A-Share Market: Strategies for Average Investors to Participate

After entering October, the trading volume of A-shares has been quite active, with the Shanghai and Shenzhen stock markets maintaining a transaction scale of over one trillion yuan for several consecutive trading days. Compared to the initial violent pull-up and comprehensive rise of the market, the A-shares have recently entered a fluctuation mode. How should we view the current market opportunities, and how can ordinary investors participate better?

Will this round of market continue?

Similar to the market recovery scenarios in November 2008, the end of 2014, and the beginning of 2019, the key to the start of this round of A-share market is a series of precise policy combinations that have successfully reversed investors' pessimistic expectations. With the influx of incremental funds, market valuations have been quickly repaired, driving the progress of this round of volume increase.

However, despite the rapid repair of A-share valuations in this process, it cannot be said to be "expensive" in any case. For example, the current TTM P/E ratio of the Wind All A is 18 times, which is at the 37th percentile since its listing; the TTM P/E ratio of the CSI 300 is 12.96 times, which is at the 47th percentile since its listing, both of which are below the historical average. If we look at the global perspective, it is relatively a "lowland". Therefore, even considering the mean reversion of valuations after the cycle returns, the market still has a certain space.

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After all, qualitatively speaking, this round of market is based on the background of the decline of the risk-free interest rate, with the policy shift as the core driver, and the opportunity of the joint improvement of domestic and foreign risk preferences. If fiscal policy continues to exert force and the economic fundamentals gradually improve, we tend to judge that the market will have the possibility of evolving from rebound to reversal, which will not be a simple short-term rise.

Of course, the first round of comprehensive valuation may have already ended, and the second round of structural market is expected to take over. In the short term, after the liquidity market, the market will focus more on the changes in fundamentals and policies. In terms of rhythm, it has now entered a policy-intensive period, and the next node is the Standing Committee of the National People's Congress and the Politburo meeting at the end of the month, with core attention to the implementation of fiscal details.

Faced with the market environment that may accelerate rotation, which directions are worth paying attention to?

Looking at the macro narrative behind this round of market violent pull-up, it mainly includes three major lines:

The first is the narrative of great power competition, which is the rise and fall of the East and the West after the stagnation of the macro cycle of China and the United States. At present, stimulating domestic demand has become one of the important drivers of domestic economic recovery. At the same time, new economic growth poles are also being formed, such as new quality productive forces represented by chip semiconductors. We see that the higher level has increased its support for technological innovation to achieve autonomous and controllable key technologies. Starting from this logic, chips and consumption are expected to become potential core lines.

The second is the policy shift narrative. Starting from the "924" new policy, recently, a package of favorable incremental policies has been introduced in terms of stable growth, stable real estate, and stable stock market. The most concerned is the statement of the central finance. From the press conference of the Ministry of Finance, the expressions of "the largest scale", "the maximum extent", and "relatively large space" not only clarify the overall direction of the central government's leverage increase but also can be described as positive. Overall, cyclical industries such as real estate, building materials, and consumption are expected to benefit from the marginal changes in policy.The third is the narrative of liquidity. This refers to the expansion of market macro residual liquidity, which brings about an increase in market valuation and a warming of risk appetite. The main beneficiaries are securities firms and some small and medium-sized companies that have been oversold, which has already been reflected to some extent in the recent market trends.

How can ordinary investors position themselves?

In terms of tactics, it might be advisable to maintain a relatively balanced approach by using ETFs and other index funds to seize the opportunities presented by the three main logical threads. At the same time, as market risk appetite fluctuates in stages, it is still necessary to continue to pay attention and maintain a configuration in the dividend direction.

Of course, some investors may feel that although industry and thematic ETFs are already a relatively convenient type of passive investment tool, there are still some barriers to research and investment, such as the need to pay attention to the evolution of policies and the performance and expectations of sectors.

Therefore, if ordinary investors want to enter the A-share market at the right time but do not know what to buy, in the current situation where the market trend is still ongoing, laying out broad-based index funds may be a relatively superior way to stay in the game.

This is because broad-based indices select targets from the entire market; they do not favor any particular industry or theme. They measure the overall market's water level. After each "market bottom," as the broad market index continues to rise step by step, the trend-following beta market will not be absent. The natural high-position operation of index funds is conducive to investors benefiting to a greater extent when the market is rising.

What are the highlights of the A500 index, which is being sought after by various funds?

Speaking of broad-based index funds, there is a new broad-based index that has recently attracted market attention and is even referred to as the Chinese version of the S&P 500, which is the CSI A500 Index, code 000510. Due to the active layout of various fund companies, the scale of related index funds is experiencing rapid expansion.

