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February 2024

THE CIO’S PERSPECTIVE

It has been a difficult start of the year in Asia, and more specifically for Chinese equities as investors manifested their impatience in front of the lack of forceful action by a Chinese government confronted to mounting economic challenges. It drove Chinese equities, both onshore and offshore sharply down, once again, with many stop-losses and forced selling triggered by derivative products. One way of assessing the disaffection of foreign investors with Chinese equities is through the premium of A shares over the H shares of dual-listed companies. That premium stands at 55%, its highest since March 2008. Other countries in Asia were flattish during the month, save for the Korean market that gave back all the gains it recorded the previous month despite some good news on the memory chip front.

One key event in January was the Taiwanese presidential election that saw the ruling Democratic Progressive Party (DPP) win a third term, albeit losing the majority it held at the parliament. What made this election noteworthy was the restrain China exercised in the days leading to the vote, despite the clear incentive it had to exert pressure against the DPP through military manoeuvres in the Formosa Strait as it happened many times in the past. Indeed, the anti-China stance of the new president Lai Ching-te and of the DPP is well known. This stance does not extend to a push for independence, however. Despite the ambiguity of the Taiwanese situation as defined by the Shanghai Communique of February 1972 (with both China and the United States accepting that there is only one China), we are convinced that the status-quo will prevail, and that’s the best-case scenario for world peace. Only foreign involvement in what is considered by China as an internal matter could derail that script.

Back to Mainland China, it is getting more and more obvious that the country is now facing deflation. For the fifth time in 40 years, the deflator that is being used to adjust nominal GDP is negative at -0.6%. Real GDP growth in 2023 was 4.6% when nominal GDP growth was 5.2%. The December Consumer Price Index was -0.3%, a third negative print in a row, while the Producer Price Index was -2.6%, the 16th negative print in a row. The impact of deflation can now be seen through all kinds of consumer goods and services. The price of cars for instance dropped by an average 4% last year, while restaurants are feeling the pinch as well. One of our investee companies, Yum China that manages KFC and Pizza Hut in China is facing intense pressure: The fight for market share through price cuts is widespread. Anecdotally it explains why hundreds of thousands of Hongkongers flock into the border city of Shenzhen every weekend to take advantage of goods and services that are materially cheaper than they are in Hong Kong. Deflation in China has given rise to a public debate among economists whether China had become the new Japan, i.e. a country that entered a protracted period of low growth, deflation, and which suffered for thirty years from shrinking consumption and ageing population. Deflation happened twice in China over the past decades, once in 1998 after the Asian financial crisis and once in 2015 when the economic stimulus related to the 2008 global financial crisis led to overcapacities. In both instances, deflation didn’t last long.

On the automotive front, the price war is not only happening in the largest market for electric vehicles (EV). It is happening globally. Car manufacturers see demand for EV cars waning at a time when capacities along the entire supply chain have expanded greatly. It is particularly obvious at the top of the chain with lithium and nickel, two critical components of EV batteries that saw their respective price drop by 80% and 50% since the end of 2022 because of large additions to extracting and refining capacity. Some of our holdings that are exposed to the EV theme were hit badly in January by the recent gloomy outlook provided by Tesla’s CEO. We also noticed the restraint displayed over the past weeks by the CEOs of GM, Volkswagen and Renault when discussing their push into EVs and more specifically into EV batteries.

On the positive side, we were impressed by the Q4 2023 results of ASML, the Dutch semiconductor equipment leader that enjoys a monopoly in critical lithography systems needed to manufacture chips and that had 83% of its sales in Asia in 2023. The order intake for logic chip related equipment went from EUR2.1bn in Q3 to EUR4.8bn in Q4, while the order intake for memory chip related equipment grew from EUR420m in Q3 to a staggering EUR4.3bn in Q4. This was followed by very good results announced for Q4 by Korean company SK Hynix, one of the three memory chips manufacturing giants (alongside Samsung and Micron). It was also followed by another set of positive guidance by TSMC, the largest logic-chip manufacturer based in Taiwan. The turnaround of the memory chip industry is in full swing, finally, and it will have positive repercussions along its entire supply chain, including for the Korean industrial gas and testing equipment producers we are exposed to (Hansol, Leeno).

It would not be possible to end this section without discussing the implications of the liquidation order made by a Hong Kong judge against China Evergrande Group. Evergrande was the largest property developer of China, and for that matter of the world. As readers certainly remember, it went bankrupt two years ago under a USD 300bn debt load with creditors left in limbo since then. Without any serious restructuring plan put forward by the management, the judge lost patience. Evergrande will be the first test of an agreement reached between the Chinese and the Hong Kong governments that came in force at the end of January whereby court decisions made in one jurisdiction can be recognised in the other in the case of civil and commercial court cases. Admittedly bankruptcy and liquidation cases are excluded from the reciprocity agreement, so it will be easy for Chinese courts to brush off the Hong Kong court order if this is indeed their intention.

Nevertheless, it will be interesting to see if the liquidator appointed in the extremely high-profile case of Evergrande’s liquidation order will be allowed to seize assets in mainland China, or alternatively if it will be prevented from doing so. In other words, for the first time we will see how Chinese courts treat foreign creditors and a liquidation order issued by a Hong Kong court. The investability of China as a country is at stake, with repercussions for years to come.

