Devaluation of Renminbi perceived as unlikely

In June, Chinese equities were sold heavily following an unexpected announcement by the US regarding import tariffs as well as a free-falling Renminbi. During the month, the MSCI China Index lost 5.2%, ending the first half of the year with a negative return of 1.8%.

Monthly Fund Commentary
24 Jul 2018

In June, Chinese equities were sold heavily following an unexpected announcement by the US regarding import tariffs as well as a free-falling Renminbi. During the month, the MSCI China Index lost 5.2%, ending the first half of the year with a negative return of 1.8%.

Just as everyone thought that the US China trade tension was easing, after Donald Trump softened his stance on the export ban on ZTE, he unexpectedly approved a 25% import tariff on USD50bn worth of Chinese goods. The subsequent strong response by China to retaliate in kind only further spooked the market. The Renminbi followed the trade war woes, overall retreating 3.5% in June, the biggest monthly decline in years. The looming trade war and weak currency at a time when China is going through financial deleveraging has re-ignited market concerns regarding the prospect of a hard landing in terms of the Chinese economy. Sector wise, Consumer Discretionary, Technology and Real Estate underperformed, while defensive sectors such as Healthcare, Telecom and Consumer Staples fared better.

Important macro numbers released for the month of May were below expectations. Retail sales, the most resilient of macro data in the past few years, showed a growth slowdown from 9.4% in April down to 8.5% in May. Further, fixed asset investment growth also weakened from 7% in the previous month to 6.1%. It appears, that the impact of financial deleveraging has filtered through to the real economy.

The Investment Adviser expects GDP growth in the second half of 2018 to moderate. This said, the slow down should be contained in a narrow range, with the government having ample tools to manage its pace. According to the team, the risk of a hard landing is unlikely.

During the month, the Renminbi plummeted against the back drop of trade war woes, as the market feared that the Chinese government would devalue its currency in an attempt to restore export competitiveness. The team think that this is unlikely as the Chinese government has learnt its lesson from the last currency reform in 2015, with a sharp currency devaluation only destabilising the economy. The Investment Adviser views the weakness of the Renminbi year to date more as a result of a strong USD, since other major currencies have also been under pressure.

China’s property sector was among the worst performing sectors in June. Apart from high gearing and exposure to foreign debt, the sector was hit particularly hard on the back of news regarding a reduction of government financing support for shanty town redevelopments. The team has talked to the major players in the market and none of them foresaw a noticeable slowdown of property sales. After the sell-off, the sector is trading at trough valuation, similar to previous downturns. At 6x 2018 and 5x 2019 P/E, the Investment Adviser continues to see value in the sector and has further increased the portfolio’s exposure. Depressed Macau gaming revenue growth during the World Cup period also exacerbated the selling pressure on Macau gaming stocks, with the team however perceiving this slow down to only be temporary.

The Fund lost 7.2% in June. The primary drag on performance was attributable to the overweight in Consumer Discretionary and Real Estate, which were down 10.5% and 9.4% respectively in June. According to the team, the maximum level of market fear should have been reached in the near term, as 1) the second round of import tariffs announced (10%) was lower than the first (25%) and 2) China’s reaction having been much milder following the second announcement. The Investment Adviser believes the trade war risk has been more than priced in, with the MSCI China trading at 12.5x 2018 and 10.8x 2019.

The views and statements contained herein are those of LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 17/07/18 and are based on internal research and modelling.