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November 2022

THE CIO’S PERSPECTIVE

Just a few days after we wrote about investors showing signs of capitulation about China, the Chinese government stepped in with a list of 20 measures that paved the way for a relaxation of the zero-Covid policy that remains, by far, the biggest issue it is facing.

Alongside a flurry of decisions made to boost the property sector, these relaxation measures triggered a very powerful rally. The MSCI China Index rebounded by 28.9% in November. Seeing Xi Jinping shaking hands and speaking with other leaders without wearing a mask at the G20 summit in Bali was a powerful signal sent to the Chinese audience that Covid was not as deadly as widely perceived. But reopening the borders of China and accepting to live with the virus won’t be easy to accept for many Chinese.

The number of cases rose across the country to unprecedented levels (40,000+ per day). Containment measures remain in force, but they are far less restrictive than they used to be, and they certainly are in sharp contrast to the hard lockdown experienced by Shanghai last April and May.

In short, the leadership has given numerous signs over the past four weeks that it wants to exit its zero-Covid policy, but it won’t be easy, the main stumbling blocks being the mindset of millions of Chinese citizens who still believe Covid must be eradicated at all costs, the specificities of the medical system and the limited effectiveness of Chinese vaccines. It is worth highlighting once again that the vaccination rate remains worryingly low: 31.6% of those aged more than 60 years old are either not vaccinated at all, or with only one or two shots and no booster. It adds up to 84 million people. Meanwhile the number of Intensive Care Units beds in Chinese hospitals stands at 4 beds for 100,000 people, to be compared with 34 in the United States, 30 in Germany, 12 in France and Italy, 11 in Korea and 2.5 in India.

It will also be difficult for the Chinese leadership to publicly admit that the policies that had been so successful in the first two years of the pandemic have failed when the successive variants of Omicron hit the country. Politically, the idea that millions may die represents a real risk. Nevertheless, we believe the direction is set, and there is no way back. The Chinese government seems to have finally accepted that “living with Covid” is the only way forward, even though it has not admitted it yet. Financial markets have taken note of it, as could be seen from the spectacular performance of Chinese equity markets in November.

In the meantime, and as mentioned above, the government has announced new measures to help the property sector, and most notably the setting up of special credit lines to the tone of RMB1,275bn between six state-owned banks and several property developers. We have also seen for the first time private property developers issuing domestic bonds guaranteed by government agencies. The Required Reserve Ratio (RRR) of banks was cut by 25bps, releasing RMB500bn into the economy to provide the banks with the liquidity they need to that effect. The weighted average RRR now stands at 7.8% of all deposits. This is happening at a time when the slowdown of the Chinese economy is intensifying. The official PMI dropped from 49.2 in October to 48.0 in November, the non-manufacturing PMI from 48.7 to 46.7 and the services PMI from 47.0 to 45.1, a direct consequence of lockdowns. 

The impact of the economic slowdown in China and of the global destocking of electronic gadgets on Korean exports is quite staggering. Korean exports altogether dropped by 16.7% YoY in November, led by a drop of exports to China of 28.3% YoY. Global exports of Korean semiconductors were down by 22.9% YoY. Measures taken by the United States against the exports of US technology to any company in the world that sells advanced chips and equipment to China is also contributing to this sharp drop, alongside the slowdown of Chinese consumption, and more specifically of retail sales that recorded a 0.5% drop YoY and a 3.3% MoM seasonally adjusted drop in October.

India is a clear beneficiary of the global macro situation and of the drop in commodities prices. It has exported a record USD1bn worth of smartphones in September as it is benefiting from Apple suppliers Foxconn and Pegatron moving capacity away from China. Russia has now become India’s largest supplier of crude oil with a 22% market share, taking advantage of discounted prices offered by Moscow. Industrial capacity utilization currently stands at 90% in the auto and textile industry, fueling a new capital expenditure cycle which itself participates greatly to the 16% YoY credit growth seen in the banking system.

A last word about Southeast Asia, and more specifically Thailand that is one of the few countries that should see its GDP growth accelerate in 2023 to reach 4%. With 1.5m visitors in September, tourism numbers were 45% of their pre-Covid levels, still rising month after month. Tourism represented 12% of the Thai GDP pre-Covid, with the largest contingencies of visitors coming from China and Russia. Medical tourism as observed at leading hospital companies Bangkok Dusit Medical Services, Bangkok Chain Hospital and Bumrungrad Hospital are back to their pre-Covid levels.

Over the past weeks we have seen the dollar weaken because of the Fed and many of its governors toning down their perspective for rate hikes next year. The inversion of the US rate curve has accelerated as the likelihood of rate cuts in the US sometime next year has risen. This is positive for Asian markets, as we have seen in November.

