Market Review
The benchmark MSCI AC Asia Pacific ex-Japan rose +2.8% in Euros during the second quarter of the year, and have now recorded a rise of +10.3% year-to-date. June was a more challenging month, following stronger start to the year.
The US dollar index has strengthened markedly since the middle of June, an indication that capital is flowing back to the US again. Holding US-dollars has become preferable given the country’s vaccine availability, economic strength, and monetary policy flexibility. US equity and bond markets appreciated in June. In particular, the NASDAQ outperformed, and it appears bond yields have peaked at the end of March, despite rising inflation data in the US. The flow of capital back to the US in turn pressured emerging markets as their currencies depreciated and equity markets corrected.
So far, emerging markets have underperformed developed markets. For the year Southeast Asian markets have risen by only a few percentage points. Market proxies for China usually show more performance divergence but year-to-date, domestic A shares, Hong Kong-listed H shares, as well as the MSCI China (incl. US ADR listings) have all returned only 3-5% within a narrow band.
Performance Review
This second quarter marks the third consecutive quarter of outperformance followed by our below expectations Q3 last year which affected the rolling one-year comparison. The fund has also outperformed its benchmark calendar year-to-date with +15.2%.
So far, winners this year were the long-term thematic investments in education (e.g., China Education), healthcare (e.g., Siloam) across the region, sustainable business (e.g. Suntien Green) and the long-term theme of investments tracking the emergence of private wealth management in China. Detractors from performance were the Thai equities in the portfolio, and some residual exposures to the China internet ecosystem.
For future relative performance it will be interesting to see how the entire China technology (and Asian technology) sector shares will perform going forward given on the one hand the strong passive flow into these names and China’s increasing drive to contain the dominance of tech platforms on the other hand.
Outlook and Strategy
President Xi’s speech marking the 100-year anniversary of the Communist Party of China was full of assertive rhetoric, and while it clearly was primarily meant for his domestic audience on a momentous occasion, it was indicative of the continued polarization of Chinese-Western relationships, which appears reflected in global opinion polls of both ordinary citizens and even business leaders.
In early 2021, it seemed a safe bet that Xi would be cautious to avoid economic or market turmoil during this anniversary. Those expecting accelerating reforms from hereon with some short-term pain for long-term gain, for example more bankruptcies in indebted state-owned enterprises and developers, will however likely be disappointed. There’s always another political event to plan for. Next year will be the Party Plenum at which Xi is hoping to be confirmed to an unprecedented third term as party leader. He likely wouldn’t want to rock the boat leading up to that, and so China is likely to offer not a “Fed put” but a “Xi put”.
Last week’s RRR cut was an important moment, as it was the first departure of a strategy of all-around controlled tightening so far this year. The PBOC had earlier announced targets to cap 2021 bank lending at 2020 levels and continued to operate quantitative controls to reduce lending, e.g. in property lending using the famous “Three Red Lines”. Curtailment measures have been so effective for the first half year, that we could expect a sequential pick-up in the second-half.
The inflation picture remains moderate, and if anything, analysts expect interest rate cuts rather than rises for China. However, the PPI (producer prices) and CPI (consumer prices) index spread is at a record high of almost 8%, i.e. inflation at the factory gate for manufactured goods and raw materials is running dramatically ahead of consumer prices. At the start of the year, this spread was negative by over 5%, so this is a major swing. This is partially a consequence of rising commodity prices. Crucially, at current levels, manufacturing companies should be particularly profitable in China this year, given wage growth has not been forthcoming. We may only see this evident in financial results published this August cycle.
We currently expect this PPI-CPI spread to be reversed not by wage rises but by a moderation in producer prices, in particular as China’s record exports normalize as the Western world re-opens and spending shifts to services. Most activity indicators suggest a recovery in retail traffic and sales, and China’s growth should also therefore shift from investment & export-led to investment & consumption-led.
The threshold for herd immunity from a combination of vaccination and prior infection is generally estimated to be in the range of 60-90% of the population. According to a comprehensive Bloomberg analysis, using existing vaccination levels combined with current vaccination run rates, China, Europe and Singapore are expected to hit the 75% fully vaccinated level by the end of the third quarter. Outside of Singapore, Southeast Asian countries are currently only forecast to match these levels next year. Slower vaccination pathways with partially less effective vaccines mean that normalization is further out in ex-China Asia, unless one accepts that immunity from past infections is very high. On balance, the earnings recovery anticipated for this year may be delayed to next year, particularly in the case of Indonesia. However, divergence across countries and sectors should allow the active investor to exploit opportunities in single stocks.
Florian Weidinger, Hansabay