collapse of cognition and faith:

a) Frontline cannon fodder in the international financial power struggle;

b) The theory of useless technology: A strong technological country relies on hard technology, and the mobile internet, which iterates "business models" without real innovation, will only "flounder in its own nest";

c) The internet has entered an era of giant competition, with strong regulatory cycles + deflationary industry policies stifling monopoly premiums;

d) In the mobile video era, old players are gradually being washed up on the beach, reshaping the landscape of China's mobile internet;

f) The difficulty of mobile internet business models going overseas,

As a result, domestic internet companies have been hit hard in terms of growth potential in existing tracks, internal business expansion capabilities, investment and acquisition capabilities, and overseas imagination, all of which have been pierced through, even the logic of buybacks has become a question mark due to issues with going overseas in US dollars.

To put it more seriously, at the worst moment, overseas Chinese concept assets almost became "the street mouse everyone shouts to beat." The result is that the entire Chinese concept asset market has undergone a long adjustment over four years from 2021 to 2024, with the recovery since the end of September 2024 mainly relying on directional adjustments in policies.

2. "Give it a little sunshine and it will shine brightly," deserving a cognitive revaluationIn the continuous decline over the past four years, even though some niche Chinese assets have shown logic in market share growth, and some have achieved considerable growth despite fierce competition, most companies have released profits through cost reduction and efficiency improvement.

However, in the eyes of most funds, this profit release lacks sustainability, with concerns about the sincerity and sustainability of Chinese assets' overseas dollar repurchases. During the profit upturn, valuations have been continuously squeezed, with fiercely competitive e-commerce platforms being compressed to 6-10X PE, and live streaming generally around 8X PE.

The first step in the valuation repair of Chinese assets is the policy correction at the end of September 2024—looking towards the bright future of becoming a manufacturing powerhouse, but also facing the short-term deflation difficulties brought about by the collapse of domestic demand.

The second step, originally intended by Dolphin Jun, was to wait for stability in real estate and macroeconomics, and for residents to reduce leverage to a certain extent (between 2025-2026), allowing Chinese assets to begin a second wave of revaluation based on fundamental recovery, with each bottom being higher than the last during the fluctuations.

The short-term upside mainly comes from: a. the consumption season during the Spring Festival; b. policy expectations before the two sessions in March. Therefore, before the Spring Festival, late January is a relatively good opportunity for Chinese assets to rise. Based on this, Dolphin Jun has made a comprehensive increase in positions for Chinese assets before the festival (details can be found in the subsequent adjustment explanation).

However, before the fundamental recovery, Dolphin Jun originally held little hope for the re-evaluation of Chinese assets: after all, the biases formed during the valuation squeeze over the past few years have been too significant, and without tangible performance to counter it, the faith in Chinese assets has long been suppressed to the point where "not a scrap is left!"

Looking back, when small changes accumulate to a certain stage, signs of collective cognitive re-evaluation, like that of Deep Seek, have long been evident:

a. During Dolphin Jun's coverage of Pop Mart, it became clear that Chinese companies telling emotional value products through IP can also soar overseas; from manufacturing capacity output to brand value output, the value chain of Chinese goods is climbing.

b. The explosive popularity of Black Myth: Wukong, TikTok's reshaping of the overseas video landscape, and Xiaohongshu topping download charts in multiple countries; how far can culture and Chinese stories go overseas?

c. The final stroke of genius is Deep Seek, with the lively Spring Festival yangge robot merely adding to the brilliance.

This is extremely important from the perspective of cognitive correction:

a) Regarding the formulation of domestic policy incentives: for the past few years, some people have held a bias that breakthroughs in semiconductors and wafer manufacturing are essential, and that hardware innovation is the only form of innovation. A set of code placed in Alibaba or Tencent is subject to antitrust scrutiny; the same code placed in an intelligent automotive factory is the subject of policy incentives.

The breakthrough of Deep Seek indicates that hardware shortcomings can, to some extent, be compensated for by software. The advancement in software (Deep Seek) can also form core competitiveness, alleviating the drag of hardware lag.

Therefore, innovation in private enterprises, whether in hardware or software, should be encouragedb) For foreign capital: even if it is being pursued and blocked, and the survival environment is harsh, the survival ability of Chinese private technology companies to "shine with a little sunshine" deserves a cognitive reassessment.

Dolphin has seen some say that Deep Seek's technical strength has been overhyped as "over-rated." However, what Dolphin cares about is not this, but the survival ability of domestic private enterprises compared to their peers in a more disadvantaged environment.

The logical certainty of "cognitive reassessment" of the survival ability of individual enterprises is more reliable than the valuation reshaping brought about by changes in government policy shifts or macro improvements, which are external Beta layer changes.

