October 2019

October was an exceptionally good month for Asian equities with China offshore shares and Taiwanese shares leading the region and Thailand being the only market going down during the month. Investors are looking forward to China and the United States approving what the White House has called the “Phase 1” of a trade agreement. This agreement will most likely not be earth shattering as it will cover the purchase by China of agricultural produce in return for the (permanent?) postponement of a 5% tariff increase applicable to USD250 billion of goods that was initially scheduled for 15th October, maybe even of more of the tariffs in place. It may also cover the protection of intellectual property and transfer of technology provisions that are low-hanging fruits that China can easily give away.

As China and the United States are both showing signs of a slowdown, both countries have indicated their respective willingness to find an agreement. Our view is that the second phase of a trade agreement will follow thereafter and will relate to the most important batch of exports from China to the United States, namely the USD160bn of exports that relate to electronic goods (including all smartphones) and that are scheduled to be taxed at 15% on 15th December. This batch of tariffs, if implemented, would likely prove to be particularly painful for US consumers right at the time when the election campaign heats up. Donald Trump is most likely torn between playing hard ball with China and take the risk of damaging the US economy while satisfying the Congress, or “do a deal” with China and prolong the strength of the US economy at the risk of losing the support of the most radical fringe of his electorate and of the Republican Party. Our guess is that he will go for “a deal” with China, and the last batch of tariffs will never see the light of day. Under such a scenario, markets would be expected to enjoy a powerful relief rally.

The second reason for the strong performance of Chinese equities in October was the weakness of the US dollar. Indeed the dollar index that measures the value of the dollar against a trade-weighted basket of other currencies lost 2.0% during the month. As our readers know, there is a long-lasting negative correlation between the US dollar index and the MSCI Emerging Markets index (the correlation coefficient has been -0.89 over the past three years). Any sustainable reversal of the strength that the US dollar has had over the past two years would be a powerful booster for Chinese equities. The reason why the dollar has been weak in October is not necessarily related to the cut in interest rates that everyone had been expecting, but more likely to the renewal of quantitative easing (“QE”) that the Federal Reserve announced on 11th October. Indeed, Jerome Powell, the Fed’s chairman, announced a new expansion of the Fed’s balance sheet through the monthly purchase of $60bn of Treasury bills (which is three times larger than what the European Central Bank is currently doing in terms of QE). This is very similar to what the Fed did ten years ago in reaction to the global financial crisis, which resulted in the US dollar index losing 16% in nine months and the MSCI China gaining 85% over the same period. Connecting these dots together made us turn bullish for the coming months.

On the Chinese macro indicators side, the PMIs that were announced for October showed a strong divergence. The official manufacturing PMI dropped significantly from 49.8 in September to 49.3 this month while the non-manufacturing PMI also declined from 53.7 to 52.8, the only bright spot being the activity of the construction sector that picked up. On that matter, it is worth highlighting that one of the sectors foreign investors “love to hate”, namely the Chinese property sector has been doing well in 2019 despite all the headwinds China has had to face this year.


By contrast, the Caixin manufacturing PMI that often tends to be a better indicator of the Chinese economy’s trend showed a rebound, rising from 51.4 in September to 51.7 in October. The reason why it tends to be a better indicator is because it mainly covers the private sector that makes up today more than 60% of China’s GDP formation and that is the main engine of the country’s growth.

The GDP growth of China for the third quarter was +6.0%, down from +6.2% in the second quarter. This slowdown was well anticipated and is just one data point along a long-lasting trend of GDP slowdown that will certainly not stop there. Indeed, it is widely accepted that the GDP growth of China in 2020 will be sub-6%. It has also been made very clear to the market that the Chinese government and its Central bank are not prepared to stimulate the economy through monetary policy as long as the pace of growth slowdown does not steepen.

