7th July 2024
June Performance Review
Dear Investor,
We apologise for the delay this month, but travel affected our schedule.
As usual, we will start the month by looking at what the markets did in the previous month, our themes, and then the thematic portfolio performance.
Generally speaking, it was another good month for global equity markets, with most of the markets we follow moving up. We continue to note significant risk in US equity markets and related equity markets as breadth continues to narrow and most sectors in the US equity markets are not doing as well as the headline indices. As an example, the S&P 500 INDEX is up nearly 17% ytd and the Russell 2000 Index is flat (blue line below).
Most people are aware or should be aware that a handful of stocks are holding up the US indices.
The equal-weighted S&P index (blue line below) is up only 4% vs the S&P 500’s 17% move.
Investors in the main US indices don’t seem to worry about this, but to us, it highlights the high level of risk in this market and by extension, many global markets including Japan.
Other indicators such as the economically sensitive transport indices (IYT US) are also telling us the same story, down 3% for the year (blue line below).
This won’t matter until it matters, and we continue to keep a close eye on these indicators. We have noted these divergences previously and they have continued to get worse.
India was the standout performer in June and as we wrote in the last monthly summary, we increased our exposure there, which helped the thematic portfolio’s performance this month as the main Sensex index rose 7%. Although Modi didn’t get a landslide majority which caused an initial one-day sell-off (and a fantastic buying opportunity for anyone who could take advantage), the fact that he may be curtailed in his religious agenda but continue to spend on infrastructure and providing services to the masses is a good cocktail for continued performance in the market.
As well as the fundamental story, which is fantastic for India and drawing global investor flows (though you could say a lot is priced in), there are also increasing inflows of money into the market from “domestic” investors. This is both from the local population, with it now very common for employees to put money into the market direct from their pay checks through a variety of tax-efficient products, as well as from the large Non-Resident Indian (NRIs) diaspora, who are allowed to invest as individuals (unlike other non-Indian investors), and who are served by an expanding army of NRI-oriented advisors and wealth managers.
Many of these NRIs made a lot of money in the property market when that was liberalised and then also in the first big India bull run from 2003 to 2008 when the market went up >600%) vs the current gain from the Covid lows of “only” 170%. From first-hand and anecdotal experience, many NRIs are continuing to want to invest more money in this market and plenty of options are being offered. Fees for NRI funds range from 2-4% so brokers and asset managers are another good way to play this trend.
Several of our other themes had a pullback this month after last month’s strong gains, specifically in Precious Metals, Energy and Other Commodities.
We will be using this pullback to increase our allocations to the first two sectors and discuss them below.
The thematic portfolio performance is detailed below, and overall, we lost 2.6% for the month.
Running through the losers this month, looking at HK, it continued its correction and, as we wrote last month:
“It is natural for there to be a correction at this stage given the fast move up, and the HSI could get to the 17,500 level and remain in an uptrend. In our mind, the balance of probabilities is that we are still in a bull market.
If we hit 17.5K on the HSI, we will increase our allocation to this market.”
This could be a risky move given the continual disappointment over the last 4 years, but our view hasn’t changed. We do not argue with the fact that China is recovering slowly, but we don’t believe that means that this move up in the stock market is finished. We would not be surprised to continue to see mixed economic data for the next six months just as we have seen for the last 6 months. Some elements of the economy are better than others and vice versa. The key is that the decline has stopped, and we are moving up erratically from a low base economically, and the government is now both fully aware and willing to do what it takes to regain confidence in both the stock and property markets.
Zooming out to a 10-year chart one can see the risk reward is still skewed towards reward.
So what will be the catalyst given the momentum for announcements out of Beijing has stalled somewhat? We don’t know exactly what, but we do expect some major announcements out of the Third Plenum to be held in July. Now these announcements are always met with actions. Whatever you want to say about them, the Chinese government usually follows through with what it says.
Property is now the key and at the recent State Council meeting on 7th June, it was again emphasised.
