China’s “New Era”

I have just spent some days in Southern China visiting Guangzhou (Canton) and Shenzhen. Guangzhou, population of 14 million, is the capital of Guangdong province, the 80 million Cantonese-speaking province of southern China and traditionally the entryway for foreign traders since the early 1800’s and before.  From 1957 the Canton trade fair was also the only outlet for Western businessmen during the Maoist period, and it still continues today.  The most fascinating aspect of Guangzhou today is that it has an estimated population of 200,000 Africans (mainly from Nigeria, Kenya, Tanzania and other nations), the largest in Asia, and almost 150,000 Middle Eastern business people from Egypt, Iran, Turkey and other Arab countries.  The old trading routes from China to the Middle East and Africa are alive and well with strong exports of clothing, electrical goods, light fixtures, leather shoes and bags, and many other products that are shipped to Africa.

Even though China’s factory labour costs have risen to about US$1,000 per month (so that Vietnam and Bangladesh particularly can compete on low cost manufactured goods), China still has a very strong market share, and an excellent distribution system, and will maintain its strong export growth to the emerging countries. When we consider that Africa is going from 1 billion to 2 billion in population in the next 30 years (it will contribute most of the demographic growth in the world over the next 30 years), it is no accident that China has built up such strong links to the African continent, as well as the Muslim world.

Going on to Shenzhen, which was a village when I arrived in Hong Kong 1982, is now China’s 3rd largest city with 15 million people, and is expected to overtake Hong Kong in GDP by 2018, was fascinating.  We visited some of the high tech companies such as Hytera (a global competitor to Motorola), Han’s Laser (which is a major Apple supplier, for laser equipment components, with nearly US$2 billion of sales, which grew by around 70% from the previous year), Tencent (which sports a market capitalisation of US$430 billion, and demonstrated some of their new AR (augmented reality) and VR (virtual reality) video games of which only one, “Honour of Kings” has RMB40 billion (US$7 billion) annual sales).

In Shenzhen one has the impression of a frontier town, with entrepreneurial energy, the ‘silicon valley’ of China, with a lot of bright young people coming in from all the interior provinces creating a very vibrant atmosphere. There are many small technology and medical companies, and the new part of the city resembles Singapore, with green tree lined avenues, excellent road systems and modern buildings and infrastructure.  It is like Pudong in Shanghai, but greener – a futurist vision of what China is creating today, and why China is, in both high tech and low tech, a formidable competitor and continues to be a very successful economy, in both domestic consumption and exports, into the developing world.

On October 25th, President Xi Jinping led out his new team of 7 senior politburo members.  Our analysis indicates that these men demonstrate a combination of liberal economic reform as well as strong party control and ideology (Xi Jinping thought is now to be included in the Chinese constitution).  We expect that China’s economic growth may indeed slow to 5%, but that the shift from infrastructure and export led growth toward consumer or domestic demand led growth will accelerate.  We are focused on key sectors such as healthcare, education, consumer spending, internet and travel and tourism where we see double digit growth continuing.  The Chinese Renminbi is likely to be stable.  Reforms of the over indebted SOEs in certain industries such as steel, chemicals, cement, shipping even banks and telecom, (which all have over- capacity problems), will be accelerated and may offer investment opportunities as national champions are identified in each major industry. All together we remain positive about China’s unstoppable momentum towards becoming the world’s major economy, with a growing geopolitical footprint across Eurasia through the ‘One Belt One Road’ initiative, which is already transforming economies such as Pakistan, Belarus, Kazakhstan, Cambodia, Laos, Sri Lanka, and even Ghana and other African nations.  The one mistake that western investors consistently make is to underestimate – or even to short-China, its economy, market and currency.  We are based in Hong Kong, we have a Chinese speaking team and we believe that on the ground research into Chinese A-Shares will be one of the winning strategies of the next 10 years.

In India too, we continue to see consistent reforms being delivered by Mr Modi’s administration. Most recently he has announced US$32 billion of new capital to bail out the state owned banks and their large non-performing loan portfolios.  This has resulted in State Bank of India, for example, jumping 23% in a day.  Our holdings include HDFC Bank, ICICI, Yes Bank, Gruh Finance and Kotak Mahindra among other smaller financials.  These are all well run private sector banks and mortgage companies which we believe will continue to gain market share and reward shareholders.  We do not generally want to be shareholders in state owned companies or banks in the major Asian markets because, as minority shareholders, we want our interests to be aligned with those of the controlling shareholder.

