August 2023
THE CIO’S PERSPECTIVE
Even though the Chinese economy keeps on flashing warning signs, we find reasons to be slightly more optimistic about the coming weeks and months than we were only a month ago.
It is possible that a trough in economic activity was reached. Private enterprises profits have recovered lately. Between January and May, they had dropped by 21% YoY, whereas the drop was reduced to 13.5% YoY between January and June, indicating a strong rebound of profits in the month of June, even though commodities prices rebounded in June which, in theory should have put further downside pressure on margins. The health of the private sector is all the more critical that it is responsible for 80% of employment in urban China, and that the unemployment rate of youths (16-24 years old) reached a new high of 21.3% as we had anticipated last month since 11.6m new graduates just hit the job market.
Exports on the other hand kept on deteriorating: From -7.5% YoY in May, exports dropped by 12.4% YoY in June. Exports to the US were quite shocking, down 23.7% in June YoY, compared to a 18.2% YoY drop in May. Exports to Europe and Southeast Asia also accelerated their drop quite significantly. Interestingly, exports to Russia rose by 90.9% YoY in June as Russia has become the largest exports market for Chinese auto makers, accounting for over half of all vehicle exports.
At a time when being pessimistic about China is the norm, we were surprised that very few commentators wrote about the fact that the GDP growth of China will likely not reach the government target of “approximately 5%” that had been set at the start of the year. Given that the QoQ growth in Q1 and Q2 were both 0.8% and that there is no reason to believe that Q3 growth, on a quarter over quarter basis, should be any higher, there is almost no chance growth this year could be anywhere close to 5%. We anticipate economists to revise their forecasts accordingly in the coming months.
After recording a 0.0% inflation in June, it is still possible that China will avoid deflation in the coming months as oil price rebounded by 14% in July. Any bout of deflation would hurt domestic consumption, especially at a time when the government wants Chinese people to spend more.
Despite this gloomy set of numbers to which we could add some more negative statistics about property sector (sales recorded by the top 100 developers dropped by 33.1% YoY in July, by 33.5% MoM, and by 4.7% over the first seven months of the year), we feel more optimistic about the future. The reasons are related to geopolitics and domestic policy.
The month of July saw the visits in Beijing back-to-back of US Secretary of State Anthony Blinken, US Treasury Secretary Janet Yellen, US Special Presidential Envoy for Climate John Kerry, and former US Secretary of State and “old friend of China” Henry Kissinger. The Biden administration seems to have realised that the degradation of relations between the two countries could lead to disastrous consequences and that it was urgent to stabilise the situation. The fact that Anthony Blinken, during his visit, explicitly stated that the United States does not support Taiwan independence was critical, especially at a time when certain US lawmakers are pushing for the Taiwanese president to declare independency, an act that would almost certainly trigger an armed conflict. Ever since it was signed in 1972, all US presidents, without exception, explicitly confirmed the terms of the Shanghai Communique, co-drafted by Henry Kissinger, that stated that “The United States acknowledges that all Chinese on either side of the Taiwan Strait maintain there is but one China and that Taiwan is a part of China”. Having Anthony Blinken reconfirm that statement reduced tension around the Taiwan Strait. The topic is no longer making headlines.
On the domestic front, a rare joint communique issued by the Central Committee of the Communist Party and the State Council pushed for the development and growth of the private sector. The tone and the words used in this communique highlighted the urgency to tackle the economic damages inflicted on the private sector by two years of regulatory crackdown under the dogmatic principle of “common prosperity”. The animal spirit Chinese entrepreneurs were famous for has taken a hit.
Watching Premier Li Qiang cajoling representatives of Alibaba, Meituan and Douyin (TikTok) and the National Development Reform Commission (NDRC) praising the merits of the platform companies was ironical as the government spent the past three years cracking down on their business models and eradicating their growth prospects. That process resulted in hundreds of thousands of jobs losses, trillions of dollars of market valuation being wiped out, and Alibaba’s founder Jack Ma disappearing for three years. The government is now reaching out to them as it needs them more than ever for the reason that the digital economy is responsible for a quarter of urban employment and for 41% of China’s GDP according to statistics released last April by the State Council. It is going all out to convince the private sector that now is the time to take risks, hire new staff and invest for the future, and the market has started reacting accordingly. Whether badly bruised entrepreneurs will follow such recommendations remains to be seen.