III. Can Chinese assets still be pursued?

Therefore, the recent rise in Chinese assets surrounding Deep Seek mainly focuses on three directions:

a. Reassessing the competitiveness of domestic similar large models;

b. Upstream and downstream: such as Alibaba Cloud, which benefits from Deep Seek's cost reduction, increasing the penetration rate of large model applications, bringing opportunities to the public cloud market; cost reduction of models brings shipping opportunities to end-side devices, such as Xiaomi smartphones, Lenovo laptops, etc.;

c. Opportunities in the upstream hardware ecosystem, as well as downstream application ecosystems, such as Kingsoft and Glodon.

Of course, a basic premise for the cognitive reassessment of Chinese assets triggered by Deep Seek is that the valuation of Chinese assets is low enough, with a significant valuation gap compared to their US counterparts, and that US counterparts are facing a short-term mismatch in input-output (high input while income is difficult to marginally increase).

From the perspective of individual stocks, among the companies covered by Dolphin, although some companies are gradually approaching optimistic expectations, such as Xiaomi and SMIC, many internet assets still present opportunities.

At the same time, from the perspective of the external market, the economic data released during the US Spring Festival: a. weak total (strong structure) fourth-quarter GDP growth, b. seemingly weak (actually strong) non-farm employment in February, c. robust consumer spending in January (pushing the savings rate to a new low).

Although these economic data are not fundamentally bad and are unlikely to convince the Federal Reserve to cut interest rates again at the next meeting, compared to the previously continuously "fueling" inflation expectations, at least they have not added fuel to the fire, and to some extent, have led to a slight decline in the yield of 10-year US Treasury bonds.

At least from the external economic data released in February, there has been no external environment that creates difficulties for the recovery of Chinese assets. This week, the CPI and PPI data for January will also be released. If US prices stabilize and do not provide upward momentum for the dollar index, then Chinese assets should still have hope before the Two Sessions.

In addition, from the situation of this earnings season in the US stock market, internet technology stocks in the US will experience a resonance period in the next six months due to three factors: high capital expenditure (CAPEX) and operating expenditure (OPEX), AI labor investment, and accelerated depreciation (a detailed overview of the US stock market will be released by Dolphin in the near future). However, from the revenue guidance, the growth rate does not show marginal upward movement, which cannot support the dilution of expenses.

At the same time, after Trump reinitiated tariffs, overseas counterparts have retaliated, and American internet and technology giants have become the "targets" in this round of confrontation. For instance, both China and Europe are launching antitrust investigations against US stock giants.

In this context, the emergence of a Deep Seek moment will naturally lead to a rebalancing of the risk-return ratio of different asset classes.

IV. Portfolio Adjustment and Returns

Last week, Alpha Dolphin did not adjust its portfolio. However, before the holiday (without releasing the strategy weekly report), Dolphin had already made adjustments in advance, based on the logic mentioned earlier, primarily due to the anticipation of consumption during the Spring Festival and the Two Sessions. The cognitive reassessment brought by Deep Seek is an added benefit.

The main adjustments were made to Apple and BYD. Apple was adjusted out due to the new iPhone falling short of expectations, and the slow advancement of Apple's smart features was below Dolphin's previous expectations. After BYD was adjusted out, there was actually a significant increase during the Spring Festival due to news events related to smart equality. Other major adjustments included Chinese concept internet assets, with China Mobile being adjusted in mainly for defensive considerations.

Dolphin's specific adjustments are as follows:

Last week, the Alpha Dolphin portfolio returned 1.6%, underperforming the CSI 300 (2%), MSCI China (4.8%), and Hang Seng Tech (9%), but outperforming the S&P 500 (-0.2%).

Since the portfolio began testing (March 25, 2022) until last weekend, the absolute return of the portfolio is 77%, with an excess return of 83% compared to MSCI China. From the perspective of net asset value, Dolphin's initial virtual asset of 100 million USD has exceeded 180 million USD as of last weekend.

V. Individual Stock Profit and Loss Contribution

During the Spring Festival, the Chinese concept assets in the portfolio generally saw significant increases due to the influence of Deep Seek. However, due to the presence of stocks like Amazon, Google, and TSMC, which experienced substantial pullbacks, the overall performance of the portfolio was dragged down.

The specific stocks with significant price fluctuations are analyzed by Dolphin as follows:

6. Asset Allocation

The Alpha Dolphin virtual portfolio holds a total of 17 stocks and equity ETFs, with a standard allocation of 8, an overweight of 1, and the rest underweight. Besides ancient coins, assets are mainly distributed in gold, U.S. Treasury bonds, and U.S. dollar cash.

As of last weekend, the asset allocation and equity asset holding weights of Alpha Dolphin are as follows:

7. Key Events This Week:

The U.S. stock fourth-quarter earnings season has reached its second half this week, mainly with some vertical small leaders releasing their results. Among Chinese assets, the recently surging Semiconductor Manufacturing International Corporation (SMIC) is leading the way with its earnings release. Dolphin covers the stocks and key focus points as follows:

Risk Disclosure and Statement of This Article: Dolphin Investment Research Disclaimer and General Disclosure

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