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Summary
In China, macroeconomic data for June demonstrated remarkable resilience despite the progressively active monetary tightening stance taken by Beijing thus far in 2017. On the fixed asset side, infrastructure investment and residential real estate investment remained robust. Infrastructure rose 17.3% year on year (YOY) in June, while residential real estate increased 10.8% YOY. Most noteworthy was the acceleration witnessed in private sector capital expenditure, which registered 8.3% YOY growth from 6.6% YOY growth in May.
Another theme throughout the past twelve months has been the buoyancy of aggregate consumption trends. In contrast to the alarming trend witnessed in America, retail sales in China accelerated in both nominal and real terms. Nominal retail sales growth registered 11% YOY in June, the highest level since December 2015, while real retail sales growth rose to 10% YOY. Encouragingly, a related continuing healthy trend in wage growth is confirmed in the latest proprietary survey work undertaken by CLSA, who find that wages of unskilled and skilled workers grew by an average of 4.2% and 3.8% YOY respectively in 2Q17, compared with 4.5% and 3.5% YOY in 1Q17. Consequently, China's average per capita disposable income growth accelerated to 8.8% in nominal terms and 7.3% YOY in real terms in 1H17.
In India, the start of July witnessed the implementation of the Goods and Services Tax (GST). This pan-Indian tax will lead to significant changes in the investment landscape for the forthcoming decades. Facilitating better efficiencies across industries promoting domestic investment and more critically, encouraging foreign capital back into the country.
Indian equity markets broke up through significant levels in July, with the 50 stock Nifty Index clearing 10,000 for the first time. Large caps, with a bias away from quality, were the index favourites over the period, which has dampened the performance of the fund on a relative basis. However we remain confident that our philosophy to invest in strong management teams, delivering consistent earnings growth, and in the interest of all shareholders will outperform over the long term.
In China, our proprietary market timing model steadfastly remained at 60 throughout July, indicating a bullish return to risk environment. Accordingly, we maintained an overweight country allocation. The model has now been bullish for 147 consecutive trading days and continues to serve the overall fund strategy well. Sector allocations within China reflected a preference for real estate and consumer discretionary (notably auto) stocks, and underweight positions to technology and financial stocks, relative to the MSCI China. China delivered another respectable month of fund performance, primarily through stock selection. Selective property, IT and auto stocks were the standout positive contributors.
Following positive earnings figures from Ultratech Cement, we took the decision to book profits through top-slicing the position and rotating the funds into the textile manufacturer KPR, which had been added earlier in the year. KPR continues to demonstrate solid performance and has strong execution of its plans following the increase in capacity so far in 2017.
The IPO market has continued to deliver fresh capital to the markets, with domestic investors selectively participating in the new issues, a trend we expect to continue in the coming months.
Outlook
We have previously outlined the risks highlighted by macro and stock market observers in China, namely the cyclical consequence of declining credit growth and potential associated systemic risks rising on account of the squeeze in shadow banking (lending outside of formal banking system channels). Over the past twelve months we have seen a coordinated policy effort from Beijing, the banking system and the relevant regulatory bodies to address these issues. Key measures have included the raising of short-term funding costs and, beginning earlier this year, the implementation of rules requiring strategically important banks to bring more loans back on to the balance sheet. Clearly there is more to be done but the initiatives have been taken positively by the stock market.
Macro developments aside, the proprietary models that govern our investment process in China continue to indicate that the current climate is conducive to positive equity market returns. As the legendary stock operator Jesse Livermore stated, '' In a bull market trade with the bulls. In a bear market trade with the bears.'' Volume, breadth and pricing dynamics are strong. We remain firmly in a bull market until proven otherwise and have allocated capital and risk accordingly. As always, we will pay close attention to our indicators for any signs of change.
Subsequent to the month end, the Reserve Bank of India (RBI) voted to cut interest rates by 25bps, bringing the repo rate to 6%, the lowest level since September 2010. The governor of the RBI was supportive of a small cut at this juncture as they await the impact of GST, the monsoon and the initial results from the latest round of pressure applied to banks to write-down bad debts.
With this mid-summer meeting now complete, expectations are building that the RBI will step up its efforts to open up the credit lending channels, through cleaning out the non-performing loans. Over the next few months there should be positive news on this to coincide with better earnings figures being declared by companies through the summer months.
With regards GST, it will be inherently positive for Indian trade in the years to come and is another stepping stone in Modi’s push to reduce corruption while enhancing tax revenues and the fiscal strength of the country. Although we expect there to be some teething problems in the coming quarter or two as consumers and businesses grapple with the administrative burden of this shift, the positives will far outweigh the negatives.
GDP growth will be lifted as the unorganised players move or are dragged into the formal economy, and India can push forward towards nominal GDP growth rates in the low double digits. India has the potential of attaining similar levels of growth to China in the late nineties and early two-thousands, ably supported by a strong reformist government and a solid central bank.
India’s investment credentials have taken another forward step, of which there remains more to follow, this is just the start.
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