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Summary
Market update
In China, GDP growth in the 3rd quarter was broadly in-line with expectations. Sources indicate that the primary driving force behind China’s economic growth has shifted towards consumption and away from investment. People’s Bank of China governor Zhou Xiaochuan surprised the market mid-month by informing IMF and World Bank officials that China’s GDP growth is likely to register a 7% in the second half of the year. Whether this transpires remains to be seen but his confidence clearly reflects a high degree of confidence on the part of authorities in the growing spending power amongst Chinese consumers.
Chinese consumption remains strong, underpinned by healthy income growth. Consumption contributed 64.5% of the country’s overall 6.9% GDP growth for 2017. As a share of GDP, consumption has remained above 60% for seven consecutive quarters, strong evidence that the much heralded economic rebalancing is firmly underway. The support from income growth to drive consumption is set to remain robust in 2018, underpinned by an improvement in corporate profitability.
Weak private investment in China remains a concern, but fixed asset investment (FAI) in ‘’new economy “ (technology and e-commerce) continues to grow at a healthy pace. Overall FAI growth slowed to 7.5%, primarily due to headwinds in the manufacturing and mining sectors. Large State Owned Enterprises (SOEs), mainly upstream producers and companies in heavy industry, saw proposed capital expenditure plans frozen or shelved by the imposition of reform policies that encourage company profits to be channelled towards debt repayment. Property also continues to slow amid further tightening risks. National Bureau of Statistics data revealed that home sales fell -1.5% in September from 4% in August, marking the first year-on-year decline since April 2015. Meanwhile, property tightening measures that began several months ago have now expanded to include 99 cities.
Turning to India, October ended with an announcement from the Finance Ministry declaring a recapitalisation of public sector banks, to the tune of US$32bn, crucial to improving access to credit for small and medium enterprises. Coupled with this, the government disclosed the largest ever investment in road infrastructure, with US$120bn to be laid out in the next five years. These efforts show Prime Minister Modi is advancing a pro-growth agenda in the run up to the national elections in 2019. The government is trying to address the ongoing fallout from Non-Performing Loans (NPL) generated since the mid-2000s that have been weighing down India’s financial system, particularly the public sector banks. Weak public sector banks have been unable to properly clean up the NPL mess, which has acted as a brake on the recovery. The infusion should meet nearly 70% of the capital requirements to deal with the NPL issue – enabling these banks to provide capital to key government focus areas of housing and infrastructure.
Fund activity
In China, our proprietary market timing model (MTM), which seeks to evaluate underlying equity market investment conditions, remained steadfast at a reading of +60 throughout the course of October, indicating a bullish return to risk environment. At the country level, our positioning translated to a maximum overweight capital allocation to China, maximum underweight allocation to India which detracted slightly from performance given the strong upside move in Indian equities in the second half of the month. Sector allocation within China reflected significant overweight positions to real estate, materials and energy stocks and significant underweight positions to technology stocks, relative to the MSCI China index. Selective energy, banking and industrials stocks delivered good alpha during the month, whilst consumer and materials stocks detracted from performance.
In India, we sold the entire position of Tata Motors following a bounce back off recent lows. The weak sterling and perceived slowness in the hybrid space have hampered the company in recent quarters, in spite of new releases such as the Jaguar E-Pace and the new Range Rover Velar. We have also cut Lupin, the pharmaceutical company. This has been an underperformer over the year, and the loss of exclusivity of one of its products further weakens the outlook for the stock, and thus the small remaining position was sold. Tech Mahindra, an IT stock was also sold over the month having rebounded off recent support levels. Lower organic growth prospects and greater client risks moving forward, coupled with issues in their telecom segment have resulted in our profit-taking in this holding. Funds raised were allocated to existing holdings, including the recently acquired Dixon Technologies.
Outlook
The Chinese Communist Party Congress had important implications for policy in Xi Jinping’s second five-year term. The adoption of ‘’Xi Jinping Thought’’ as part of the constitution illustrated the leader’s dominance. ‘’Socialist modernisation’’ will focus on state-led upgrading of industry, whilst the power of Communist Party cells in companies will be increased. While foreign investment will still be welcome, it will be expected to serve the national interests of China, bringing technology the country needs for further development.
We allocate capital to what we deem to be the most attractive companies that comprise the MSCI China universe and currently, our model indicators remain bullish and we are positioned accordingly, with overweight allocations to cyclical sectors.
In India, the recapitalisation and the infrastructure investment clearly demonstrate Prime Minister Modi is advancing a pro-growth agenda in the run up to the national elections in 2019. Modi will be seeking to ensure momentum begins building in the upcoming state elections in Gujarat and Himachal Pradesh, thus we can expect further supportive measures to follow. India’s growth path is clearer after this announcement. We have a reformist government that is not afraid to take big decisions and introduce supportive policies to ensure opportunities are captured across sectors. India remains at the forefront of global growth and is capitalising on its opportunity.
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