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June 2020

Key takeaways:

The very strong performance of Chinese equity markets in June did not come to us as a total surprise. The measures taken by the Chinese government to prevent any “second wave” of coronavirus from hitting the economy were drastic and, admittedly, efficient. We saw how entire neighbourhoods of Beijing were put in full lock-down in the middle of June when approximately 100 new cases were identified in the vicinity of a food market.

More recently, the Anxin county of Hebei province that is located 150km from Beijing completely locked down its 400,000 residents after only 18 new cases were reported.

The prevailing rule across Asia has been to re-open the local economies without letting people in and out of any country. Borders remain tightly sealed with quarantine procedures being strictly enforced for returning nationals. Even within the small triangle that consists of Hong Kong, Macau and Shenzhen where we are based, there is no sign that borders will reopen anytime soon despite none of these three cities having had new cases for weeks, if not months.

This policy seems to have worked well, judging by the macro numbers, China being at the forefront of the recovery alongside Taiwan and Korea: The official manufacturing PMI of China rose from 50.6 in May to 50.9 in June, beating the Bloomberg consensus of 50.4. The non-manufacturing PMI showed the same trend, up from 53.6 in May to 54.4 in June (Bloomberg consensus was 53.5). The Caixin manufacturing PMI also showed an acceleration in the turnaround in June with a 51.2 reading, up from 50.7 in May (the Bloomberg consensus was 50.5). Industrial production was 4.4% higher in May 2020 than it was in May 2019, industrial profits were 6.0% higher than they were a year ago. Retail sales were still 2.8% lower in May 2020 than they were in May 2019, but it was still a marked improvement from the -7.5% recorded in April. It is widely expected that the June sales numbers will show an increase year-on-year as the pace of recovery is accelerating.

As the macro picture of China is improving, we expect to see a positive spill-over effect on the rest of Asia as trade resumes. China will most likely play once again its role of economic locomotive for the region.

The only country under our coverage that remains worrying is India where the number of new Covid-19 cases keeps on rising day after day, in sharp contrast with all other countries of Asia. Furthermore, military tension in Ladakh, at the border of China and India, left at least 20 soldiers dead earlier this month and opened up a new period of tension between the two countries at the worst possible time. The macro outlook of India is dire with Moody’s now anticipating a -3.1% drop in GDP this calendar year while Crisil, the Indian subsidiary of S&P is anticipating a 25% drop in GDP for the April to June quarter. 

Back to China, the macroeconomic picture is one reason for the outstanding performances of our equity funds this month. The other reason is the injection of liquidity by western Central banks that is finding its way towards emerging markets. According to Bloomberg, foreign investors were net buyers of mainland Chinese “A” shares (listed in Shanghai and Shenzhen) to the tone of USD7.4bn in June.

We believe this flow of liquidity will not stop here as China is actively opening its financial markets to foreign investors – banks and insurance companies can now have their own 100%-controlled operations in China.

As onshore financial markets open up wider, we expect MSCI to increase further its weighting of A shares in its indices. By moving step by step, so far MSCI has only included 20% of what it ultimately wants to include in A shares, thus leaving room for five times more weighting in all its global and emerging markets indices.

The ongoing quantitative easing by the Fed and the ECB is not going to end anytime soon despite being already truly mindboggling: As the Covid-19 keeps on spreading in the West, even more liquidity injection is to be expected. To put numbers in perspective, Gavekal, a macroeconomic research firm, calculated that the current Covid-19 program of government spending by the United States, already adding up to USD3.7 trillion, is equivalent in today’s dollars to almost 4 times the cost of the Vietnam war, 24 times the cost of the entire Apollo space program by NASA and 20 times the cost of the Marshall Plan that rebuilt Europe after World War II.

All this liquidity needs to find a home at a time when interest rates are either negative or close to zero across developed countries. Emerging markets, and especially Chinese markets that run particularly deep, are the logical beneficiaries, together with luxurious properties and collectible items.

Having adopted a prudent fiscal and monetary policy during the Covid-19 outbreak, PBoC kept Chinese interest rates at an attractive level: a 10-year Chinese government bond currently yields 200bps more than its US equivalent and 330bps more than its German equivalent.

Finally, the Hong Kong market saw a strong bout of activity during the month of June with the listing of Netease and JD.com. These two companies acted in a pre-emptive way ahead of the possible forced delisting of their ADRs from the New York Stock Exchange, alongside all other Chinese ADRs that the US Congress wants to see delisted. This is potentially USD1.5 trillion of market value spread over approximately 250 companies that are likely to be transferred from New York to Hong Kong, Shanghai or Shenzhen within the coming two to three years. More on this topic and on the numerous ramifications this decision will have on major indices and trackers can be found here.

