November 2023
THE CIO’S PERSPECTIVE
The events that occurred this month in Israel shocked the world. The sudden realisation that a military conflict could spread once again across the Middle East pressurised financial markets as a sudden spike of energy prices would immediately hit corporate profits. An oil embargo against Israel or disruptions of oil supply from Iran and Saudi Arabia would have a significant impact on equity markets. Oil price gained 8% in the days that followed the attack by Hamas, before retreating.
The other major event that shook financial markets was the continuing rise of US Treasury Bonds. The 10-year T Bond rose from 4.57% at the start of the month to 4.93% at the end of it, at some point hitting 5%, its highest level since June 2007. This was the consequence of strong economic data published in the United States which increased the likelihood of seeing the Fed hiking rates further in the coming months. Despite the spike in US Treasury yields, the US dollar remained remarkably stable in October. However, this stability did not deter Indonesia and the Philippines from raising their policy rates in October to 6% and 6.5% respectively. The move in Indonesia was more surprising since inflation dropped to 2.3% in September, at the bottom of the Central bank’s 2-4% target range.
This global context saw equity markets in the red across the world. In Asia, Korea, Thailand and the Philippines were hit the hardest (-7.6%, -6.1%, -5.5% for the month, respectively) and Malaysia the least (+1.3%). For once China was not an outlier, the MSCI China and the CSI300 indices having dropped by “only” 4.4% and 3.2% respectively. The reason was that macroeconomic numbers published in October confirmed that the Chinese economy was on the recovery path, albeit a slow one. GDP growth in Q3 was 4.9%, a significantly higher reading than the 4.5% average market expectation collated by Bloomberg. Quarterly growth accelerated from +0.5% in Q2 to + 1.3% in Q3. Retail sales growth accelerated from +4.6% YoY in August to +5.5% YoY in September, also a significantly higher reading than the Bloomberg consensus of +4.9%. Unfortunately, PMI numbers published at the end of the month were a stark reminder that China’s economic problems are far from being over. The official manufacturing PMI and the Caixin PMI dropped by 0.7 and 1.1 points respectively to reach both 49.5, an indication that China had moved back to economic contraction.
The government seems to have realised that it needed to be more proactive to start 2024 on a proper footing. It decided to raise the fiscal deficit target it set at the start of the year from 3% to 3.8% of GDP through the issue of an additional RMB1 trillion of government debt. This move raised eyebrows as it is extremely rare to see Chinese official targets being adjusted in the middle of the year. The money will be used to invest in flood-control infrastructures that are certainly needed given the disastrous floods that took place last summer in the Northern part of the country.
Another major decision was made in October by the Chinese government when it allowed provincial and municipal governments to issue domestic bonds to refinance Local Government Financing Vehicles that are coming due. A first batch of bonds totalling RMB410 billion (USD56bn) were issued between 16th and 18th October by nine different provinces. As these new bonds had maturities ranging from 3 to 30 years and were bought by state-owned banks, this is in effect the start of a state bail-out of the entire LGFV sector which is estimated to have RMB40 trillion of debt outstanding (33% of the Chinese GDP) and which is facing a wall of repayments. Refinancing of this mountain of off-balance sheet debt had become a critical issue as local government revenues are suffering from a steep drop in proceeds from land sales. This LGFV debt overhang was a major uncertainty for bond investors, including foreign investors as a sizeable portion of that debt is denominated in USD. With this fresh injection of cash, local municipalities have called 33 outstanding bonds in October, up from 25 in September and 19 in August.
This decision to nationalise LGFV debt came a few weeks after China reformed the property sector by ditching all house purchase restrictions, a powerful measure that so far has not convinced many Chinese to buy properties, even though the first data points that followed the announcement were promising. Inertia among a deeply shaken Chinese population has proven to be difficult to combat, hence the acceleration of piecemeal stimulation measures.
PMIs are also dropping in India, admittedly from a much higher base than in China. The Indian economy is still in a fast expansion mode, but this expansion is slowing down. The manufacturing PMI of India dropped to 55.5 in October, down from 57.5 in September and 58.6 in August. The service PMI also dropped from 61.0 in September to 58.4 in October. This slowdown should entice the Reserve Bank of India to no longer hike interest rates.
