Market Review
The benchmark MSCI AC Asia Pacific ex-Japan declined severely -20.1% during the first quarter of the year. We had observed an improving macroeconomic data picture across Asia in January, and if it wasn’t for Covid-19, we would be looking at very different performance data now. In fact, many companies reported a constructive Q4 and early January operating data.
We are seeing indiscriminate selling across asset classes, not only equities. Asian credit markets are pricing high yield bonds at a significant risk premium to developed market peers of the same rating class. Around half of the issuer universe is represented by Chinese property developers.
Curiously, within Asian equities, China – the likely origin and epicentre of Covid-19 – was a surprise outperformer due to the strong domestic support for A-shares on the Shanghai and Shenzhen exchanges, and through the southbound connect into the Hang Seng’s market segment of China mainland companies.
Performance Review
While we are disappointed to see negative absolute performance, the fund once more demonstrated resilience in down-markets, and shows good outperformance year-to-date in 2020, for the current financial year since June, and since the new investment manager was appointed around three years ago. For what it’s worth, performance is also substantially stronger relative to the German DAX Index.
Backward-looking earnings estimates have become somewhat meaningless. Even though many companies reported strong earnings, their share prices declined due to the uncertain outlook associated with Covid-19. For example, Dream International, a Hong Kong-listed toy manufacturer, announced a more than 40% rise in its 2019 earnings, and yet the stock is down -16% year-to-date, trading at 4x earnings.
It is important to understand that it’s not the virus itself that is hurting the economy, it is global governments’ and business’ containment policy (to protect human life, social cohesion and health care system capacity) that lead to reduced activity and an unprecedented sudden stop to economic activity, providing a simultaneous supply and demand shock. This is remarkedly different from prior such case studies like SARS.
Outlook and Strategy
China is stabilizing its current account into surplus with tourism shut off and oil down. Last year a c. 3% of GDP positive goods balance was counteracted by a negative -2% from services (tourism including some hidden money flight). With a sudden halt in tourism, presumably for a good part of this year, the current account is currently as high as 2010. This is likely why the Renminbi hasn't sold off heavily, and Chinese bonds have been a counterintuitive safe high interest haven. Dry bulk shippers are telling us their China business is doing well right now, suggesting a significant inventory build-up in e.g. steel as construction in China remains low, while industrial plants run at full capacity again. This inventory build-up could clear soon however, as property companies have opened their sales offices again and volumes have already gone back to around 70% of prior year sales in March. We are hearing similar levels for most other activity indices in China, and social media accounts show significant improvements in daily life.
Thailand is Asia’s most obvious Covid-19 victim given its dependence on tourism (11% of GDP direct and more than 20% incl. indirect effects). Chinese tourists stopped coming in January, and Western tourists in February, and even healthcare stocks provide no refuge given the reliance on medical tourism even in that sector. We expect however that infrastructure-related themes are safe as this is an easy lever for the government to get cash to the masses/day labourers.
Indonesia is under severe pressure due to the Rupiah currency depreciation (-15% within 3 weeks). We have been weeding out dollar borrowers out of the portfolio. However, there are signs the worst is behind the Rupiah. Last week, the central bank Bank Indonesia (BI) signed a US$60 billion repo facility with the US Federal Reserve to boost dollar liquidity, and BI has signed bilateral agreements with other trading partners worth a comparable amount. The Republic of Indonesia managed to sell Asia’s first ever 50-year US Dollar bond, at a yield of only 4.5%. This illustrates how US monetary policy does positively spill-over into emerging markets.
Covid-19 is spreading across Asia, albeit at least for the moment at a slower rate than is the case for Europe or the US. However, outside of Korea/Singapore/Taiwan, this may have more to do with the low levels of testing and the actual number of infected are relatively high. Indonesia is slowly emerging as a hotspot in infections. Developed countries have committed around >10% of GDP in fiscal stimulus compared to most Asian economies at around 1-5% of GDP (with Singapore and Malaysia the big >10% of GDP exceptions).
Asia is in relatively good shape in macroeconomic terms. Most countries’ external financing position is strong, with rising foreign exchange reserves and stable current accounts. On average, countries have been running a 3% fiscal deficit, and the pandemic-related fiscal expansion on top is around 2-3% (with the exception of Malaysia and Singapore). Those are defendable figures with 5-10% of nominal GDP growth. Developed countries have committed around >10% of GDP in fiscal stimulus and will see much worse deterioration in their finances. Lower oil prices should broadly be positive for the region. Foreign direct investment (FDI), worth around 4% of GDP for many countries, and remittances worth up to 10% of GDP for most of Southeast Asia, act as a further buffer.
At some point Covid-19 will be history, but there are already signs what its long-lasting legacy will be. In the West, quantitative easing, yield curve control, modern monetary theory (MMT), maybe even universal basic income and euro-bonds. For Asia, the future of the globalization and the global supply chain is the key question. Outside of select geostrategic considerations (e.g. self-reliance in certain pharmaceutical goods), supply chains will primarily shorten and diversify, according to a survey of more than 3,000 companies by BofA. Just as was the case with the trade war, the long-term case for Southeast Asia remains intact in such a scenario. Supply diversification will also necessitate regional intensification i.e. instead of combining a China and Vietnam component, manufacturers will deepen their Vietnam cluster to a full chain to create more redundancy in the system, alongside China. Existing and attractive FDI hubs will thus benefit from this intensification, and this will counterintuitively also mean a continued strong China presence. Vietnam, Thailand, and Malaysia should do well out of this. More marginal hubs (e.g. Laos) may lose out to reshoring to the US (incl. probably Mexico). All in, we would expect to see excess capacity build up in global manufacturing, as just-in-time gives way for some intended slack. Returns on capital across the world would fall.
Over the past two decades, global investors have become accustomed to the S&P500 ETF being the consensus long investment, and indeed the outperformance has been tremendous. It is well known that through share buybacks corporates were by far the biggest source of demand (about $500bn p.a.) for equities in the US, driving up share prices while flattering price-to-earnings-per-share valuations. This driver will be materially absent in the near term, opening the window for other parts of the world to shine.
Florian Weidinger, Hansabay