Japan has also had an important election in the past week, which has given Mr Abe a strong majority to pass his long planned reform of the Japanese constitution. This will allow the Japanese military to be rebuilt and to spend more than 1% of GDP on defense. Coupled with China’s growing military power and spending and the unstable situation in North Korea, (which was a major theme of the Japanese election), this does not bode well for peace in North Asia.  However, the Japanese market looks increasingly attractive, and with the Yen at 113 versus the US dollar, corporate earnings are likely to exceed expectations and we see more gains ahead in Japanese shares.

In South Korea there has been a period of depressed earnings owing to the Chinese ban on tours to Seoul, which have particularly affected retail, hotels and cosmetics companies. There is some suggestion that this ban may be lifted, and that there could be a recovery in Korean consumer shares.  Samsung Electronics also has exceeded all expectations and continues to be one of the leading regional technology plays, along with Tencent, TSMC, Alibaba and Baidu.  Unlike the ‘FANGS’, (Facebook, Amazon, Netflix and Google), which are likely to come under more antitrust and antimonopoly pressure from US authorities, we do not see such a risk in China, where the power of the e-commerce sector such as Alibaba and JD.com and the search engines such as Baidu, or the video game sector such as Tencent, are unlikely to be curbed by the Chinese authorities.

As investors, we try to take the long view and use the best information available to intuit the disruptive technologies that are coming, and how they will affect the incumbent leaders of industries. In the past decade we have seen an enormous effect already on travel, on stockbroking, on taxis, on hotels and even on education and medicine.  The rapid ascent of artificial intelligence is an important theme in our investing universe and China may well be one of the regions where we see this development play out most rapidly.  Medical technology also is an area where we expect Chinese research to surprise investors.  We have made a number of visits to Chinese pharmaceutical and other medical companies, which are very promising.

2018 is shaping up to be another year of continued growth and performance in the world’s equity markets, driven by the enormous availability of savings and low bank deposit and bond yields, with which equities are favourably compared. Some of the froth may be going out of the high-priced property markets in London, New York and perhaps Hong Kong and the Chinese cities, and some of that speculative capital may be redirected towards stock markets.  At least, that is how we are seeing things in Shanghai and Shenzhen.  The lure of new technologies and medical breakthroughs will be as exciting in our view over the next decade, as the speculation in property assets has been in the past 20 years.

In our Bamboo strategy, we are now 95% invested, as we are in the Indian Ocean Fund, and in the course of redeploying capital we have greatly increased exposure both to China as well as India. The only risks that we currently are monitoring are the external factors such as what the Federal Reserve policy is likely to be under new leadership, whether inflation might re-appear in 2018 and propel interest rates higher, and what is the expected direction of the US dollar?  In Asia itself we do not see outsized risks as long as the political leadership remains in place, and the long term reform strategies are followed.

In January 2018 we plan to launch a US$100 million China New Era Fund in which we will target a concentrated portfolio of the best A Shares, H Shares, and Chinese technology small cap companies. As we have successfully achieved in India, we believe that a long term horizon coupled with intensive research and local knowledge can pay off for our investors.

Robert Lloyd George
1st November 2017
Hong Kong

India and China Reflections on 25 years and a Look Forward

I was invited to speak in Shanghai on 18 September about our two major Asian Emerging Markets and my experience in investing in them. Since we began, the average annual return in India has been 13.6% in US dollar terms over the past 25 years, compared to 12.9% in China, with the respective economies growing at a nominal GDP 13.5% and 15.2%.  What is interesting in the following chart is that today the US market is valued at a 150% of GDP while China and India are still around 70%.  For any US or international investors looking at the world today, it must be evident that growth in the next 10 years will continue to come from Asia and specifically from the spending of the growing middle class consumers in the region, which are estimated to reach 380 million in India, 350 million in China and 210 million in other Asian countries, so that 90% of the next billion people joining the middle class will be in Asia (adjusted for purchasing power parity).

Part of my bullish forward analysis comes from the fact that many of these middle class consumers are also investors in their own share markets, and that we see, for example in India today, that flows into the capital markets are coming much more from domestic investors than foreign investors. In China there is a shift away from real estate into equities and other financial products.  Although both countries have a debt problem, (this is not unique when we think of Europe and the US today), their respective growth rates of 6 to 8% will help them to grow out of this debt.  In addition, it is worth reflecting on the fact that the PBoC (China Central Bank) has expanded its money supply by more than the Federal Reserve, the Bank of Japan and the Bank of England combined. One comment that I heard in Shanghai was that the China A-Shares, (the domestic Chinese equities), were receiving “a wall of money” which is supporting the economy and the financial system.

