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Summary
Monthly performance
The Ashburton Chindia Equity Fund returned -4.26% in May, with the composite benchmark (50% MSCI China/50% MSCI India, TR USD) returning -6.65%. Market update
China
MSCI China returned -14% in May as changes in the market narrative triggered a shift towards risk-off sentiment, with negative implications for equity prices. Domestically, concerns centred on a potential China policy stimulus fade-out following high level comments that deleveraging and risk prevention would be maintained, predicated on a stronger than expected showing in economic data. Externally, geopolitical tensions were reignited following US President Trump’s escalation of the trade war with China just days before an anticipated ‘deal’ between the two countries was due to be signed.
Trump’s move included the raising of tariffs on US$200 billion equivalent of Chinese goods effective May 10, and a threat to impose 25% tariffs ‘shortly’ on a further US$325 billion equivalent of - as yet untaxed - Chinese goods. In addition, Trump signed an executive order to restrict US business (both procurement and sales) with Huawei, a move that is set to have far-reaching negative ramifications for the technology sector.
The net effect of these developments has been a swift derating of equity prices as investors reassess both the prospects for China’s short- to medium term growth outlook and the prospects of a full-blown trade war.
India
MSCI India returned 0.22% in May, significantly outperforming the Asia region. India’s Nifty Index briefly touched new all-time highs in local currency terms as political uncertainty was lifted with Prime Minister Modi re-elected with an absolute majority, thus ensuring policy continuity. Indeed, the result marked the first consecutive majority for an incumbent party since 1984, wrong-footing the bulk of the political analyst community in the process.
Having expected Modi to form the next government but with a reduced number of seats, markets began repricing a far more positive outcome in the fortnight leading up to the election result, announced 23 May. With the bulk of disruptive reforms now behind the ruling BJP (including, but not limited to; demonetization, the Real Estate Regulation and Development Act, the bankruptcy law and GST implementation), the government’s focus is expected to shift to growth.
This is particularly prevalent given the slowdown in India’s growth trajectory over the past five years, with government facing questions about the related issue of insufficient job creation (unemployment is currently at decade-old highs).
Our capital allocation model seeks to generate positive alpha on balance, through cycles, by actively tilting the country exposure between China and India. The model generates, on average, 1-2 signals per annum, remaining neutral c.65% of the time. The current model signal is neutral, advocating a close-to 50% allocation to both countries.
As a consequence of our recent initiative to move the China portfolio to quarterly rebalancing from monthly rebalancing previously fund positioning will remain consistent for this quarterly period.
Within China, our strategy has major investments in real estate, industrials and information technology sectors, funded by significant underweights to consumer discretionary and communication services, relative to the MSCI China Index.
The China portfolio generated modest positive alpha on the month relative to the MSCI China Index, driven primarily by stock selection in the real estate sector.
Sector performance in May was unsurprisingly led by the industrials sector on renewed expectations of infrastructure and capital goods expenditure. Within the India portfolio, Larsen& Toubro, the country’s largest industrial stock, gained 16% in INR terms on the month.
Other noteworthy gainers included Merck and Aarti Industries, and with the portfolio positioned over weight to financials, and underweight to energy, decent positive alpha generation was achieved.
In last month’s commentary we noted; ‘it could be argued that the market has factored in much of the catalysts of the equity rally YTD; the trade deal, stimulus and Fed easing, suggesting that the likelihood of a correction is growing.’ A re-escalation of China and US tariff tensions has shifted market expectations to the extent that a full-blown trade war (tariffs placed on all Chinese imports and reciprocal levies/restrictions on selective US imports into China) is now not a low probability event.
Overall, weaker than expected Chinese economic activity in April (manufacturing investment, private sector fixed asset investment, industrial production and retail sales also slowed sharply) suggests the growth recovery is not firm yet. Expect policy responses from the Beijing authorities to underpin growth stabilization efforts that may include fiscal subsidies to support consumption and RRR cuts.
Investor attention is likely to be directed towards India’s platform for growth in the coming months. The first two pages of the BJP election manifesto give an insight into the mind-set of PM Modi and the path that he envisages India taking over the coming 5 year cycle; ‘there are two commitments that I am extremely passionate about: doubling of farmer income and housing for all, by the year 2022’.
Key policy initiatives in the following areas might be expected;
A key achievement of the Modi government has been in bringing down the inflation rate substantially in recent years, with an inflation-targeting framework signed in August 2015 (4.0% CPI is the benchmark). Low current inflation (2.9% in April), the RBI’s own benign inflation projections and slower GDP growth present an opportunity to cut further amid an environment for lower rates for longer.
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