In this briefing:
China News That Matters
- Beijing to the rescue, with cost cuts
- Racing for a vaccine, not international flights
- Countdown starts for Hong Kong crackdown
- US plans sanctions on China
- Skirmishes in the Himalayas
In my weekly digest China News That Matters, I will give you selected summaries, sourced from a variety of local Chinese-language and international news outlets, and highlight why I think the news is significant. These posts are meant to neither be bullish nor bearish, but help you separate the signal from the noise.
There has been a recent continuing controversy about the usefulness of forward P/E as a valuation tool in the current recessionary environment. On one hand, past bear markets have typically bottomed out at a forward P/E ratio of 10, with a low of 7 (1982) and a high of 14 (2002). FactSet’s reported market rating of 21.5 forward earnings is very stretched by historical standards.
We go back to the basics of equity valuation by considering the following questions:
- How will this crisis affect the company in the near term (2020)?
- How will this crisis affect the business the company is operating in, and its standing, in the long term?
- How will the crisis affect the price of risk, including the likelihood of default, equity risk premium and default spreads?
The current operating environment is dismal, and there is little hope of relief over the next few years. Credit conditions are deteriorating. Unless some miracle medical advance appears in the immediate future, we are likely to see widespread business failures over the next 12 months that will cripple the economy and, in Jerome Powell’s words, “make the recovery slower and weaker”. The Fed is doing what it can to put a cap on risk premiums. It can print liquidity, but it cannot print sales, nor can it print equity for failing firms.
One (Fed support) out of three isn’t good enough. Current valuation is discounting a V-shaped recovery and strong Fed support. It has not even begun to discount the aftershocks of the COVID-19 crisis. Equity risk and reward is tilted to the downside.
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