The 19th National Congress of the Communist Party of China will be held on October 18th, and will be very important in cementing President Xi Jinping’s leadership, and the reform policy which we expect him to follow.  China A-Shares will also be included in the MSCI Emerging Markets Index by May 2018, and we expect a significant capital inflow from international institutions in anticipation of this important change.  Both the Chinese Renminbi and the Indian Rupee have strengthened this year against the US Dollar, and we forecast political, economic and currency stability in the next few years.  Both Mr Modi in India and President Xi Jinping in China are attacking corruption.  This is the “Key-Man Risk” in investing in each nation.

The sectors which we select in both markets are similar: internet, e-commerce, consumer, travel and tourism, healthcare and education. Just as in the United States where the technology sector has been leading the market, so too in China there is a highly advanced internet market led by Alibaba, JD.com, Baidu and Tencent.

In India, in the ten months since demonetisation, there has been a shift from a 70% cash economy to around 40%, with rapid growth in digital and online payments. India today is at the take-off point where China was 10 years ago in terms of infrastructure, internet, e-commerce and accelerating economic growth.  Based on the successful model that we have developed for the Indian Ocean Fund, where we have experienced local advisors in Mumbai, Pakistan and Bangladesh, we have now identified such a partner in China that will enable us to invest capital for our clients into China A- Shares, especially in the small and mid-cap companies listed both in Shenzhen and Shanghai.  This is where we see the most interesting investment opportunities for the next decade.

Robert Lloyd George
1 October 2017
Hong Kong

China Deleverages

China has not collapsed. There is no financial crisis in China. Instead, China is undergoing a gradual deleveraging of its financial sector. As far as we can judge from published statistics, this has been successfully managed by the authorities and confidence has returned to the Chinese market. The RMB is strengthening against the US dollar and foreign exchange reserves have climbed back above US$3 trillion. The money market has tightened. 3 month Shanghai Interbank Rate has risen to 4.43%, and 7-day reverse repo rate to 2.81%: Both the Producer Manufacturing Index and industrial profits are rising gradually. GDP growth is likely to continue at 6% plus in the 4Q, although much will depend on the property and construction sector, which accounts for nearly 20% of GDP.

We are planning to launch our “China Hedged Investment” (CHI) Fund in October. We continue to believe that exceptional investment opportunities exist in the healthcare, tourism, education, and internet sectors.

In India, there has been some volatility over the summer but the Rupee remains strong and corporate earnings are growing over 15%, especially in the small and midcap sector of consumer goods.

Among the losers in August were the public sector banks, which fell 11.6% on news of increased nonperforming loans. It is worth emphasizing that the private sector banks, such as HDFC, ICICI, Yes Bank, among others which we own, have not been so negatively affected. In fact, they continue to report strong profit growth and relatively low NPLs. During the month of August, the Reserve Bank of India also cut its policy rate by 25 basis points, taking the Repo Rate to 6%, in line with market expectations. Inflation is forecast at 3.5% for the next year. The monsoon has been quite satisfactory, and India’s agricultural sector continues to do well. However, the impact of demonetization and the new Goods and Services Tax (GST) introduced July 1st is now visible in the GDP growth falling to 5.7% for the quarter ending June vs. 6.9% in the previous quarter. This may continue into the next quarter ending September.

By contrast, the Pakistan market continues to vex long-term investors with its heightened volatility (caused mainly by the political fallout after the Prime Minister’s resignation and a large US fine against Habib Bank): As a result we have reduced our exposure to 6%. Sri Lanka (6.5%), Vietnam (5%), Bangladesh (3%), Mauritius (2.5%) and Naspers in S. Africa (3%) continue to outperform and provide excellent diversification to the core commitment in India.

As the US economy continues to be remarkably resilient (3% GDP growth in the last quarter), despite Hurricane Harvey’s impact on energy, agriculture, and insurance, as well as cancelled flights, and disruption in the distribution of food, and other goods due to the floods, this will certainly affect Asian economies, which continue to be dependent on US demand. However, China now accounts for 8% of Asian trade.

Even commodity prices have strengthened in the past 3 to 6 months.

In “The Rational Optimist,” Matt Ridley eloquently makes the case that humanity’s worst fears about the future are not usually realized; that in most fields – medicine, nutrition, education, longevity – human life is improving steadily. The “outliers”, or exceptions to this optimistic assessment of the global economy, such as North Korea, only make it more convincing.  Somehow or other, the threat of Kim Jong-un’s crazy behaviour (especially this week in directing a missile over Hokkaido), will have to be neutralized.  Asia continues to be a region of extraordinary growth and rapid reduction in poverty (especially in China and India).

 

 

Robert Lloyd George
8 September 2017
Hong Kong

Hong Kong – Twenty Years Later

On July 1st, President Xi Jinping paid his first visit to Hong Kong to celebrate 20 years since Britain handed over the territory to China in 1997, and to inaugurate a new Chief Executive, Carrie Lam (the first woman CE and a welcome change from her predecessor C Y Leung).