CHINA PORTFOLIO

The fund outperformed its benchmark in June. Top attribution contributors were Hefei Meiya, Hangzhou TigerMed (two A shares) and Times China, in that order. What contributed negatively were mainly our cash position and our structural underweight on Tencent that gained 18.4% with a 14.8% benchmark weighting (as all UCITS funds, our fund is capped at 10% by European regulators).

During the month, we added to Li Ning and Xinyi Glass on dips and we trimmed Sunny Optical on weaker outlook convictions. We initiated a position in Meituan Dianping at benchmark weighting for tracking-error management purposes. We also inaugurated Aier Hospital and Hansoh Pharma for our high valuation basket. We are humble enough to understand that specific names and industries with long term visibilities and good management track records can be trading at premium valuations for sustained periods as the valuation discovery process might not be conventional. That said, we are mindful of downside risks on valuations, which is why we do not go beyond 1% weightings in these names until we find a reasonable valuation point. The key principle is that we need to like the business and the management and have a clear visibility over its earnings trend.

We need to explain further why we invested 3% in Meituan Dianping in one go. It is a name we had been following for quite some time, and it is not a typical steady growth company comparable to those we own in our portfolio, quite the opposite. Its growth is exponential, and its service value became more evident than ever during the COVID-related lockdown of China. Founded in 2010, Meituan Dianping is the largest O2O (online to offline) company of China. It is the world’s largest food delivery company as well as the largest hotel booking platform (in terms of hotel room nights). It has partnerships with many supermarket chains for grocery food delivery, among many other services the company provides. With a market capitalisation of USD145bn, Meituan ranks among the largest companies of China, even though it is barely profitable. But in June, MSCI suddenly adjusted Meituan’s weighting in the MSCI China index from 0.9% to 3%, while the Hong Kong stock exchange made it likely that the company would be included in the coming weeks in the Hang Seng Index. All of a sudden Meituan became for us a high tracking-error risk that we needed to hedge, in a way similar to Tencent and Alibaba.

News wise, Hefei Meiya Optoelectronic launched a new product, an intraoral scanner named “MyScan”. The company held an online product launching event in June that triggered a powerful rally for the share price. This new product will significantly help dentists improve their treatment’s efficiency, their accuracy and the patients’ comfort levels. The commercial launch will be in July. The share price of Meiya gained 34% since the start of the year.

ASIA PORTFOLIO

The fund did very well in June, outperforming its index by more than 2%. Top attribution contributors were Hansol Chemical, Hefei Meiya Optoelectronic and Hangzhou TigerMed, in that order. The performance detractors were the fund’s cash position, Muangthai Capital and Li Ning, in that order. During the month, we continued to add to Li Ning Co on dips and we also increased the fund’s exposure to Chroma in Taiwan and Vitzrocell in Korea. We trimmed some SK Hynix, AIA Group, Muangthai Capital and China Merchant Bank. We exited Ping An Group as planned, and we initiated Xinyi Glass and Leeno.

Leeno is a Korean small-cap that our technology and healthcare analyst (who is a Korean native) had been following for almost a decade. The company makes test sockets that fit into IC (integrated circuits) testing machines, as well as the disposable metal pins that fit into these sockets and that test the conductivity of the IC when the IC is positioned in the socket. Leeno has been the global No.1 in testing pins and sockets for more than ten years with a market share of 35-40% in the high-end segment. Clients are the main foundries and IC design houses, i.e. Qualcomm, TSMC, Samsung and Apple among others. We like the core edge of the company, which is the ability to manufacture pins and sockets that are 100% customized to cater for each customer’s needs. ICs tend to have unique designs that make testing more specific, unlike memories (DRAM and NAND) where the form factors are relatively unified. We also like the management’s long track record and the high entry barrier of its business.

Newswise, Xinyi Glass announced a profit warning for the first half of 2020, expecting net profit to decline by 25 to 40% YoY, due to the absence of any one-off gain such as the HK$633.4 million gain in 1H 2019 related to the disposal of Xinyi Solar shares. The decrease in demand and the average selling price of float glass, together with the approximate 5% depreciation of the Chinese yuan also contributed to the drop in profit. It is worth highlighting that China float glass price has rebounded by 15% since its end-of-April trough, which is why we initiated this name. We have been following this name literally for more than a decade, and we own it in all our China portfolios. We like the management’s long-term track record and we believe it could be a good portfolio stabilizer with steady growth over time.

 

The information and material provided herein do not in any case represent advice, offer, sollicitation or recommendation to invest in specific investments. 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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