Market Review
The broader MSCI AC Asia Pacific ex-Japan index declined by -3.3% in Euros during the first quarter of the year.
This has been a very volatile quarter, particularly in Hong Kong. Southeast Asia was the only exception, up around 4% in the first quarter. The Hang Seng finished the quarter down -3.8% and the Hang Seng China Enterprise Index was down -6.5%. From 14th to 15th of March, the Hang Seng declined by more than 10%. Markets had not seen this level of volatility since the 2008 Global Financial Crisis. Not even China’s renminbi depreciation event of 2015 came close. As of April 2022 Hong Kong is the worst performing major market in the world over the past 12 months, worse even than Russia.
The escalation of the Russia-Ukraine conflict has also hit Asian equities, even though Asian GDP growth is forecasted to again be higher than US and Eurozone growth for 2022, and importantly, Russia represents less than a percent of regional trade or investment, with Vietnam and India the only (minor) exceptions.
Globally equity and bond markets are experiencing an unusual simultaneous drawdown, with the typical 60/40 portfolio down for the quarter for the first time in many years. The global tightening of commodities markets is indirectly affecting input costs. Federal Reserve hike expectations have dramatically increased since the beginning of the year in turn.
Other than the global cycle, the evolution of regional consumer inflation indices, and in China, Covid lockdowns, further policy easing and property sales are the key items to watch.
Performance Review
The fund was positioned to benefit from policy relaxation in China. The year started strong with a relaxation of mortgage rates and loan-to-value ratios, and an overall easing of lending standards intended to support the property market. However, this has not been enough to support share prices as discussed above.
Meaningful positive contributions came from our Indonesian positions, among them Media Nusantara, the dominant Indonesian media player who reported strong earnings, and Bukalapak.com, the first of the tech unicorns to list in Jakarta, who both saw their shares re-rate. Other strong contributors were the state-owned enterprises China Railway and China Resources Land.
The fund was negatively affected by each of the following shares: China Suntien Green, a renewable energy developer, reported results in line with consensus but investors marked the shares down as unfavorable weather is expected to impact 2022 earnings for its wind farms. China Education Group (CEG) was an innocent victim of a further tightening of regulations of for-profit education providers. A curious and disappointing aspect here is that while policy has been aggressively targeting K-12 operators, CEG focusses on vocational courses and higher education, which are a clear policy priority. It does appear the baby has been thrown out with the bathwater by investors. Halyk Savings Bank was hit by the January demonstrations in Kazakhstan and the devaluation of the Tenge, and while both of these issues have since moderated, the shares remain down. Sunny Optical shares have sold down sharply year-to-date on expectations of a weaker smartphone cycle, and in sympathy with a broader decline in technology stocks.
Outlook and Strategy
China’s simultaneous slowdowns, Zero-Covid and the deflating of the property developers, remain the dominant drivers across Asia. The key question is not if, but when government stimulus, both fiscal and monetary, will lift growth. Liquidity is building up in the system after the one trillion renminbi reserve transfer from the PBOC to the Ministry of Finance and relaxation of lending standards across the board.
The long-term expectation and ambition for China’s economic growth had been to be more balanced, and with consumption as more dominant driver, compared to historic investment-led growth. “Common Prosperity” is a major plank in Xi’s policy platform, recognizing that investment-led growth had led to rising inequality and an urban-rural divide. Policymakers have been trying supply-side reforms to steer the economy away from investment-led growth, with the reigning in of the property sector through the “three red lines” one of the key examples.
While Beijing still is following a long-term goal of a rebalancing growth, and Xi’s guidance that “property is for living, not speculation”, immediate policy has shifted to damage control following what they see as an overshoot in their attempt to reign in the property market. Restrictions are being eased every day across cities in China. During April, Quzhou became the first city of size to cancel all Home Purchase Restrictions both for buyers and sellers returning the situation to where it was in 2018.
The Chinese government declared a 5.5% GDP growth target for 2022, which was above expectations. But at the same time activity proxies such as those produced by Capital Economics suggest lower actual growth, actual growth will be lower. Stimulus and liquidity can only effectively leverage the economy if activity is allowed to return, which will happen once Zero Covid is relaxed.
Outside of China, even the laggards like the Philippines are firmly reopening, and Asia ex-China is broadly going through a similar reopening experience as the West, with a shift in spending categories. Death rates in Asia generally remain very low, and vaccination rates keep rising.
The implications of war in Russia-Ukraine combined with unprecedented sanctions have upended several forecasts, especially on inflation. Raw material price increases are creating winners and losers, and Indonesia (and to a lesser extent Malaysia) could be the stand-out winners since they are not exporters of food and energy. Russia and Ukraine combined are around 30% of global seaborne wheat trade. China is an importer of soybeans but is otherwise nearly self-sufficient in grains and fertilizer. With the exception of the Philippines and Singapore, Southeast Asia is net long food, i.e. the key concern of food price inflation should be managed well. We all remember the Arab Spring started off with escalating prices of tomatoes and onions in Egypt. As an aside, the Middle East was historically getting most of its wheat directly from the Ukraine, and is now looking to plug the gap, and curiously India, who had a bumper wheat harvest, is stepping in.
Major thematic portfolio exposures remain aligned to the “China easing” theme, primarily cyclical shares in, including a small allocation to stronger Chinese property developers viewed as winners from this crisis. Regionally healthcare and financial inclusion remain an important theme.
Florian Weidinger, Santa Lucia Asset Management Pte Ltd