I would like to reflect on Hong Kong as a corporate base for Lloyd George Management, as an investment market, and for its larger meaning for China. We have been based in Hong Kong since 1992 (and in our newer incarnation since 2014) and I have been personally resident and domiciled here since March 1982.  In 35 years, Hong Kong has gone through some remarkable changes, but it remains a dynamic business centre with low taxes, an excellent legal system and infrastructure, and minimal government interference in business.  Nobody who has lived in Hong Kong can fail to love the place for its energy, dynamism, quirky Cantonese-speaking “can-do” spirit of efficiency, and the beauty of its mountains, islands and parks.  But in the past few years, the mood has changed among Hong Kong people (especially the younger generation) to one of frustration, and anger, at the gradual erosion of freedom, and the high-priced rents and living costs of the city (akin to London, New York and other financial centres, but more extreme).

The older generation, especially grandparents who were refugees from China in 1949/50 might well say “Look how lucky you are to live in a free city where you can make money, travel freely, and enjoy international education, books, ideas and lifestyle”. But the issues of democracy, human rights and freedom will not go away as the death of Nobel Prize winner Liu Xiaobo reminds us.  Hence Hong Kong – whose economic importance as a percentage of China’s output has diminished since 1997 from 20% to 3% – continues to have an outsized political meaning and importance for China. (And behind all this, looms the question of Taiwan)

Since Xi Jinping came to power in 2010, there has been a steady regression to rigid Communist Party controls, including even Hong Kong’s educational system which is now supposed to teach China’s history according to the Party’s handbook. When Hong Kong publishers of books on China’s leadership were whisked away in the night by China’s State Security Police,  there was a frisson of fear among the population – so much for “One Country, Two Systems” continuing until 2047.  And the 2014 “Umbrella Movement” was ostensibly not only a protest by students against the erosion of democracy, but equally the erosion of their economic dreams and property aspirations.

Yet it is true to say that Hong Kong has in the financial sector at least progressed to being an important centre for listing Chinese shares, and being a conduit for Chinese capital via the “HK-Shanghai” and “HK Shenzhen” Connect. In this respect it is important for overseas investors to focus on the continuing discount of “H” shares (Hong Kong listing) compared to “A” shares in Shanghai and Shenzhen.  The mainland China market (market cap US$7.9 trillion, number of listed companies 3,300) continues to be driven to the tune of 80% by retail investors, with high PE ratios and inadequate research – compared to the Hong Kong market (market cap US$3.8 trillion, number of listed companies 2,060) which has low PEs, high dividend yields, low price/book (or price/NAV for property shares), and an intensively researched institutional market.  Over the past 20 years, the leadership of the market has shifted dramatically from banks, properties and trading houses, to Chinese SOEs.

Despite the temporary strength of the Chinese Renminbi against the US dollar/HK dollar, it seems clear that the desire of PRC investors to expatriate their capital (very often for their families) will not diminish in the next few years. Hong Kong is the first destination for this capital, being in a good legal jurisdiction with Trust Law and a sound internationally convertible currency. The strength of the Hong Kong share market in 2017 bears witness to this growing influx of mainland money, as do the sky-high rents and property prices. The proportion of mainland buyers in the Hong Kong property market has grown from 12% to 14% of the total transacted value over the last one and a half years, pushing property prices to increase by 25% over the same period.  Mainland investors have also targeted the share market through H-shares, registering CNY160bn (US$24bn) in net southbound inflows – double the amount that went north. The Hang Seng Index in 2017 (24% year to date) has outperformed the Shanghai Composite by 18% and the Shenzhen Composite by 28%. The movement of the A-share/H-share premium over the past three years demonstrates this change in sentiment, from the northbound inflow of newly permitted foreign institutional investors buying A-Shares that caused the premium to expand to 150% in the peak of 2015, (i.e. A-shares traded at a 50% premium to its dual listed H-share equivalent), to a subsequent contraction of the premium to as low as 115% when Chinese investors sought dollar denominated equities. Our conclusion is Hong Kong blue chips remain attractive for Chinese investors as a hedge against the depreciating Chinese Renminbi.

In May 2018, we will see MSCI include China A-shares in their global index for the first time. With a capitalisation of US$7.5 trillion, China will initially comprise about 25% of the Global Emerging Market index, and with full inclusion about 40%. This is an unprecedented change, given the size of the market, compared to Pakistan added this year or UAE, Qatar and Saudi Arabia two or three years ago.  Currently, there is US$2 trillion in index funds or ETFs benchmarked to the MSCI Emerging Market index and we will expect significant inflows of international money to enter the China market for the first time in many years.