We will end this section by discussing the rebound we are finally seeing in the smartphone sector. We saw some very encouraging signals coming from TSMC, the largest microprocessor foundry in the world that has a bird eye view over the global electronic sector. Alongside its Q3 numbers, TSMC provided sectorial breakdowns. Sales of chips to the smartphone industry rebounded strongly in Q3, up 33% QoQ as TSMC’s clients replenished their inventories. TSMC is also the sole supplier of Apple’s 3-nanometre A17 Pro chip that sits at the heart of the new iPhone 15 smartphone. Transsion, the Chinese mobile phone maker that dominates Africa and some parts of South Asia with its Itel, Tecno and Infinix brands grew its sales by 39% YoY in Q3. Huawei, the Chinese smartphone maker that saw its development curtailed by the American government, also recorded a 37% YoY growth in sales in its smartphone division. The trough seems to be finally over for the industry, and that’s excellent news for the entire supply chain.
WORDS FROM THE MANAGER
Source : Bloomberg, JKC – November 2023
Asian markets continued to decline in October, the third ‘down’ month in a row. In addition to macro events discussed above, third quarter earnings reports published by companies in China, Korea, Taiwan, India and Indonesia were the key share price swing factors.
Specifically, thanks to a marginal recovery in China’s economic growth in the third quarter, the net profit of A-share listed companies went up by 1.2% YoY in 3Q23, according to CICC, with profits of non-financials A-share companies rising by 4.7% YoY, a sign of a slow recovery. Earnings growth of most sectors picked up when compared to the first half of 2023. Upstream cyclical sectors saw profits rebounding notably when earnings of midstream manufacturing sectors diverged. Alternative energy-related sectors reported slow earnings growth, and sectors along the real estate value chain remained weak. By contrast, the auto sector maintained rapid earnings growth. The recovery in the travel industry chain also continued. Over the first three quarters, net profit of all A-shares companies, financial companies and non-financial companies were respectively down by 2.3%, up by 1.0%, and down by 4.8% YoY. In other words, financial companies did much better so far this year than non-financial ones.
As at early November, companies in Korea that reported their Q3 numbers have shown a 13% decline YoY in net profit but a 33% growth QoQ, according to Goldman Sachs. In the past nine months, the net profit of these companies was down 41% YoY, reflecting the impact on earnings of weaknesses throughout the technology sector. Similarly, companies in Taiwan that reported their Q3 numbers saw a 24% decline YoY in profit and a 21% improvement QoQ. Over the past nine months, the same Taiwanese companies saw a 28% decline YoY in profits.
In India and Indonesia, the numbers look much better. Approximately 100 companies in these markets reported their Q3 results, and growth was inspiring: +30% YoY on average in India and +10% YoY in Indonesia, although sequentially, 3Q was weaker than 2Q. Over the first nine months of the year, Indian and Indonesian companies grew their profit by 24% and 9% YoY respectively.
Unfortunately, our holdings reported weaker-than-expected results, leading to drastic share price movements amid jittery investment sentiment. We believe some of them remain good holdings, and the difficulties they are facing are temporary. That would be the case of Sany Heavy Equipment International, Sinbon Electronics, Rianlon Corp, and Chroma. We took action to exit some other names where weak results exposed management mistakes or industry woes, e.g. Li Ning, Amoy Diagnostic, Aavas Financiers and Sido Muncul.
CHINA PORTFOLIO
La Francaise JKC China Equity saw its NAV per share drop by 7.2% in October when the MSCI China index dropped by 4.4%.
Year-to-date, the fund is down by 21.7% while the MSCI China index is down by 12.9%.
The cash position of the fund stood at 9.6% at the end of the month.