Indonesia’s president, Joko Widodo, during his second term’s inauguration speech, vowed to kick-start sweeping reforms, pledging to overhaul the nation’s labour law by the end of the year and to open up more sectors of the economy to foreign investors. He also said he wanted Indonesia’s GDP to reach USD 7tr by 2045 – or more than five times the 2018 GDP. The priority for him is to avoid the middle-income trap, the same message he conveyed during his campaign. Jokowi, as he is known locally, also surprised everyone by naming his two-time challenger Prabowo Subianto Minister of Defense. This was a bold move that will hopefully help reunite the country after the elections sparked deep division and deadly protests. Jokowi’s announcements started a wave of optimism in the market as many anticipated growth measures and infrastructure projects to follow. Whether it will happen and the “coalition” government will work remains to be seen. 

In the Philippines, the central bank surprised investors with a 100bps cut in RRR (“Required Reserve Ratio”) in October, effective in the first week of December. This will bring down the country’s RRR to 14%, or a 400 bps reduction YTD. The Philippines still has one of the highest RRRs in Asia, leaving room for further cutting. Two good pieces of news on the macro front is that gross international reserves rose to an all-time high of US$86.2bn and that the Filipino peso has already appreciated by 3.2% against the USD this year and will likely carry on strengthening. 

The Reserve Bank of India (RBI) announced its fifth rate cut last week, slashing the repo rate by 25bps to 5.15%. The rate cuts since February 2019 aggregated to 135bps driving the repo rates to its lowest since March 2010. RBI also trimmed its economic growth forecast for fiscal year 2020 from 6.9% to 6.1% highlighting the economy’s sagging momentum. On the other hand, inflation risks seem to be looming with oil price uncertainty and a rise in food prices due to extreme monsoon rains. Amidst low repo rates and brewing inflationary pressures, the Indian central bank’s ammunition to flex monetary policy appears limited if economic growth continues to disappoint. 

ASIA PORTFOLIO
Top performers this month were Vitzrocell Co Ltd (+29%), Hansol Chemical (+18%), and China Jinmao (+17%). At the other end of the spectrum, the weakest performers were Indusind Bank Ltd (-5.1%), Ace Hardware (-4.5%) and PVR (-3.4%). During the month, we increased the weighting in ASM Pacific Technology Ltd and Hansol Chemical. We added three new names, Ace Hardware (in Indonesia), Hefei Meiya Optoelectronic (in China) and SK Hynix (in Korea) while we exited LG Chemical (in Korea) and Jiangsu Yanghe Brewery (in China). 


During the month, portfolio companies overall reported good third-quarter results. Hangzhou TigerMed had quarterly revenues increasing by 23.5% YoY and profit increasing by 77.3% YoY. China Jinmao released its September sales data which showed an 83.0% increase YoY and a 26.5% YoY increase for the first nine months of the year. Inner Mongolia Yili managed to grow revenue by 10.4% YoY and net profit by 15.6% during the quarter. The gross margin of the company also increased by 0.2 percentage points to 36% due to an improved product mix, which is particularly positive. What we did not like were the Jiangsu Yanghe results. For 3Q19, the sales of the company declined by 20.6% YoY, and net profit dropped by 23.1% YoY, disappointing yet again. We no longer have the same high conviction on the name given the weak growth driven by a wrong product pricing strategy, hence our decision to exit the name. 


Outside China, Bank Tabungan Pensiunan Nasional Syariah in Indonesia reported another strong set of results with loans growth in the third quarter having reached 26% YoY, pre-provision operating profits growth being 25% YoY and net income growth being 27% YoY. During the month, we got increasingly cautious on the global electric vehicle sector and were disappointed by LG Chemical’s multiple factory fire incidents and ever-delayed EV battery profit outlook, which led us to sell the position.

 

CHINA PORTFOLIO
Our sole property developer in our portfolio, China Jinmao was up 16.5% this month as the company announced having recorded an 83.0% YoY increase in contracted sales in September, taking its growth over the past nine months to +26.5% YoY. Another strong performer this month was Li Ning, the sportswear retailer that is going through a spectacular turnaround of its business. Li Ning’s share price gained 18.4% in October. Our two favorite healthcare companies Hanghzhou Tigermed (an A share listed in Shenzhen) and 3S Bio (listed in Hong Kong) also did very well in October, having gained 10.1% and 12.8% respectively.

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