Chinese Premier Li Qiang presided over a regular meeting of the State Council to hear the report on the current situation of the real estate market and considerations for the next step. He advised that efforts should be made to promote the implementation of the policies and measures that have already been introduced and to continue to study and prepare new policies and measures for de-stocking and stabilizing the market.
He said that it is necessary to accelerate the construction of a new model of real estate development, improve the “market + protection” housing supply system, reform the relevant basic system, and foster the stable and healthy development of the real estate market.
Source: AA stocks
The housing inventory is key as sales continue to slow and the efforts to date have not achieved the required goals so it is good to see the PBoC weigh in here.
China’s central bank has backed the government’s plans to use public resources to absorb the nation’s unsold homes as it moves to remove an inventory overhang in the world’s largest property market, which a data provider said could take as long as 18 months to work through.
People’s Bank of China (PBOC) on Wednesday held a virtual meeting on the topic, on the heels of Beijing’s announcement last month of a 300-billion-yuan (US$41.5 billion) fund to help clear excess housing stock.
The meeting was attended by major national banks and top officials from provincial cities, who discussed follow-up measures on the fund, which is earmarked for repurchasing unsold homes nationwide.
Top officials from Jinan, Tianjin, Chongqing, and Zhengzhou, which were involved in a similar 100-billion-yuan pilot relending programme last year, also spoke at the meeting. As at the end of March, only 2 billion yuan had been drawn down under this trial with China’s property market yet to see any signs of a turnaround.
Source: South China Morning Post
We have read some commentary that China shouldn’t be throwing good money after bad in the property market but if it worked for the US, then what’s the difference here?
For reference, during the bursting of the US housing finance bubble, TARP (Troubled Asset Relief Program) was authorised for expenditures of US$700 billion to buy “toxic” housing assets. The final amount spent? US$426 Billion. The act of providing a backstop helped stop the rot.
The inventory situation is worse in the smaller cities and while the initial measures have included lowering down payment and mortgage rates as well as relaxing restrictions on who can purchase, more is needed. Our educated guess as we have said, is that discussions are ongoing as to who is going to take the losses, for losses there will be.
The whitelist of developers who can receive finance to complete projects is working and money is being drawn down. This is to help the end buyers, not the developers themselves and is a mechanism to increase buyers’ confidence.
Banks are also offering loans to SOEs to buy housing to develop into affordable housing.
So we do expect some further support measures out of this July Plenum. There is a risk that the announcements underwhelm the market, but given the focus of the Government so far, that is a small but not zero probability.
The warm-up for the Plenum which gives a flavour of what is to come, was a symposium held in Jinan at the end of May which was the first held since 2020.
Xi’s symposium in Shandong is a critical indicator of the themes and priorities expected to dominate the forthcoming Third Plenum of the Communist Party’s Central Committee, which is scheduled for July. The symposium’s panel featured six business executives from state-owned, private, and multinational enterprises, alongside three prominent economists. This diverse assembly, including high-profile foreign business leaders such as Isabel Ge Mahe from Apple and Yin Zheng from Schneider Electric China, underscored the international dimension of the gathering and signaled an effort to integrate global perspectives into China’s economic policymaking.
Source: The Diplomat
The topics discussed all focused on the economy and improving the business environment for foreign investors, improving corporate governance and areas to aid consumption including jobs, income, healthcare and housing.
China signals economy is priority as Xi Jinping meets business leaders ahead of key party meeting
- President calls for deepened reforms to address economic woes and says country should pursue ‘goal- and problem-oriented’ approach
President Xi Jinping has called for deepened reforms to address the country’s economic problems during a meeting with the bosses of state-owned firms, private entrepreneurs and overseas investors.
Source: South China Morning Post
If the leadership is serious about tackling the problem, they could address some of the barriers to home ownership, the “hukou’ system is one of them. Allowing more freedom of movement and the ability to purchase property in areas where people are currently not allowed to as they don’t have residency rights would be a big, bold move and if some version of this was enacted and would provide a lot of support for the housing market.
