By Lilian Co
Chinese stocks experienced a roller coaster ride in November. The disappointing northbound buying of A shares after the launch of the Hong Kong-Shanghai direct stock connect program prompted a market sell-off in the first half of the month. The MSCI China Index was down 2.9% in the first three weeks of the month, at which point it made a strong recovery in the final week following a surprise cut in Chinese interest rates.
The MSCI China Index and the CSI 300 Chinese Securities Index ended the month at +1.6% and +10% respectively, extending the October gain. This was primarily due to the fact that investors rotated out of non-financials to chase financials, which Institutional investors have previously largely ignored for the last two years. As for Energy related stocks, they were once again under intense selling pressure as the Crude oil price continued its recent sharp correction.
The interest rate cut in China was surprising for two reasons. Firstly, the timing was earlier than expected as the government had been emphasizing the use of targeted stimulus, instead of outright monetary easing. Secondly, the rate cut was asymmetric. The deposit rate was cut by 25 bps whilst the one year benchmark lending rate was cut by 40 bps, and the deposit rate ceiling was also raised. Despite the fact that this could be viewed as a negative to bank earnings and that the net interest margin could suffer, the Investment Adviser believes the contrary and feels that the property sector should benefit from the rate cut. Property transactions have escalated since October, thanks to mortgage easing for home up-graders and relaxation of the home purchase limit. The recent rate cut should further boost home buyers’ confidence. Additionally, the sudden rate cut could suggest that the economic slowdown is more severe than expected. In the prior rate cut cycle (Dec 2011 to July 2012), the reserve requirement ratio (RRR) was cut three times whilst interest rates were cut twice. The Investment Adviser believes that there will be further interest rate and RRR cuts should the government envisage a further downside risk in the economy. Whilst Investors are likely to be excited in the short term as they anticipate additional easing, there is a danger that the underlying economy may weaken further before the positive benefits of easing filter through; the macro data announced in recent months has painted a mixed trend.
In November the Fund underperformed the MSCI China Index. This was attributable to the Fund’s limited exposure to financials (which were the major driver of index return in the month) and also the decline in prices for over 60% of the Fund’s positions as investors rotated out of non financials to fund the purchase of financials. The Fund’s weighting in A-shares was increased by 5.9% to 7.4% after the rate cut, but the focus remains on non financials as the Investment Adviser holds the view that the market has overreacted to the rate cuts.
Commentary provided by LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 15 December 2014