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August 2020

Once again, Chinese equities have performed well during the month of August, the MSCI China having gained 5.6% and the CSI300 that tracks A shares being up 2.6%. Year-to-date, looking across the globe and across asset classes, the best performing equity markets have been the US Nasdaq (up 31.2%) and the Chinese markets (MSCI China up 17.3% and CSI300 up 17.4%) while on the fixed income side, the best markets in the world have been the US investment grade market and the Chinese USD investment grade market (the respective Barclays Bloomberg Indices are up 6.6% and 6.1% since 1st January).

One can legitimately ask why this is the case at a time when the two countries are openly confronting each other and whether this bull market is sustainable. The answer to the first question has remained the same since the end of the first quarter: To a certain extent it is related to the macro picture of China that does not seem to be suffering much (if at all) neither from US tariffs or from the pre-election anti-China rhetoric that currently prevails in the US. But to a much larger extent it is related to liquidity.

Liquidity is akin to water spilled on a wooden floor: It disappears through the widest cracks. These cracks are the most fluid markets that can absorb the immense volumes of cash that keep on being injected every day by the Fed, by the ECB, and by other leading central banks, with the notable exception of China’s PBoC. And the two most fluid markets are those of the US and of China. China’s financial market ranks global second in terms of size and liquidity. Foreign institutional investors and index compilers are finally paying attention. This is the result of efforts made over the years to open up the Chinese financial market to the outside world through the introduction of QFII in 2002, RQFII in 2011, Stock Connect in 2014 and Bond Connect in 2017.

The attraction of China from a global institutional investors’ perspective recently increased as the orthodoxy of PBoC’s monetary policy turned the Chinese RMB into an instrument of savings as the RMB’s interest rates are getting increasingly attractive compared to all other global currencies that offer literally no yield. This has brought stability to the RMB at a time when the USD is weakening as a result of the Fed’s monetary policy. Which takes us to the second and most critical question at this juncture: Is this trend sustainable?

The answer was given last week by Jerome Powell, the Fed’s chairman, at the annual Jackson Hole gathering. “Following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” In other words the Fed is prepared to do whatever is needed to get to a 2% inflation rate, and even exceed that rate, without adapting its monetary policy to slow down the rise. Inflation stood at 1.0% when last published in July 2020. To get from 1% to “moderately above 2%” will need quantitative easing, i.e. money printing, to carry on for an extended period of time – economists are saying three years at least. In other words we have entered a new era where markets are no longer driven by valuation and companies results but by the amount of liquidity printed by central banks, and by the capacity different markets have to absorb such liquidity, i.e. the comparative sizes of the cracks on the wooden floor. And this is happening at the time when China is opening up further its financial markets to foreign investors and when the flow of IPOs is accelerating, first in line being all the Chinese ADRs that the Trump administration is pushing out of the US.

Mr. Powell strategy may or may not work: The Bank of Japan set a similar 2% inflation target back in 2013 and embarked in aggressive quantitative easing alongside a negative interest rates policy that is still very much in place today, but the central bankers never managed to reach their goal: The Japanese inflation was 0.2% in July 2020.

Hence the disconnection between macro / corporate numbers and stock market performance, especially in the US and in China where the cracks on the wooden floor are the widest. After listening to Jerome Powell, we now expect this disconnection to last for quite some time, possibly years.

Chinese markets are also getting a lot of interest from foreign investors as the technology-driven STAR Board market of Shanghai that was launched only last year is already showing up in the global league tables: As at early August, companies had already raised $19.4 billion in 2020, trailing only the New York Stock Exchange’s $29.7 billion worth of IPOs and Nasdaq’s $29.4 billion. By the end of the year it will probably become the biggest IPO market of 2020 as Ant Group will do a joint listing of its shares in Shanghai and in Hong Kong in October. Ant Group is the largest digital payment platform of China. It is controlled by Jack Ma, Alibaba’s founder. Ant Group’s valuation is estimated at USD220bn. The IPO is anticipated to exceed the USD29bn raised by Aramco last December and to become the largest IPO that ever happened globally.

Over the month of August we saw the US administration taking additional coercive measures against Huawei, as well as targeting for the first time Tencent and its WeChat online platform. Once again, the stock market impact was short-lived. And once again the Chinese government refrained from reacting in any way, hoping that Huawei’s inventory of US-made and US-designed chips will allow the company to keep on operating until after the US presidential election when Beijing is anticipated to deal with the matter in a less toxic environment.

Outside of China, we are getting more and more concerned for some parts of South East Asia that remain under strict lockdown. Thailand’s economy is still totally closed to tourism even though Thailand badly needs tourism to prosper. This is despite the fact that it is only having four new cases per day on average and that it has had no death since early June. We are also seeing more and more student-led demonstrations against the ruling military junta, and, interestingly, against the taboo topic of monarchy.  

In the Philippines, the lock-down has led to a national adult jobless ratio of 45.5% across the country, and 43.5% in Metro Manila according to the Social Weather Stations’ national mobile phone survey. There are roughly 4,200 new cases of Coronavirus per day across the country, but interestingly the number of registered deaths in that country for the first half of the year is 10% lower than what it had been on average over the previous five years.

We remain significantly overweight North Asia (China, Taiwan, Korea) and underweight South East Asia (Singapore, India, Malaysia, Thailand, Indonesia and The Philippines) to the tone of +/- 9.2% against the benchmark. This geographical tracking error explains to a significant extent the outperformance of our Asia funds since the start of the year.