On a different but still important note, Alibaba is moving its primary listing to Hong Kong and this may be another positive catalyst.
That move will allow it to be part of the Southbound Connect scheme and give access to the stock to millions of domestic investors.
There is no doubt Alibaba is extremely cheap on the numbers, even more so if you back out the cash which likely will go towards share buybacks. It has had a massive derating due to the political issues it faced, but some of the 200 million retail investors in China may think it’s worth buying here once Hong Kong is its primary listing which could put a fire
Source: Koyfin via Michael Burry Stock Tracker
If/when the Federal Reserve cuts interest rates that will also help this and many international markets. The latest expectations are for one 25 bps cut this year likely in September. We have discussed this at length and believe the Federal Reserve is looking for any excuse to cut rates but that is just our opinion.
Valuations are still cheap in many sectors in the Hong Kong market and buybacks by corporations continue apace.
Chinese companies rush to hike dividends, buy back shares in Japan-style reform
SHANGHAI/HONG KONG May 30 (Reuters) – Chinese listed companies are rushing to buy back shares and lift dividends as they respond to regulators’ calls that echo reform efforts in Japan and South Korea, driving a welcome rally even if investors doubt that broader governance changes are afoot.
China-listed firms announced record cash dividends totalling 2.2 trillion yuan ($300 billion) for 2023 despite a fall in combined profit, official data shows. Over 100 listed companies returned money to investors for the first time.
Meanwhile, a growing number of firms are unveiling share buyback schemes to avoid being delisted or sanctioned with other penalties under tougher rules.
Source: Reuters
More than 1,500 listed companies in China’s A-share market have announced buybacks so far this year, sending a positive signal to the market while underscoring their confidence in a sustained economic recovery.
As of Thursday, at least 1,544 A-share companies had announced share buybacks valued at more than 93 billion yuan ($12.8 billion), a record high, according to information provider Wind.
This round of intensive stock buybacks came after the State Council, the country’s cabinet, released a new guideline on strengthening capital market regulation in April.
The new guideline urged rigorous sustained oversight of listed firms, noting that authorities should crack down on illegal shareholding reductions, boost listed companies’ investment value with measures like stock buybacks, and tighten regulations on cash dividend payments by listed firms.
Source: Global Times
Chinese retail investors are buying Hong Kong stocks as the southbound flows show. A few investment banks have started turning positive on China which will start the process of institutional flow back to HK/China. It has likely started with hedge funds who can spot an opportunity or who have covered short bets, before moving to non-European or American institutions (Middle East), then Europeans and finally the Americans.
There have also been some large (given recent trading history in Hong Kong) blocks of securities issued in the last couple of months.
Saudi Arabia Builds Bet on Asia Tech With $2 Billion Lenovo Deal
Lenovo Group Ltd. plans to sell $2 billion worth of zero-coupon convertible bonds to Saudi Arabia’s sovereign wealth fund, part of a broader strategic pact with the tech-hungry kingdom.
Lenovo said it will issue bonds to Alat, an investment firm wholly owned by the Public Investment Fund, at an initial conversion price of HK$10.42 per share. That’s a roughly 12% discount to Lenovo shares’ closing price the previous day, near a nine-year-high for the stock.
Source: Bloomberg
Convertible Bond Boom Grows as Trip.com Follows Alibaba
There’s no let up in the rush by Chinese technology companies to issue convertible bonds, with online travel agency Trip.com now following industry giants such as Alibaba Group Holding Ltd. into the action.
Trip.com announced Tuesday an offering of $1.3 billion convertible senior notes due in 2029 to help repay debt, expand overseas and for working capital needs. To ease any dilution effect, the company plans to repurchase 6 million American depository shares for about $300 million at $50.16 each, the same as the latest close, according to a separate statement on the bond pricing Wednesday.
The issuance follows hot on the heels of several announcements late last month, the biggest being Alibaba’s record-breaking $5 billion issue. JD.com Inc. set the ball rolling in May with a $2 billion convertible bond offering
China-Backed Miner MMG to Raise Over $1.0 Billion in Rights Issue
Source: Market Watch
Yankuang Energy raises HK$4.96bn from upsized placement
Source: International Financing Review
There is continued demand for HK/China securities despite the ongoing negative press.