We are now working on the launch of a China Hedged Investment vehicle which will comprise A-shares as well as H-shares and international listed companies. While we retain our long term optimism about China, we have concerns about the short term direction.  On the one hand President Xi Jinping appears to have made rapid progress in cleaning up corruption and excluding all his rivals (especially the recent change of leadership in Chongqing).  On the other hand, there is an expectation, as we go to press in early August, that the USA may be on the point of taking its first trade measure against China, probably to do with steel dumping, or intellectual property concerns.  This would be a shock to the market, after 6 months of relative calm, as the Dow Jones Index has just recently passed 22,000 and the Hang Seng Index has also followed up strongly.  We are therefore in a cautious tactical position over the summer, looking for great buying opportunities in Hong Kong and China by the last quarter of the year.

Robert Lloyd George
3 August 2017
Hong Kong

South Korea and Vietnam

This month I have made visits to two of the most impressive and interesting Asian markets. South Korea now has an economy which is, in many respect, more advanced than most European economies with an income per capita near to US$30,000, and US$600 billion of exports, half of which is machinery and automobiles.  They are now also a substantial investor in the emerging nations of Asia, especially Vietnam, where they are (with Japan) the largest source of foreign direct investment (and Samsung Electronics alone, accounts for 20% of Vietnam’s exports).  In fact Vietnam, alone among ASEAN nations has the same intensive private education emphasis as the North Asian nations (Japan, Korea, China and Taiwan).

It is interesting to reflect that it is just over 40 years, since the end of the war in Vietnam in 1975, and the unification of South and North Vietnam. This is now a young, dynamic and progressive country with half the population under 30 years old, and a tremendous thirst for self- improvement.  For instance, we visited the Vietnamese software company (FPT) which reminded me of the Indian software company, Infosys, 20 years ago.  They are training 17,000 students a year and pay their software engineers competitive salaries compared to India.  They have a particularly strong position in servicing major Japanese corporations.

Although from the US perspective, North Korea looks very threatening, the surprising thing is that on the ground in Seoul, people are so accustomed to living 30 miles from North Korea, that (after 64 years) of living with a “crazy neighbour” it is no longer a daily concern. South Korean investors are much more focused on whether the new government, under President Moon Jae-in will be able to reform the Chaebols, and improve corporate governance, transparency and dividend payout ratios. From being the most leveraged companies in the world in 1998, Korean companies are now the most cash rich, and the market is selling on a PE of 9x and less than 1x book (including Samsung Electronics with a PE of 8x).  There are also many smaller companies like Nasmedia, NCSoft and Naver in the on-line, video game, and digital advertising businesses which despite the sluggish South Korean economy, are achieving 20 to 30% earnings growth.

Korea is an impressive and disciplined Confucian culture, but it also has a creative side visible in the popular TV shows, the Gangnam music, and in the business creativity of the younger generation in these new internet fields, and the digital sector. The immediate problem for the Korean consumer and hotel companies is the collapse of Chinese tourism, as a result of the freezing of tours by China, after the Terminal High Altitude Area Defense system.  We expect this situation may take a year to resolve, but longer term, the real question is whether Trump and Xi Jinping will make a deal to denuclearise the peninsula, remove Kim Jong-un, and enable China to have an unchallenged regional influence, while allowing a reunited Korea to develop economically. This would be very positive for Korean shares.

The US military has just moved to a very expensive new base outside of Seoul, so there is no immediate sign that a deal is imminent, but it is something worth considering as an outside possibility. North Korea is also developing more capitalist tendencies and this will slowly undermine the monolithic totalitarian rule.

As for Re-Unification, the previous examples of Vietnam (since 1975) and Germany (since 1990) suggest that the cost, and the time for Korea to reunify and rebuild the shattered economy of the North would be a huge drain on their resources (the estimated GDP of North Korea is US$12.38 billion with an estimated population of about 25 million, compared to South Korea with US$1,443 billion and 50 million population).

Meanwhile, in China, my concern remains that despite the professed desire of the government to have a smooth transition to the autumn 19th National Congress of the Communist Party of China, the over investment and the debt bubbles are still at extremes, and the level of property prices remains very inflated. We are beginning to see some signs of weakness now in Shenzhen, and of course in Hong Kong which is also very high.  This summer we expect a correction to begin in these inflated property markets.  The risk in China is not so much economic as political: if there is any factional discord ahead of the party meeting, this will certainly spill over into the markets.