We also heard rumours that the Chinese government was about to tackle the property-related debt problem of Local Government Financial Vehicles that we touched on last month. The central government is apparently working on a plan that will see Beijing bail-out the numerous municipalities that are running out of cash, and issue specific bonds to that purpose. This will inevitably push up the overall debt level of China, at the chagrin of the central government that spent the past ten years trying to stabilize it.
The succession of announcements made in July by so many arms of the government are signs that Beijing has finally woken up to the deteriorating macroeconomic situation. One could also easily detect in these communiques a growing sense of panic.
Another reason why we are gradually turning less negative on Chinese markets is the Fed monetary policy. After another hike in Fed fund rates in July and a greater-than-anticipated drop in US inflation, it is increasingly likely that the ongoing cycle of monetary tightening may soon be reaching its peak. Any stabilization of US interest rates, let alone cuts in interest rates if a US recession was on the card, would provide tailwind for emerging markets in general, and China in particular.
In the meantime, the Indian economy’s outlook remains robust. We saw GDP growth accelerate from 4.4% in Q4 2022 to 6.1% in Q1 2023 and reach 7.2% for the fiscal year 2022/23 that ended in March. India’s growth is back to its pre-Covid trend and ranks among the highest in the world. With general elections scheduled in April-May 2024 and Narendra Modi running for the third time, we should expect a surge in public sector spending, including infrastructures. We can also anticipate interest rates in India to start coming down as inflation is abating, and more populist measures in favour of consumption be taken to ensure that Modi’s party, the BJP, obtains a majority of seats at the Lok Sabha, the lower house of the parliament. The stability of the rupee is another comforting factor. It is directly related to a surge of foreign reserves as India is paying more and more of the oil it buys from overseas in rupees. Foreign investors like the story and invested $13.5bn in Indian equities in Q2 2023.
We remain bullish about the Indian economy as we see more and more companies setting foot there, especially after Modi announced $10bn of subsidies for foreign semiconductor companies deciding to invest in India.
WORDS FROM THE MANAGER
Source : Bloomberg, JKC – August 2023
Chinese markets are the focus point of managers this summer as the government is facing a confidence crisis among the population. The trauma caused by three years of zero-Covid policy combined with a high and ever-rising unemployment rate among the younger generation, alongside the dislocation of the property sector and a lacklustre stock market are the reasons why Chinese people are extremely prudent with their personal savings and not inclined to spend. There is a prevailing feeling that the traditional playbook that consists in publishing official statements to boost confidence and push consumption is not working anymore. The leadership seems to have finally realised how urgent it is to take actions, but it also seems clueless as to what to do.
Nevertheless, high beta equities were still very reactive to the succession of statements issued by different arms of the Chinese government over the month.
The script is now familiar: A communique is published each time a closed-door meeting takes place among policy makers in which is stated that there is a need to boost entire sectors of the economy. But no concrete action follows through. These announcements create a sense of optimism for a day or two before disappointment kicks in and markets come back to down.
This sense of urgency for action with no concrete action being taken still managed to turn July into a good month, with China leading the way. The MSCI China index gained 9.3%, pulled by the e-commerce heavyweights Alibaba, Meituan, JD.com et Pinduoduo which each gained between 20% and 30%, while the CSI 300 index that tracks Chinese A shares gained 4.5%.
Outside of China, all Asian markets gained in July. They were largely fuelled by a sharp drop in the US dollar in the first half of the month as inflation in the United States surprised investors on the downside. Indonesia that is always very sensitive to US dollar movements because of the large amounts of foreign-denominated debt issued by local corporates saw its main Jakarta Composite Index gain 4%. The high-flying Indian market also did well, the Nifty index gaining 2.9%.