The biggest performance dragger was Li Ning, which dropped by 27% after reporting weak Q3 operational results and revising downwards its full-year guidance. Even though we believe the market overreacted to the news, we are disappointed by the reasons behind the results that reflected management’s poor handling of channel inventories. Sany Heavy Equipment International dropped by 17% during the month on weaker-than-expected results, as did Amoy Diagnostics. For the latter, what concerned us was the impact of the latest anti-corruption campaign on hospitals’ purchases which is hurting the entire healthcare supply chain. We decided to exit Li Ning and Amoy Diagnostics as a result.
On the positive side, the fact that we do not own Baidu helped us. The resilient performance of Shenzhou (+2.4%) and Zijin Mining (+1.6%) also helped. In terms of trades, in addition to the three exits mentioned above, we also exited Heifei Meiya because of the impact of the latest anti-corruption campaign within the hospital sector. We added to JCHX Mining, Tencent and Fuyao Glass Industry.
ASIA PORTFOLIO
La Francaise JKC Asia Equity saw its NAV per share drop by 7.1% in October when the MSCI Asia ex-Japan dropped by 3.9%.
Year-to-date, the fund is down by 17.3% while the MSCI Asia ex. Japan index is down by 6.2%.
The cash position of the fund stood at 7.6% at the end of the month.
The Taiwanese testing equipment Chroma ATE Inc. hurt the performance the most as it dropped by 21.4% amid disappointing results and fading interest for companies exposed to the growth of artificial intelligence (Chroma supplies the equipment that tests the AI chips made by TSMC for Nvidia). The company will see sequential earnings improvement in 4Q. Sany Heavy Equipment International was the second main performance dragger. The stock corrected by 17% in October, even though on a year-to-date basis it is still up by 20%. The weaker-than-expected results prompted some investors to take profit aggressively. On the positive side, hospital chain Medikaloka Hermina in Indonesia reported excellent results, and its share price gained 13% during the month. Similarly, Taiwan’s Poya International’s Q3 numbers exceeded expectations. The stock rose by 2.7% in October, reversing an earlier decline.
Regarding trades, we exited Sido Muncul, Li Ning, Amoy Diagnostics and Aavas Financiers. We also added two new names: Fuyao Glass Industry in China and Rainbow Children’s Medicare in India. We increased our exposure to Shenzhou International and trimmed Chroma, Sinbon and Sany Heavy Equipment International ahead of the post earnings sell-off. We also re-initiated a position in TSMC to reduce the fund’s tracking error.
OUR ESG ENDEAVOURS THIS MONTH
On the ESG front, some setbacks were seen as a group of more than 40 lawmakers in the European Parliament filed a motion calling for the rejection of the recently passed European Sustainability Reporting Standards (ESRS). This motion argues that the current ESRS “introduces a high administrative burden for companies due to the high complexity of sustainability reporting standards,” and aims to replace it with simpler, less burdensome, and less expansive sustainability disclosure rules for companies. Subsequently, the European Commission announced a proposal to delay key aspects of its Corporate Sustainable Reporting Directive (CSRD) by two years, including the adoption of requirements for companies to provide sector-specific sustainability disclosures as well as sustainability reports for companies based outside the European Union.
In other parts of the world, significant developments are unfolding. Following the release of sustainability disclosure standards by the International Sustainability Standards Board (ISSB) under the IFRS Foundation, in October Brazil mandated that public companies commence annual sustainability and climate-related disclosures beginning in 2026. The Australian Accounting Standards Board (AASB) also introduced a draft requiring companies to report climate-related information based on the same standards as those set by the ISSB.
Back to our turf, following the revival of trading in China Certified Emission Reduction (CCER), the Ministry of Ecology and Environment (MEE) announced the first batch of CCER methodologies, including afforestation carbon sinks, solar-thermal generation, offshore wind generation and mangrove restoration projects. In October, the MEE initiated another round of reporting and verification of greenhouse gas emissions for high-polluting industries, including petrochemicals, chemicals and construction materials. It is believed that the emissions accounting for these high-polluting industries will lay the groundwork for expanding the coverage of the Chinese carbon market. Notably, the cement, electrolytic aluminium, and steel industries are anticipated to be among the first to be included in this expanded coverage.
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