If, in the past, the mainstream broad-based indices of A-shares were always known for their distinct market value labels—for example, when mentioning the CSI 300 and the Shanghai 50, they are associated with large caps and blue chips; when mentioning the CSI 500 and CSI 1000, they are associated with mid caps and small caps—then the birth of the CSI A500 Index may be a "rebalancing of large and small caps" on top of the broad base.

This is related to the way the index itself is compiled. When compiling the CSI A500 Index, a "three-level industry full coverage, first-level industry rebalancing" method is adopted. First, it ensures that all third-level industries can be included in the index, then selects leaders, and strives to make the index industry weight distribution close to the full market industry weight, which is the CSI All-Share Index. At the same time, it also excludes securities with an ESG rating below C, limits the maximum weight of individual stocks, and requires that they belong to the scope of the Shenzhen-Hong Kong Stock Connect or Shanghai-Hong Kong Stock Connect, making the index more investable.In this way, firstly, it has achieved a relatively even distribution of market value. Compared with the similarly named CSI 500, although both are integrated with 500 constituent stocks: more than half of the constituents of the CSI A500 have a market value exceeding 100 billion yuan, while the constituents of the CSI 500 are concentrated between 10-30 billion yuan; moreover, the market value range of the CSI A500 constituents covers from 4.5 billion yuan to 2.3 trillion yuan, and the minimum market value of its constituents is even smaller than that of the CSI 500.

Secondly, it can better reflect the context of China's economic transformation. This is because when compiling the CSI A500 index, priority is given to selecting securities with the largest free-floating market value in the third-level industry or with a total market value ranking in the top 1% of the sample space as index samples, resulting in a more even market value distribution. It covers 92 of the third-level industries of the CSI, while the Shanghai-Shenzhen 300 mainly prefers large market value and only covers 36 of the third-level industries of the CSI. Compared with the Shanghai-Shenzhen 300, the CSI A500 includes more emerging industries such as power equipment, pharmaceuticals and biology, communications, and computers. These industries are not only important drivers of the transformation of China's economic dynamics but also indicators of the development of new quality productive forces.

At the same time, in terms of profitability and representativeness, the CSI A500 index is also commendable. The constituents of the CSI A500 index account for 10% of the constituent stocks of the CSI comprehensive index and 55% of the free-floating market value, obtaining 63% of the net profit attributable to the parent company. In a sense, investing in the CSI A500 index is equivalent to "packaging" a layout of the core assets with the strongest blood-making ability in the A-share market, which helps investors better grasp the core of the rising trend of the new economic cycle.

In fact, another important point is that in response to the current market environment, the balanced market value distribution of the CSI A500 index just has the corresponding advantages.

Why is the CSI A500 index more adapted to the current market environment?

Because although the CSI A500 index prefers "leading stocks," it does not blindly pursue "large" during the compilation process, but also pays attention to "little giants" in the sub-fields. That is to say, although it is generally biased towards large-cap stocks, it includes both large-cap and small-cap stocks, with a market value range covering from 4.5 billion yuan to 2.3 trillion yuan.

Looking back at history, the A-share market has obvious characteristics of switching between large-cap and small-cap styles, sometimes "sinking market value" and sometimes "beauty in largeness." The alternation of offensive and defensive forms brings a difference in interval returns that can be as high as 190%.

At present, under the new "Nine National Articles," with the return of value investment and the aesthetic of fundamentals, high-quality large-cap leading stocks have regained valuation premiums, and small-cap styles have continued to underperform large-cap styles this year. Considering that inflation and social financing are currently in the recovery process, the new "Nine National Articles" and the reform of central and state-owned enterprises have indeed opened a policy cycle, which is expected to help large-cap stocks continue to be strong.

However, at the same time, China's economy is currently at a critical period of transforming towards innovation-driven and high-quality development. As the top level has set the tone, "to promote Chinese-style modernization, science and technology must take the lead," the small-cap style may still benefit from abundant liquidity and run out of "dark horses" represented by "new quality productive forces," allowing investors' confidence and persistence in the capital market to bear fruit.

History has proven countless times that from a short-term perspective, the market's changes are often unpredictable, and a strategy that bets on a single style is therefore inadequate.In the midst of endless changes, the only constant is "allocation." By adopting a balanced approach to asset allocation between large and small caps, not only can we effectively mitigate the structural risks in the equity market, but we can also better adapt to market changes. If there is a subsequent shift in style, it is hoped that we can quickly adapt and keep up. Therefore, choosing the CSI A500 Index is, to some extent, choosing to embrace a balanced style.

Recently, the market has begun to price in "style rebalancing," and the balanced attributes of the A500 may make it more suitable as a "core index." It could become an important direction for future capital inflows and is expected to become a new benchmark for the A-share market.

Having discussed so much today, the overall message remains the same: it is still crucial to stay engaged at this juncture. The way of investing is such that slow is fast; perhaps the current patience and waiting are the best chips we have.