India has seen the introduction of the Goods and Services Tax on July 1st and as far as we can judge it has been a smooth process, as the demonetisation was last year, improving the transparency and level playing field of Indian business, and reducing a large part of the ‘black economy’ which has been estimated to be up to 40% of GDP. There is an increase in M&A activity – one of our preferred financial groups, Shriram City Union, has been the target of a takeover bid by IDFC. Among Mr Modi’s achievements in the past 3 years, has been an increase in FDI to about US$50 billion annually, a reduction in India’s external deficit from 5% to less than 1%, and a fall in inflation to 2%, so that today India is one of best performing emerging markets, with the Rupee up 5% this year.

In Pakistan, there has been some currency and political instability but we take a long term view of our investments in the Frontier Markets and are gradually adding to core positions there and in Bangladesh, Sri Lanka and Vietnam.

In conclusion, the risk for Asian markets over the summer remains the global risk of rising rates, and “tapering” QE, but we believe that any correction will prove a long term buying opportunity in the East.

Robert Lloyd George
14 July 2017
Hong Kong

Inflection Points

The study of historical cycles has, for many years, suggested a seasonality and decennial cycle in sunspots, human psychology, and stock prices. The mania of 2017 reflects closely the mania of 2007, or even perhaps 1999 (1997 in Asia), which was followed by the “dot com” bubble and collapse.

The narrow character of the market’s steady ascent, for months now, has been focused on the FAANGs (Facebook, Apple, Amazon, Netflix, Google) in the US market and BATS (Baidu, Alibaba, Tencent, as well as TSMC, and Samsung) in Asia. One must ask oneself how far this phenomenal rise in technology valuations can go, and is it justified by future earnings?  The market has possibly discounted too far forward as it did in 2000 – interest rates will rise, growth will slow, property will depreciate, and share prices will most likely follow.

In May, we had two important elections. I was in Paris on Sunday, May 14, at the inauguration of Emmanuel Macron, who has impressed all observers by his youthful energy and determination and the expected success of his party, En Marche, in the legislative elections coming in June.  Simultaneously, in South Korea, Dr. Moon Jae In has overturned ten years of conservative rule, following the impeachment of President Park and formed a strong reforming government, which is likely to try to improve relations both with North Korea and with China and possibly remove the American Missile Defense System (THAAD).  More importantly for investors, Dr. Moon has appointed some longstanding advocates of corporate governance reform to target the top four Chaebol groups – that is, Samsung, Hyundai, LG, and SK.  Between them, these four account for 50% of the Korean market capitalization.

The Kospi, or Korean Index, is now on 1X book and 9X earnings, even though it has risen by 25% this year, based on earnings growth and, in particular, on the strength of Samsung Electronics, which is about one-third of the market. But the market still has great potential to get re-rated if the reform effort is successful in persuading these large Korean conglomerates to restructure and reward their shareholders properly (as we have seen happen in Japan in the past three years).  The Korean companies are cash rich and pay very low dividends, and we expect to see a significant improvement in the next two years, which could result in a 50% premium improvement in the multiple of the Korean market.

In addition, we are seeing improvements in the least-loved market in Southeast Asia – that is Malaysia, where the ringgit is up 5% against the dollar and the economic growth has accelerated to nearly 6%. Indonesia and the Philippines are more popular among investors, but we see more risk, both political and economic, as their monetary policy tightens.

For the month of May the mid-cap index in India fell by 4.2% (in dollars) while the large cap index gained by 2.4%. Both domestic institutional investors as well as foreign institutional investors were net buyers, and we believe the volatility in mid cap stocks was generated by high networth investors. However, the market is happy with the March 2017 quarterly earnings and is looking forward to a further 20% profit growth in the year to March 2018. Initial views for this year’s monsoon forecast have been normal according to the Indian national weather service. The Goods and Service tax appears to be on track for implementation by July 1, 2017 and this could be supply disruptive in the short term. However, it will benefit the corporate sector and government revenues, in the long run. We are long-term holders of Indian shares and continue our policy of patient accumulation.

Regarding China, there continues to be evidence of economic and business momentum, especially in the internet and travel sectors. With the withdrawal of the USA from the Paris Climate Accord, China is likely to step into the vacuum and become the leader in renewables, both solar, wind, and electric vehicles.  This will be a very interesting space to watch, and we should not underestimate the determination of the Chinese to succeed in alternative energy sources, given their own pollution problems.

In fact, both India and China are now rapidly scaling back their coal usage in favour of solar energy. It is these two of the world’s most populous countries, representing almost 40% of the world’s population, that have accounted for the greater part of the increase in carbon emissions over the past 20 years.  Perhaps we should be more optimistic about climate change and about global warming despite the decision of Trump to withdraw the USA from Paris Climate Agreement.  In addition, natural gas, in the form of LNG, is becoming a much more competitive energy source in Asia, and is also helping to reducing oil and coal consumption.

