In China, major activity growth indicators eased from September. Industrial production growth slowed to 6.2% from 6.6% in September, driven by weaker manufacturing growth. Fixed asset investment (FAI) growth softened to 7.3% from 7.5%. The modest acceleration in infrastructure and manufacturing investment growth was outweighed by weaker property FAI growth in October. Nominal retail sales growth edged down to 10.0% from 10.3% in September, while real retail sales growth also declined to 8.6% from 9.3% in September.
Tighter financial conditions and property market measures will likely continue to impose downward pressures on FAI growth in the short term. Additionally, tighter environmental protection measures in northern China have negatively impacted industrial and construction activities. A breakdown of the retail sales figure suggests the moderation was mainly driven by auto and housing-related spending (such as furniture, construction material and home appliances), as the peak of property-related consumption is likely behind us.
Turning to India, mainline Indian indices suffered some profit taking in November. Mid-cap indices continued to outperform, reflecting continued strong domestic participation. Indeed domestic liquidity has been behind a record initial public offering boom year to date. More than US$10bn has been raised so far this year, with the insurance sector representing the bulk of deals. From a macro perspective the latest quarterly GDP data showed a much welcome pickup in growth following disruption from the implementation of GST and the longer term impact from demonetisation. Manufacturing and investment spending were particularly strong. While the recovery was predicted by economists, growth was marginally light compared to expectations due to a slight deceleration in the services sector.
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 November, indicating an environment conducive to positive equity returns going forward. At the country level, our positioning translated to an overweight capital allocation to China, underweight allocation to India. However, from a sector perspective, the Fund was positioned poorly relative to benchmark positive returns.
Information technology and healthcare were the standout performers during November, returning 5.09% and 3.75% respectively, while real estate and materials (two extremely strong performing sectors year-to-date), returned -4.6% and -6.1% respectively. Positioning 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 consumer discretionary, insurance and information technology stocks delivered good outperformance during the month, while materials, industrials and most real estate stocks held detracted from performance.
In the India portfolio we have made a slight change in focus following announcements from the government late last month over public sector bank recapitalisation. We added the first public sector bank for many years, buying the State Bank of India: the best positioned and undisputed leader of the pack. We expect to hear continued news flow from the government to clear the lingering non-performing loan (NPL) issues that public sector banks in particular and corporate banks in general have been suffering. While resolving the NPL problems will undoubtedly take further time, we believe that from a risk/reward perspective having exposure to specific public sector and corporate banks looks compelling.
Looking ahead in China, a slowdown in headline growth is anticipated, especially on the investment front, as the impact of tighter financial conditions starts to emerge. However, with a benign global economic environment and resilient domestic consumption, the overall growth slowdown will likely be modest. Without substantial deceleration in activity growth data, the People’s Bank of China will maintain a monetary tightening bias and continue to implement financial deleveraging.
With that said, Ashburton does not rely on any economic data or forecasting in our decision-making framework to allocate capital and manage risk in China. Our preference in assessing underlying market conditions is to look at the internal dynamics of the equity market itself. As we stand here today, the internals are leaning bullish (a position we have held since 11 January 2017), suggesting healthy equity market returns going forward into 2018. We are positioned accordingly, with a skew towards cyclical sectors.
We are now hopeful that the road to a final clean-up of India’s banks is much clearer. The NPL issue has been a key factor holding back growth over the last few years, albeit not the only one. The recapitalisation is a significant move that cannot be underestimated, and we expect further actions from the government in the months ahead. What is clear however is that we have already seen a pick-up in bank credit growth over the last couple of months. While that is too short a period to extrapolate a trend, we do believe that we are on the cusp of a revival in bank credit growth which should benefit the corporate lenders relatively better than the much higher rated consumer facing banks. For that reason we will be favouring the corporate banks in the period ahead.
One of the most common concerns regarding India amongst foreign investors remain valuation. Although there is no doubt that on current earnings valuation does look somewhat extended, we remain hopeful that the recent earnings season represents the trough for this cycle. With the negative impact from demonetisation and GST now behind us, the low base for both economic growth and earnings leaves plenty of room for surprises. Add the overriding growth objective from the government in the lead up to the election in early 2019 and we remain comfortable with India’s outlook.
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