Asian Diary - January 2015

Asian markets have had a solid start to 2015, with the regional index¹ rising 2.51% in January - comfortably ahead of the MSCI AC World Index, and the US in particular. The external environment appears to be helping Asia out at the moment, with Eurozone Quantitative Easing alleviating fears of Fed tightening, and the oil price falling. Asia is a significant importer of oil, so the recent decline in prices has had a meaningful impact on inflation across the region. This is particularly welcome in inflation-prone economies like India – where inflation has dropped to 5% from 8% only a few months ago – and Indonesia. Lower inflation potentially gives policy makers more room to cut rates, and in fact India’s central bank surprised the market mid-month by cutting rates ahead of its normal meeting, leading to the Indian market returning 7.8% in January. Elsewhere the Philippines rose 6.7%, reaching new all-time highs on the back of continued economic strength. The primary losers over January were Singapore (-2.3%) and Malaysia (-2.8%) which are the markets most negatively impacted by lower oil prices.

January tends to be a busy month in terms of team travel. The year began with two major China conferences, one in Beijing and one in Shanghai. Most of our Asian team, along with a number of overseas visitors, attended at least one of these.

China has been a conundrum for investors in recent months with deteriorating economic data, but relatively strong equity market performance, especially in mainland stocks. A rate cut in November last year led to a cyclical rally in some of the financial stocks that have struggled to make consistent headway in recent years – and we certainly weren’t alone amongst buy siders in not capturing this rally last December. At the conference, a meeting with the Head of Research of China’s State Council confirmed their goal is to shift the growth mix from exports/investment towards consumption/services, and to focus on the quality of growth and corporate profitability. As a result, GDP growth should slow towards 6/6.5% over time, but they don’t want this happening too fast and recent stimulus is evidence of China’s ability to manage the slowdown.

Our meetings with Chinese corporates were enlightening. Management teams were generally very cautious about the outlook for the economy, and are really starting to manage their companies for this tougher environment. Capex has been reined in, with much more focus on balance sheets and cashflow. We were also looking for evidence of state-owned enterprise (SOE) reform, though we expect this to appear only very gradually over coming years. In one example, one such SOE told us that their provincial government has restructured the ownership of the business such that the government now owns shares directly in the listed company instead of via a joint venture, a move which better aligns the firm with minority shareholders.

Other reforms however, such as management compensation via stock options, seem to be slower coming through so far. We also met with a number of consumer companies. Here again we heard the focus on margins. Unfortunately the demand environment remains a little tough, but with a tailwind from lower raw material prices we think certain companies may do better this year after a disappointing couple of years, especially as valuations have been reset to much more reasonable levels.

In a separate trip, our financials analyst visited Kunming, Shanghai, Changzhou and Beijing, meeting provincial / municipal governments, local government financing vehicles, local regulators, bank branch managers, shadow banks, local businesses and industry experts to get first-hand knowledge of the implications of the easing cycle. The trip confirmed his thesis that banks face a tough profit environment due to the slowing economy and that we should remain cautious on asset quality/non-performing loans as the problem loans are still not being classified correctly. With further policy easing ahead in the first half of 2015 it may be the case that China’s bank stocks continue to perform, but we’re not going to be chasing them here.

Analysts from our small cap team were also in China in January looking for ideas in the A-share market. We continue to add to research coverage of the A-share market and anticipate many of our portfolios will be able to invest more into the market in coming months as access improves. Interesting ideas from their recent trip included a company in China, which is a beneficiary of tighter laws on emission standards for trucks, and a company that makes condiments such as soy sauce, with great branding, high margins and very attractive growth. Overall, these visits around China re-enforced our view that whilst the early part of 2015 may be dominated by cyclical newsflow, there are pockets of secular growth which should still be rewarded as earnings come through.

Later in the month, several of us were in Jakarta. We had the opportunity to hear presentations from the Minister of Finance and the Governor of Bank Indonesia (BI), as well as meeting companies across a range of sectors. Indonesia’s stock market performed strongly in 2014 as a new President, Joko Widodo, was elected in July and hopes are high that he will kick-start Indonesia’s reform agenda. Progress so far has been decidedly mixed, partly because Jokowi (as he is widely known in Indonesia) has been unable to appoint all of his key advisors, something that was highlighted again in January when his pick for Police Chief was placed under investigation by the anti-corruption committee! But there have been successes too, such as the important fuel subsidies reduction.

Our meetings gave us greater confidence that Indonesia will gradually make progress on reform, especially in the area of infrastructure improvement. Navigating Jakarta’s notorious traffic jams provides immediate evidence of how much needs to be done to improve infrastructure, and the same problem can be seen in air, rail and port capacity. The Minister of Finance explained that the intention is to take the money saved from fuel subsidies and put most of it into increased infrastructure spending. He and the Governor of BI both expect GDP growth between 5.4-5.8% this year, an increase from the 5% seen in 2014. We were encouraged by the realistic targets these officials are aiming for, and the sensible policies they want to implement to get there. In contrast to China, Indonesia’s economy has been driven by consumption in recent years and going forward more primary manufacturing and fixed asset investment will be needed. So with growth improving, and valuation levels for the market reasonable (expectations are lower here than in India), we are cautiously optimistic about the outlook for equities in Indonesia this year. Banks should still do well, and we are on the lookout for businesses exposed to the infrastructure cycle.

¹ MSCI All Country Asia Ex Japan Index in USD

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