Our strategy over the past few months has been to challenge the high conviction we had for certain names which, which in some instances, led us to exit certain names. We also re-assessed the risk profile of the portfolios and reduced the Value at Risk (VaR).
CHINA PORTFOLIO
La Francaise JKC China Equity saw its NAV per share rise by 5.0% in July when the MSCI China index rose by 9.3%.
Year-to-date, the fund is down by 5.2% while the MSCI China index is up by 2.7%.
The cash position of the fund stood at 6.9% at the end of the month.
The best contributors in July were mining-related stocks Zijin Mining (which extracts gold and copper) and recently-bought Sany Heavy Equipment International that specializes in the production of automated mining equipment. The two companies gained respectively 16.7% and 20.7%. CICC, the investment bank cum broker gained 27% after the politburo issued a statement stating that it wanted to restore entrepreneurs’ confidence. The same announcement also made an impact on consumer-related companies Li Ning and Shenzhou that gained 12% and 10% respectively even though there was no follow-up action plan, as discussed above.
At the other end of the spectrum, car parts makers Tuopu and Sanhua gave back some of the good performance they had in June and corrected 7% and 6.5% respectively. We exited Meidong Auto, the car dealer in June as we lost our conviction about the likelihood of a rebound of luxury car sales in the near future.
ASIA PORTFOLIO
La Francaise JKC Asia Equity saw its NAV per share rise by 2.5% in July when the MSCI Asia ex-Japan rose by 5.7%.
Year-to-date, the fund is down by 2.1% while the MSCI Asia ex. Japan index is up by 7.6%.
The cash position of the fund stood at 6.5% at the end of the month.
The technology sector remains very volatile with Samsung Electronics and TSMC dropping by 3.3% and 2% respectively after Samsung announced that its operating profit had dropped by 96% YoY in the second quarter. The large inventory situation that prevails in the memory chips industry is now expected to be sustained in the second half, with a possible improvement towards the end of the year, two quarters later than initially thought.
Other than our investee Taiwanese company Chroma that has exposure to artificial intelligence and which gained 12% as a result, other technology names did not perform particularly well in July. For instance, the Korean company Hansol Chemical that provides H2O2 gas to memory chip makers Samsung and SK Hynix dropped by 15.5%. The same happened to passive component maker Silergy as the rebound of the industry is now pushed back to 2024. We just need to be patient and wait for the ongoing destocking across the overall chip industry to run its course before order books start expanding again. As always, Samsung Electronics and TSMC will be the bellwether of the entire industry.
OUR ESG ENDEAVOURS THIS MONTH
In early July, the IFRS Foundation’s International Sustainability Standards Board (ISSB) announced that it will take over responsibility for monitoring the progress of companies’ climate-related disclosures from the Task Force on Climate-related Financial Disclosures (TCFD). This marks a milestone in the ongoing consolidation of sustainability reporting standards/regulations, following the publication of ISSB’s global standards for sustainability and climate reporting in June.
The Chinese Ministry of Ecology and Environment launched a public consultation on a set of rules regulating the development and trading of voluntary carbon credits, signalling a long-anticipated relaunch of the China Certified Emissions Reduction (CCER) scheme. Initially launched in 2012, the scheme was suspended in 2017 but has always been regarded as one of the three important pillars to decarbonize the country’s power sector, alongside the China ETS (Emission Trading Scheme) and the ongoing market liberalization reform. The revitalization would allow power generators to have more flexibility when fulfilling their carbon reduction obligation. It will also enable green project developers to further monetize their assets by turning emission reductions into tradable carbon credits.
Following suit with other market regulators, the Securities and Exchange Board of India (SEBI) also announced a set of disclosure & investment rules for ESG funds. The new requirements cover the names funds can adopt, the use of external rating providers, monthly/annual disclosure and proxy voting. Under the new investment rules, ESG funds in India will be required to have at least 80% of their assets invested in securities aligned with their specific strategies (Exclusion, Integration, Best-in-class & Positive Screening, Impact investing, etc.) and asset managers will be required to provide monthly ESG scores for their holdings.
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