CHINA PORTFOLIO

The fund did well in August, outperforming the index by 1.2% despite a high cash level of 11.4% on average. Top attribution contributors were SITC International, Shenzhou International and Li Ning, in that order. The cash position, Times China and Sunny Optical contributed negatively. The driving force of the stellar performance was the strong first-half results. Out of the 26 names held by the fund, more than half reported excellent results and only four were disappointing. By excellent results, we refer to both spectacular numbers reported by companies that are immune or that benefited from the COVID outbreak (e.g. Meituan Dianping, Wuxi Bio and Tencent) as well as the outstanding resilience or the fast recovery of individual businesses despite the pandemic (Li Ning, Shenzhou, Techtronic, CICC & SITC).

During the month, we continued to add to Will Semiconductor, and we took some profit on Heifei Meiya due to valuation concerns. We exited ASM Pacific, Sunny Optical and AIA as our conviction in these names is no longer high. We initiated a position in China International Capital Corporation (CICC). We also inaugurated Jiangsu Hengrui Medicine and Shanghai Henlius Biotech for our Opportunity basket with 1% in each.

China’s pharmaceutical sector has been the underperformer within the high flying healthcare sector year to date. Compared to the service providers as well as the equipment makers which benefited from the COVID outbreak with spiking demand, the drug makers suffered from weak prescription drug sales during COVID as people avoided going to hospitals. The concerns over centralised procurement (CP) program also played a role. CP is an effective way for the government to control the nation’s healthcare spending by negotiating a group purchase price with drug makers and direct the funding toward the most needed drugs. We find the approach sensible, even though it temporarily brings uncertainties to the sector. We continue to like the long term winners in the pharmaceutical industry. As such, we added Jiangsu Hengrui Medicine, the most innovative pharmaceutical company in China in the fields of oncology, surgical drugs, and contrasting agents, and Shanghai Henlius Biotech, a leading biopharmaceutical company with a rich pipeline of biosimilars and bio-innovative drugs.

We also added CICC to the core basket of the fund. CICC is a leading securities firm engaged in investment banking, investment management, brokerage, and other financial services. China Construction Bank and Morgan Stanley initially set up CICC following the western investment bank model. Overtime CICC has developed into a ‘global-local expert’ connecting international clients to Chinese markets. We believe CICC has an edge to benefit the most from the long term industry growth driven by China’s capital market reforms, by the growing attraction of Chinese equities and Chinese bonds in the eyes of international institutional investors and by China’s further opening of its financial sector.

On the interim results front, regional container shipping company SITC released flat first-half revenues with gross and net profit growing by 10% yoy, while it expects the second half volume outlook to be better than the first half. Overall, the results proved to be satisfactory, showing the resilience of SITC’s earnings within a tough operating environment.

Garment maker Shenzhou International announced that its net profit increased by 4% YoY despite sales going down 0.4% YoY, beating consensus. What’s more, the management guided for a brighter outlook for its clients (Puma, Nike, Adidas, Uniqlo) compared to six months ago, which indicates further recovery down the road. Sportwear retailer Li Ning reported recurring net profit growth of 22% for the first half, much better than expected, with sales going down by 1% YoY only. We were happy to learn that the newly hired CEO had laid a solid foundation for the company to move forward in the coming years with an optimised channel mix and product innovation.

ASIA PORTFOLIO

The fund continued to do very well in August in both absolute and relative terms. Top attribution contributors were SITC International, Shenzhou International and Li Ning (all Chinese companies) in that order, while performance laggards were Vitzrocell (from Korea), Sunny Optical and China Resources Beer (both from China). The strong 1H results of the Chinese holdings were the driving force of the stellar performance of the fund. Out of its 28 names, all but four reported either excellent or inline results.

During the month, we increased our exposure to Leeno Industrial and to Yum China, and we took some profit on Hefei Meiya due to valuation concerns. We exited ASM Pacific and Sunny Optical as our conviction in these two names is no longer high. We also initiated a new position in China International Capital Corporation (CICC) which is mentioned in the China section.

CICC reported in August a robust set of first-half numbers. Revenues grew by 40% YoY driven by a strong performance of the investment banking division which posted a 134% growth in top line, alongside a 68% growth in revenues for its equities brokerage business. Profit before tax grew by 57% YoY, and net income increased by 62% YoY.

Power tool manufacturer Techtronic’s first-half revenues grew by 12.8% YoY at a time when its competitors Stanley Black & Decker and Makita had a dismal first half. Its gross margin trajectory continued to improve for the 12th consecutive year to 38%, up 40bps YoY. EBIT was up 15.6% YoY, and net income grew by 16.3% YoY.

In other regions, Hansol Chemical in Korea, our top active bet, posted sales growth of 12% and an operating profit growth of 24% YoY for the second quarter, reflecting a strong demand for its quantum dot and lithium-ion battery binder chemicals.

In Taiwan, the sales growth of Chroma ATE was +14% and operating profit growth was +23% YoY for the second quarter of the year. The company saw a strong demand for its semiconductor-related and photonics products. Still in Taiwan, uninterrupted power supplies and solar inverter manufacturer Voltronic Power Technology reported a set of very robust second quarter results that exceeded by a wide margin the market consensus. The beat mainly came from the margin expansion and the strong growth of its solar invertor business. In Q2 Voltronic’s sales grew by 12% YoY . Its net margin reached its highest point since 3Q15 at 20.5% as its net income for 2Q20 grew by 32% YoY.

The information contained herein is issued by JK Capital Management Limited. To the best of its  knowledge and belief, JK Capital Management Limited considers the information contained herein is accurate as at the date of publication. However, no warranty is given on the accuracy, adequacy or completeness of the information. Neither JK Capital Management Limited, nor its affiliates, directors and employees assumes any liabilities (including any third party liability) in respect of any errors or omissions on this report. Under no circumstances should this information or any part of it be copied, reproduced or redistributed.

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