WORDS FROM THE MANAGER

Source: Bloomberg, JKC – December 2022

We commented last month on how unusual the October market fall was and that the market had entered an oversold territory with extreme bearishness, reflecting a confidence crisis in the Chinese government’s ability to make the right decisions for the nation.

In November, everything reversed. The Chinese leadership is back on the world stage, meeting other global leaders and emphasizing openness and collaboration. Domestically, China’s self-destructive zero Covid policies finally reached its inflexion point amid numerous zigzags and social uprisings. We have seen city after city announce relaxing measures, allowing people’s lives to return to normal gradually. Economic recovery and confidence in the future can only follow.

For many investors, 2022 was one of the most challenging years. For the first time in decades, many felt speechless trying to explain what was happening in China, ourselves included, at a time when it was already difficult to assess the full repercussions of Russia’s invasion of Ukraine, of unprecedented US-China geopolitical tensions and of the global ripple effect of a fast succession of US Fed rates hikes. The macro and political uncertainties became impossible to underwrite at some point. It was a humbling experience.

The good news is that China has finally pivoted. There is light at the end of the tunnel. The unprecedented rally Chinese markets experienced in November will need to pause, but there is little doubt that things will be moving in a positive direction in the coming months.

Our portfolios underperformed the indices during the powerful beta rally. We traded actively in November to increase weights to beta-sensitive names, but overall, the portfolios’ quality bias is why our funds underperformed this month. It is for the same reason that they outperformed in October. We will likely make more adjustments in the last month of the year. 

CHINA PORTFOLIO

La Francaise JKC China Equity saw its NAV per share rise by 21.2% in November, when the MSCI China index rose by 28.9%. The cash position of the fund stood at 4.1% at the end of the month.
Year-to-date, the fund is down by 30.4%, while the MSCI China Free index is down by 27.3%.

Hefei Meiya, a highly resilient stock that contributed the most last month was the biggest drag this month, even though we slashed the weight on this position by almost 40% since the beginning of the month. Our 4.1% cash also hurt, which in itself is not a big number, but the relative impact on performance was big in a rare month like November when the index went up almost 30%. The third element was Tencent which gained 40.5% in November after falling 53% in the year’s first ten months. The stock had an average 11.8% index weight in November. We exited Tencent a couple of years ago as its days of glory are over, but it remains a prominent position in most of our peers’ portfolios due to its index weight. On the positive side, China Meidong, Yum China and Xinyi Glass were large contributors to the performance.

We did many trades to increase the fund’s exposure to the post-Covid theme: we cut significant weights on resilient names like Hefei Meiya and BOC Aviation and added to higher beta names such as China Meidong, Zijin Mining, Xinyi Glass, CICC, Yili and Li Ning. We exited Naura Tech and Will Semiconductor as the convictions are no longer there.

ASIA PORTFOLIO

La Francaise JKC Asia Equity saw its NAV per share rise by 16.5% in November when the MSCI Asia ex-Japan rose by 18.7%. The cash position of the fund stood at 3.9% at the end of the month.
Year-to date, the fund is down by 24.2% while the MSCI Asia ex-Japan index is down by 21.2%.

Our exposure to Aavas Financiers in India hurt, alongside our lack of exposure to Tencent and our cash weight of 3.9%. On the positive side, CICC, Yum China and Voltronic Power helped the performance. As for trades, we cut resilient names such as Poya International, BOC Aviation, Aavas Financiers, Bank BTPN Syariah Tbk and Hefei Meiya and added some beta rally names, including CICC, Silergy, Zijin Mining and Li Ning.

OUR ESG ENDEAVOURS THIS MONTH

In November, JK Capital became fully compliant with the SFC’s climate-related risks disclosure requirements by publishing ESG & Climate Risk Disclosure. In addition to fulfilling baseline regulatory requirements, we also voluntarily disclosed information that is part of the Enhanced Standards which is mandatory only for larger asset managers (AUM > HK$8 billion).

The Hong Kong Stock Exchange also published a report on ESG Disclosure Analysis, as part of its efforts to assess and improve ESG disclosures made by its issuers. An executive summary of the report will be sent to our portfolio companies as part of our continuing engagement effort to improve ESG disclosure quality.

In late November, the European Union Council announced its approval of the Corporate Sustainability Reporting Directive (CSRD), a major update and expansion to the current EU sustainability reporting framework adopted in 2014. The new regulation will likely impact some of our portfolio companies as it now covers non-EU companies with a net turnover of more than EUR 150 million in the EU and those with subsidiaries in the European Union. 

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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