Robert Lloyd George
19 June 2017
Hong Kong

What’s next for China?

Although most investors focus on the US economy, China as the second biggest economy in the world, with US$11 trillion GNP needs close scrutiny. In addition it has an outsized impact, probably bigger than the US, on all its Asian trading partners and many emerging countries in Africa and Latin America.  For even some of the leading members of the European Union, such as Germany, China has become significant factor in their external trade.  Therefore, we are trying to dig down into the monthly data of the Chinese economy on a regular basis to understand the current trends.

In April, we have seen China’s economy slow down to a 6.9% growth rate with the PMI falling slightly to 51.2%. The People’s Bank of China (PBOC) has tightened up policy with M2 growth falling to 10.5% and sales volume in property also falling 10% yoy.  Some commodity prices such as iron ore weakened as a result of the slowdown in China’s infrastructure spending and construction demand.  As a result of tighter control on foreign remittances by Chinese citizens, the Renminbi has remained steady against the dollar, and foreign exchange reserves rose slightly to over US$3 trillion.

Last week, we have seen the “One Belt, One Road” forum held in Beijing with President Xi Jinping, making commitments of up to US$130 billion in loans and infrastructure spending in Central Asia, Pakistan, Sri Lanka and in South East Asia. The impact on smaller economies such as Pakistan, Sri Lanka, Laos, Cambodia, Thailand and Vietnam is significant, and it appears now that over 130 countries including most of the European nations have committed to join China’s efforts in the Asian Infrastructure Investment Bank and the new Silk Road vision.  This could prove an epochal transformation in many areas of Eurasia over the next 20 years, compared by some observers to the Marshall plan, promoted by the US in Europe in the late 1940s.  This time China is the leading player in promoting trade and globalisation, whereas the US, under Trump, appears to be retreating from its trade and military commitments in Asia.  It therefore becomes more than ever important that China’s own domestic economy continues to grow and have the financial strength and health to support these ambitious overseas projects.

For some time, we have been conscious of the growing risk of the domestic debt which is estimated at between 250 to 300 percent of GDP. However, like Japan in 1990, this is almost entirely internal debt owed by local municipalities to the Central government or by state owned SOE’s to state banks.  It is therefore within the power of the PBOC to regulate and reorganise as they have done before. This fact is often forgotten by Western observers who wrongly speculated on a severe slow down or even crash in China in early 2016.  It has not happened.  On the contrary, China has re-accelerated its infrastructure spending and its industrial growth.  The latest GDP figure shows a steady 6.9%, but, as Premier Li Keqiang famously observed, we should disregard the headline number and look at railway freight (19.6% yoy), electricity usage (7.9% yoy) and exports (8% yoy).

The most remarkable recovery in the 1st quarter in 2017 was seen in the property sector across China, which has shown a strong rebound, and share prices of Chinese property companies have risen 25 to 30%.  However, we now see some monetary tightening by the PBOC and an excess of new supply of residential and commercial space in many cities which is beginning to weigh on prices.  The artificial stimulus to the real estate sector was in part caused by the November 2016 clampdown on capital outflows in order to stabilise the Renminbi and maintain China’s forex reserves at US$3 trillion. This may, however, be a short-lived phenomenon and our opinion is, that property values in many leading cities in China, as well as second tier cities, will begin to fall in the second half of this year.  What is harder to ascertain or predict, is the impact that this may have on consumer sentiment, and on consumer spending, as well as tourism, travel, education, healthcare and e-commerce, which are the leading growth sectors, in which we have invested.  We tend to believe that these sectors will maintain double digit growth, in the face of a slowdown in the state owned sectors of heavy industry including steel, aluminium, energy and construction in China. That is also why we are carefully watching the prices of iron ore (down 25% this year), copper (down 5%), steel, and of course oil and gas.  Australia, as one of the principal suppliers of iron ore, coal and LNG to China, may be one of the regional economies which is most severely affected by a cut back in Chinese orders in these raw materials.

One recent example of China’s outsized influence was in South Korea, where in July 2016, the Americans announced the Terminal High Altitude Area Defense (“THAAD”). The Chinese authorities reacted with fury and cut back immediately on purchases of Korean made goods, and tourism numbers from China to South Korea plunged by 60%. With the election of the new liberal President, Moon Jae-in, who is taking a softer line on North Korea (and may request the removal of the THAAD), we expect that China trade with Seoul will quickly recover and consider some Korean consumer companies to be undervalued on that basis.

