NESTOR China - Quarterly Report 2/2020

Nestor China is up +5.6% during Q2, lagging recovering China markets

Market Review
The benchmark MSCI China rose +12.2% during the second quarter of the year, more than making up prior losses as of the March lows.
As we enter the second half of 2020, Mr. Market has for now decided that the severe headwinds to the global economy posed by Covid-19 and – maybe more important: the economy – are outweighed by fiscal policy (supporting corporate earnings and households in the short-run) and most of all monetary expansion across the globe.  

China’s outstanding performance in managing Covid-19 is doubted by the naysayers, but well confirmed by sources on the ground such as hospitals.  With China back at work faster than the rest of the world, it is not surprising to China outperforming other global markets.  Further below we comment on how constructive optimism has now resulted in a retail-driven speculative dynamic.

Performance Review
After Nestor outperformed very strongly throughout the market downturn, the fund was too conservatively positioned into the upturn, which was both stronger and faster than anticipated.  As a result, while performance was positive for the quarter, the relative performance was below the benchmark for the quarter, but remains ahead year-to-date.  

The e-commerce and online entertainment themes have contributed well with Pinduoduo and Bili Bili, and there were few detractors, primarily in infrastructure.  The relative underperformance was mainly the result of positioning, and the fact that the fund is unable to participate in the “A-share” market (the fund participates in the Hong Kong “H-share” market or overseas listings).

Outlook and Strategy
Somewhat away from global attention, the domestic equity market in China (“A shares” in Shanghai) has been on a tear this July.  A more than 10% rally was triggered by a government-approved editorial in the China Securities Journal suggesting to the average retail investor that it is safe to buy stocks, with an imaginary central government put.  Trading volumes and margin lending have risen significantly, inviting comparisons to 2015 when a similar market dynamic imploded, resulting in the first major devaluation of the Yuan.  This trading frenzy is also seeping over into Hong Kong.  

For now, there is room for speculative fever to run further since both margin lending and price levels remain at around half their April 2015 peaks.  It is notable that most margin lending activity has occurred in Shenzen rather than more institutional Shanghai.

The Chinese economy continues to stabilize and has been dubbed the “90% economy” as so many measures of activity have returned to around that level in proportion to their pre-Covid state, for examples night lights at industrial parks.  Fixed asset investment in real estate and infrastructure are supporting the current cycle it appears from the data.  While steel and cement output are strong, the inventory build-up question remains unanswered, i.e. to what extent is high utilization and output in basic manufacturing on borrowed time as real demand remains below prior levels.  Crude oil could be at risk on account of this dynamic.  In a positive sign, copper inventories remain significantly below past year.  

Florian Weidinger, Hansabay