We believe it makes sense to start increasing allocations to this market, taking off hedges and scaling into positions over the next few months at this stage given the correction the market has gone through, depressed valuations, and multiple potential catalysts going forward.
In terms of the thematic portfolio, we will be replacing China Mobile (941 HK) and CNOOC Ltd (883 HK), not because we don’t like them or think they are overvalued but after very good performance for the last 2 years, we think there is a better risk-reward elsewhere.
We will widen the basket of coal stocks as they fit the theme of SOEs, dividends and H share discounts.
We have already included a couple of Alibaba spinouts and will add Alibaba Health also, as health is supposed to be one of the topics covered in the upcoming Third Plenum in July.
Within our overall “infrastructure basket” we will add telecom infrastructure company China Tower 788.HK as 552.HK is already part of the thematic portfolio, as well as another rail infrastructure stock 1766.HK. They fit the mould of cheap, net cash, SOEs with high dividend yields.
Turning to Gold.
Gold Mining Stocks will need Gold to break to new highs before making their major move and, if it follows the traditional pattern, it will be the seniors followed by the juniors, then silver will follow suit followed by silver miners. On a short-term basis, gold is being moved around by interest rate expectations and economic data points that are frankly irrelevant in the grand scheme of things. A plus 0.1% miss positive or negative in PCE has no statistical significance. A strong or weak payroll number (which will be later revised up or down by millions) should have no market impact but it feeds into what people think the Federal Reserve will be doing and hence gains that significance.
In our view, US real rates continue to be negative as inflation is both understated and rising (as we have commented on previously). In addition, it is becoming clearer that whichever candidate wins the US Presidential Election, the fiscal spigots will not be turned off and any reduction in nominal rates will mean real rates will become more negative.
The above chart shows the CRB index whose rate of change has moved up from 2% y/y in January to 18% y/y. The CRB index feeds into commodities, which feeds into PPI which eventually feeds into CPI.
The Shanghai Containerised Freight Index chart for the last two years shows how much this has risen. This index feeds into and leads CPI by ~12 months.
In terms of interest rates, the US NFP report last Friday ratcheted up the expectation of a cut in September to 73% from 58% a week earlier. It’s only a matter of time before Gold starts to discount a US recession.
We continue to believe Gold should replace Western government bonds in any portfolio. Let’s look at the performance of both XAU and TLT over different time frames. The below charts show XAU (blue) vs TLT (white) rebased to zero for various time frames. Now this doesn’t include coupon payments but given the low level of interest rates generally since 2008, it doesn’t alter the argument.
1 year
5 years
20 Years
Over any investment time frame, gold has done its job of protecting value compared to bonds. The 60/40 portfolio will continue to be discredited, and as more institutional investors become aware of this and of what the continued bond issuance for Western countries means for supply, there will be a further move into gold. The miners will then follow. We said that we would increase allocations to the sector if gold hit 2200 and 2100 but we now think that the balance of probabilities means we won’t get to those levels. Gold has been consolidating between 2280 and 2400 for the last 3 months and there seems ample demand at the lower of those levels so we will increase now.
Energy: As can be seen from the one-year chart of crude below, it fell from April to Jun, yet our energy positions in the thematic portfolio did very well. Conversely, they fell this month as crude rallied!
We have written extensively on why we like the energy sector and so we will be increasing the allocation this month
Within energy, we will revisit the uranium sector as both the physical commodity Sprott Physical Uranium Trust (U-U CN) and the miners Sprott Uranium Miners ETF (URNM US) have corrected somewhat off their highs and the fundamentals for this sector are entirely divorced from whether the US goes into recession or not. It is a case of the baby being thrown out with the bathwater.
The thematic portfolio for July is shown below, with changes highlighted in red as usual:
July Thematic Portfolio
Until next time,