WORDS FROM THE MANAGER

                                                                                                      Source : Bloomberg, JKC – February 2024

When the year started, no one had much illusion about 2024 being a great year for Chinese equities following the tough lessons learned in 2023. However, another 10.5% drop for the MSCI China in a matter of a month still blew us away, especially after three consecutive years of decline. The overall sentiment and level of confidence hit historical lows in many ways. In January, the Chinese authorities made some comments in which they tried to restore confidence and give a positive impulse to the market. What is often nicknamed the “national team” (which consists of state funds and leading state-owned insurance companies) did support the markets temporarily, but it typically did not last longer than one day of trading. Investors have lost their trust in the once highly regarded capable government which used to deliver what it wanted and meant what it said when it came to economic growth policies. Any government announcement that is meant to reassure investors is now systematically met with doubts, if not outright cynicism. Like many, we believe the market correction of the past three years was excessive, but we struggle to predict what would bring an end to the negative sentiment spiral.

Korean equities also did poorly with the Korean constituents of the MSCI Asia ex Japan index dropping by 9.8% before rebounding slightly towards the end of the month. Local brokers have been arguing that a third of the voting population that owns Korean equities matters to politicians. With the upcoming general election in April, we have seen various equity market supportive measures being discussed or announced. A ban on short selling was announced at the end of last year. More recently, a possible lifting of capital gain tax thresholds for retail investors was discussed. Regulators also asked companies trading below 1x book value to identify ways to boost that ratio. The president of Korea also ‘suggested’ a policy revision aimed at modifying the highly punitive inheritance tax structure. With all these populist measures, we continue to believe Korean equities should see good support this year, especially at a time when its semiconductor industry is seeing a recovery.

India was the only major market that kept on generating positive returns, driven as it is by an overall bullish sentiment as well as positive fundamental news. According to the Ministry of Finance, the economy is likely to grow by more than 7% in the coming years, which would push India from its current position of fifth largest economy in the world to becoming the third one in three years with a GDP of USD 5 trillion. The push is to be driven by domestic demand alongside supply-side measures such as rising investments in infrastructure and measures to boost manufacturing. We are actively working on adding more India names that can take advantage of the structural upside in the Indian economy. 

CHINA PORTFOLIO

La Francaise JKC China Equity saw its NAV per share drop by 11.8% in January when the MSCI China index dropped by 10.5%.

The cash position of the fund stood at 9.0% at the end of the month.

Our holdings Ningbo Tuopu and Sanhua Intelligence that lost 28% and 29%, and Maxscend Microelectronics that lost 35%, were the biggest performance draggers. Tuopu and Sanhua’s biggest client, Tesla, announced disappointing 4Q23 earnings with weak forward guidance. As for Maxscend Microelectronics, it went down with the smartphone sector amid a bleak economic outlook. On the positive side, Fuyao Glass stayed resiliently flat. BOC Aviation also outperformed the market by dropping by only 2%.

Regarding trades, we increased our exposure to Alibaba after its founder and main partner started to buy back shares. The valuation of Alibaba currently stands at a jaw-dropping PE multiple of 7.7x earnings only and a P/Book multiple of 1.2x. We increased our exposure to Yili and reduced the one we have in Fuyao Glass to reduce concentration risks. We also added large Chinese banks to benefit from the large cap rally driven by the ‘national team’. We exited Ningbo Tuopu and trimmed some Yum China as we anticipate a weak set of results.

ASIA PORTFOLIO

La Francaise JKC Asia Equity saw its NAV per share dropped by 8.1% in January when the MSCI Asia ex-Japan index dropped by 5.5%.

The cash position of the fund stood at 8.1 % at the end of the month.

Same as what we saw with our China fund, our holdings Ningbo Tuopu that lost 28% and Maxscend Microelectronics that slumped 35% were the biggest performance draggers. On the positive side, Bajaj Auto went up strongly (+13%) followed by Rainbow Hospitals (+2.3%), both companies being from India.

Regarding trades, we lowered the weight of Fuyao Glass in China and added exposure to Sinbon Electronics and Chroma ATE in Taiwan. We added Tencent and Alibaba to hedge the index exposure. We trimmed Medikaloka Hermina due to some management changes that left us puzzled. We also initiated two names in India, Titan Company Ltd, the leading jewelry retailer, and PVR Inox Ltd, the leading movie theater chain. Both companies are poised to benefit from India’s consumption growth story and from the fast emergence of a middle class that had been missing until recently.

OUR ESG ENDEAVOURS THIS MONTH

The month of January witnessed significant developments in biodiversity policies and regulations. The Ministry of Ecology and Environment of China unveiled the “Biodiversity Conservation Strategy and Action Plan (2023-2030)” aimed at advancing initiatives within the “Kunming-Montreal Global Biodiversity Framework”. By outlining specific priorities and actions, the Action Plan is poised to offer guidance for biodiversity measures at both regional and sectoral levels in China, potentially expediting the implementation of relevant financial products.

Simultaneously, GRI (Global Reporting Initiative) introduced the “GRI 101: Biodiversity 2024” reporting guide, representing a substantial update to existing disclosure standards. It places a greater emphasis on supply chain impacts and highlights reporting on significant impacts.

In another significant development, January marked the official relaunch of the Chinese Certified Emission Reduction (CCER) trading scheme, which had been on pause since 2017. This provides an alternative avenue for companies voluntarily reducing emissions to engage in carbon trading and enhance their green income, complementing the existing Emission Trading Scheme.

However, there were also retractions as the European Parliament endorsed a two-year delay in developing sustainability reporting requirements for specific sectors and non-EU companies. This decision extends the timeline for sector-specific disclosure requirements until mid-2026, particularly impacting companies in emission-intensive sectors like oil and gas, coal and quarrying, power production, and energy utilities. Extending the timeline for companies based outside the European Union will also likely be a discouragement, negatively impacting the sustainability progress of non-EU companies.

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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