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

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

We should rationally recognize that the fluctuations in A-shares are primarily driven by trading factors. Since April of last year, the Shanghai Composite Index has not undergone significant adjustments, soaring from 3,300 points to nearly 4,200 points. The combination of profit-taking, crowded trading in overvalued sectors, and factors such as margin trading and automatic stop-losses in quantitative trading have all contributed to the heightened market volatility.

From a fundamental perspective regarding A-shares, the current valuations are at historical lows, with dividend yields far exceeding risk-free rates. Share buybacks and dividend payout ratios are both on the rise, while hundreds of trillions in fixed deposits are seeking alternative yields. Global capital is also searching for safer havens, and China is viewed as the world’s “cornerstone of certainty” and “harbor of stability.” As the renminbi slowly appreciates, A-shares will inevitably become a destination for global risk-averse funds.

Furthermore, investments need not be held hostage by the anxiety surrounding the Strait of Hormuz. Currently, the overall state of crude oil is one of oversupply, with no substantive supply shortages on the horizon. Investors should avoid overreacting to geopolitical conflicts. Notably, during the two oil embargoes of the 1970s, inflation soared while unemployment rose, and interest rates reached double digits, yet Buffett navigated through such a harsh macro environment with a fully invested portfolio.

Buffett stated, “Every ten years or so, dark clouds will cover the economic sky. At that time, a ‘golden rain’ will suddenly descend, and when this happens, you must run out with a bathtub, not a spoon.” For investors, it is this series of challenges that leads to extremely low valuations in the stock market, and these difficulties will eventually become the past. However, the window for buying at such low valuations will not remain open indefinitely.

Panic is the greatest enemy of investment, and investors must maintain their composure. As seasoned investors firmly believe, the sky will not fall. If it does fall, doing anything would be futile; under such circumstances, it is better to take advantage of the low prices to buy stocks.

Four Factors Leading to Increased Volatility

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

First, the 2.6 trillion yuan in margin financing is highly sensitive to market fluctuations, and declines in the stock market force some margin traders to sell, amplifying price movements;

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

Third, some high-valuation stocks in competitive sectors are overcrowded, and once market sentiment shifts, selling can happen very rapidly, driving overall market volatility;

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

However, these are merely disturbances on 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 and sustainable heavy asset companies trading at low valuations, offering long-term stable dividend yields for China’s “hard assets.” Statistics show that as of March 27, the dynamic price-to-earnings ratio of the Shanghai Composite Index was 16.52 times, with a dividend yield of 2.54%; the dynamic price-to-earnings ratio of the dividend index was 8.86 times, with a dividend yield of 4.32%; the dynamic price-to-earnings ratio of the Shanghai 180 Index was 11.92 times, with a dividend yield of 3.27%.

In terms of yield, major asset classes can be compared, and it is evident which is more attractive: the annualized return of the stock market is approximately equal to the dividend yield plus the economic growth rate, currently about 8%; the current yield on ten-year government bonds is 1.8%, and the interest rate on bank deposits is about 2%; the rent-to-sale ratio for properties in first-tier cities is about 2%. However, the annualized return of the stock market is realized over the long term and through volatility.

Assets such as gold and bitcoin have recently shown weak performance, as non-yielding assets are purely speculative; the peak of such assets may coincide with periods of intense conflict. However, “hard assets” with stable dividend yields have inherent value, and during times of severe conflict, stock prices may have already hit their lows, as falling prices can make these already attractive companies even more appealing.

Given the favorable backdrop of a steadily improving Chinese economy, a slowly appreciating renminbi, and ample liquidity, investor anxiety over the Strait of Hormuz may have been overreacted to. Yi Yingnan, a researcher at Renmin University’s Chongyang Institute for Financial Studies, recently wrote that the U.S. strategic dilemma dictates that the war will not escalate long-term, and the overall state of crude oil is one of oversupply. China has diversified its import sources for over a decade, continuously reducing its reliance on any single source.

Cheap is the Hard Truth

The recent conflict between the U.S. and Israel has triggered comparisons to the two oil embargoes of the 1970s. Both oil embargoes indeed caused severe shocks to the global economy at the time, including double-digit inflation, double-digit interest rates, and near double-digit unemployment in the U.S., resulting in stagflation.

However, Buffett held a full stock portfolio during both oil embargoes. Notably, 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 so many stocks that his limited funds forced him to borrow against bonds to increase his capital.

In 1973, he invested a total of $10.62 million to acquire a 9.7% stake in The Washington Post. 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 one of Buffett’s classic successes, later yielding him hundreds of times the return.

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

Nonetheless, going against the tide in a panic-stricken market requires immense courage. The book “Where Are the Customers’ Yachts?” published in 1940 depicted Wall Street during the 1929 crash. At that time, the author observed: “You cannot expect an experienced Wall Street trader to buy stocks when cargo shipments have just dropped below new lows, unemployment has peaked, steel production is less than half of usual, and a big shot confidently tells him that a large midwestern underwriter is in crisis. Unfortunately for everyone, this is the only time stocks are down.”

Over the long term, the market will reward the courage and patience of those who buy against the tide. “How can I buy stocks at extremely low prices?” In his youth, the late global “value investing master” John Templeton asked himself this pivotal question, and his answer was, “Unless someone is eager to sell, no other factor can drive a stock down to an extremely low price.” It was this answer that led him to borrow money to buy $10,000 worth of stocks during the most challenging period of World War II, and after holding for four years, he sold them for three times the profit.