Summary

• Global equity markets witnessed a heightening of volatility and negative stock market returns as the macro outlook appeared to worsen, despite the micro economic factors turning incrementally more positive.


• The key development from China was the unexpected Party Congress meeting held in Beijing during the final week of the month which included the announcement by state media that the Party wants to abolish term limits for the State President and Vice President.


• Our China market model seeks to provide timely buy and sell signals, on balance, through cycles. With the return of volatility and accompanying choppy markets, the model has been busier than usual.We received a fresh ‘sell’ signal in the early part of February leading to an allocation shift to move the China country allocation to a modest underweight position.


• The Indian GDP data for the quarter ended December 2017 surprised on the upside, with a reading of 7.2%, ahead of consensus and the full year has also been estimated to be better than forecast. 

Market update

Amid a resurgence of rising volatility and negative global stock market returns during February, the key development from China was the unexpected 3^rd Plenum of the 19^th Party Congress held in Beijing during the final week of February. The most newsworthy event was the announcement by state media that the Chinese Communist Party (CCP) wants to abolish the term limits for the State President and Vice President, confirming rumours in Beijing over the past twelve months that Xi’s term in power would be extended beyond the usual 10 year term. From a short to medium term investment perspective, clarity over the direction of strategic policy is now clear, although many observers may point to the return of ‘Great Leader politics’ as a long-term negative outcome.

Meanwhile, an announcment was also made by the China Insurance Regulatory Commision on 23 February that with immediate effect, it is taking over the management of Anbang, the notorious Chinese insurer on account of aggressive overseas acquitions. This latest move reflects the growing efforts of Xi to restore the legitimacy of the CCP in the eyes of the population via the anti-corruption campaign, now five years old and immense in terms of scale and reach. The campaign’s tentacles have extended into the area of financial services more recently, accompanied by an intensifying crackdown on shadow banking (lending outside of the formal banking channels). A positive interpretation from the latest Anbang development is that authorities are seeking to control the domestic fallout, while Anbang’s numerous foreign assets will be put up for sale. An interim management has been appointed for a year until the process of finding suitable shareholder(s) is completed.

The Indian equity markets trended lower during the month, giving back most of the gains accrued in January.  In addition to more widespread caution in the markets, the Union Budget announced at the outset of February undoubtedly contributed to the correction. 

Midcaps reacted more negatively to begin with, before showing greater stability into the month end, with the large cap indices underperforming the mid and small caps by the close of the month.  The Public Sector Banks were once again in the spotlight for an increase in provisioning and issues around corporate governance, with a notable fraud uncovered at Punjab National Bank (PNB), following which the Reserve Bank of India stepped up the provisioning requirements and further tightened governance regulations.

By the close of the month the latest Gross Domestic Product (GDP) figures were announced, and surprised on the upside, with GDP expanding to 7.2%, the strongest figures since demonetisation in late 2016.  Earnings for the quarter began well and despite a drop off towards the conclusion of the reporting season, earnings had grown by just over 13%, which was short of the full year expectations of 17-18%.  However, since 2014 we have seen earnings expectations in the 16-18% range, yet those have been cut quarter on quarter to very low single digits.  This is the first time in five years where the expected earnings figure will be in the mid-teens, which is particularly encouraging looking forwards.

Fund activity

China

Our China market model seeks to provide timely buy and sell signals, on balance, through cycles. With the return of volatility and accompanying choppy markets, the model has been busier than usual.  We received a fresh ‘sell’ signal in the early part of February leading to an allocation shift to move the China country allocation to a modest underweight position. Whipsaw signals - a condition in which the market’s price heads in one direction, but is quickly followed by a movement in the opposite direction - can be frustrating and are a drawback to systematic investing. Nevertheless, they must be accepted as part and parcel of following a rules-based approach that instils clarity, objectivity and discipline to our investment process. The high tracking error reflects genuine active fund management in our quest for outperformance.

In line with our mandate flexibility and tolerance, a protection strategy in the form of HSCEI (Hang Seng China Enterprises Index) put options and VIX (Volatility Index) call options has been implemented. The objective is to dampen short-term volatility and/or the prospect of further downside returns in a manner which is cost-effective and can provide value to our clients. We are also holding c.6% cash which we anticipate deploying into stocks at more attractive levels.

India

A quiet month on the Fund for Indian stock trades, we introduced Interglobe Aviation (IndiGo) which is India’s dominant low-cost airline.  Structural growth stories in India are trading at heady valuations, and while there are many critics of airline stocks, we can find few opportunities in India where we see massive structural growth - upside in air transportation due to very low penetration - trading at reasonable valuations.  We remain underweight to India at this point given both the short-term negative macro market sentiment and weak technical picture.

Outlook

For China, the latest developments underpin the long-term strategic objective of rebalancing the economy via promotion of consumption over investment. The principal outcome behind Beijing’s decision to wade into the often opaque world of financial services should be a significant improvement in the allocation of credit and resources, though clearly a delicate balancing act will need to be maintained between allowing companies to fail and avoiding a full-blown credit crisis. Alongside this, the Supply Side Reform Programme continues in earnest, notably in the coal and steel industries that have witnessed dramatic capacity cuts.   

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. The managers continue to pay close attention to our models. As of now China country positioning reflects the recent bearish model signal, but we remain cognizant of the fact that the equity market landscape can change quickly. We will be swift to act should we be required to do so.

In India, the Union Budget and the introduction of a Long Term Capital Gains tax (LTCG), coupled with on-going issues at the public sector banks and a rising oil price has further added to concerns.  Despite these factors there are elements of encouragement, such as the upbeat GDP announcement, and the expectation that the final quarter of FY18 will be better than forecast.  Earnings figures are growing in resilience and are a further sign that the micro factors are turning positive after recurring disappointing quarters. 

At the start of March, Prime Minister Modi’s Bharat Janata Party (BJP) won a state election in Tripura, a remarkable turnaround given the party held no seats at the time.  Defeats for the Congress Party in Nagaland and Meghalaya have lifted the prospects of a BJP victory in May and December state elections, while Congress returns to lick its wounds.