The key issue will be what happens in US-China relations? On April 8, when President Xi Jinping visited Donald Trump in his “winter White House” in Florida, what was mainly discussed, apart from North Korea, was the issue of trade. Wilbur Ross, the US Secretary of Commerce, announced that they were commencing a 100-day review of China’s trade practices especially in sensitive areas such as steel and aluminum.  We therefore expect some actions to be taken by the US Commerce Department, by the beginning of July, and believe that this could have a shock effect on investor sentiment, which has so far viewed Trump, while eccentric, as following a sensible pro-business policy with regard to China, in contrast to his outlandish campaign promises to brand China as a currency speculator and so on.  In fact, the Renminbi has been abnormally stable against the dollar since Trump’s inauguration in January.  We expect that if some US trade measures are announced, that China will quickly retaliate, and perhaps a devaluation of the Renminbi would be more probable in the second half of the year.  In any case, a tussle between the two elephants of the world economy will certainly mean that the lesser economies, especially the Asian exporters which are tied into the supply chain for technology, among other sectors will be trampled on.

India, however, is of course an exception to this view of Asia, because it has little direct trade with China and not that much with the USA. The one area, which we have already seen affected by the H1B visa situation becoming more uncertain, is the IT sector, with companies like Infosys and Tata Consulting being negatively viewed.  Also some Indian pharmaceutical companies have come under the purview of the FDA which has also held back share prices.  For the other 80% of the Indian stock market, we have seen strong performance in domestic consumer companies, as well as the financial sector, led by banks such as Yes Bank, ICICI, HDFC and smaller names like Gruh Finance and Shriram City which have all benefitted from being go ahead private sector banks, innovative, and prepared for the digital transactions which have multiplied since the demonetisation on November 8 last year. In addition, the Indian Rupee has surprisingly appreciated by 5% against the US dollar since the beginning of the year.  We are, therefore, looking at gains of nearly 15% in our Indian Ocean Fund in the past few months, and our broader Bamboo Asia strategy is up 22% year to date.  We remain somewhat cautious about the next 3 to 6 months and intend to try and lock in these gains and preserve capital as much as possible.

Most of our companies have been producing very good earnings results, for instance, China Lodging came out with some very good numbers, net revenue grew 10.8% yoy and net income grew 113% yoy to RMB148 million. China Lodging now has 3,336 hotels or 335,900 hotel rooms with average hotel occupancy rate at 83.9%.  As of March 31, the company’s loyalty program had 814 million members who contributed more than 77% of room nights sold in 1Q2017.  TAL Education’s latest numbers showed net revenues up 81% yoy driven by student enrolments up 70% yoy to 1.34 million in a quarter.  Among the Indian holdings, Gruh Finance and HDFC Bank among the financial reported excellent quarterly numbers with growth in Net Interest Income by 18.6% yoy and 21.5%, respectively and good control over the asset quality, while Maruti Suzuki surpassed our expectation with revenue growth of 20.3% and profit after tax growth of 15.8% yoy.

In our broad Bamboo strategy, which has 25 “conviction” positions, we also have some defensive shares such as Link Reit and AIA in Hong Kong, and our Malaysian exposure in BAT and Public Bank, which has not performed yet but we see as a defensive diversification.   We also have some exposure to gold and oil through Evolution Mining in Australia and PTT in Thailand.  The oil price has been fairly weak recently but we expect that it will recover towards the second half of the year.

We are wholly focussed on picking great companies which we intend to own for five years, and believe that this “buy and hold”, dollar cost averaging, low turnover approach, which we have especially followed in our Indian Ocean Fund because of liquidity constraints, will be the most successful route to consistent outperformance of the passive indices and benchmarks. There is a real opportunity today for a return to traditional stock picking instead of low cost indexed products and we aim to consistently outperform our benchmarks in order to justify our existence.

Robert Lloyd George

15 May 2017

Hong Kong

Asia and the Jihadists

We are living through a war between Western Civilization and the radical Islamic Jihadists who have now attacked us in London, Brussels, Paris, Nice, Berlin, Stockholm, St. Petersburg and Egypt (as well as Orlando and San Bernardino in the USA). As one commentator said, “Even if we defeat ISIS in Mosul and Raqqa and wipe out their geographical territory, they have now gone “virtual” and on-line, and tell their followers around Europe that all they need to execute an attack, is a car, and a kitchen knife.”  We have, therefore, the horrible prospect of a continuing series of low-level attacks in major population centers of Western Europe.  Whilst we are confident that eventually European and Christian civilization will overcome this threat, as it has historically overcome Nazism and Communism (and, indeed, anarchists around 1900 who were also crazed fanatics with bombs), it is a deterrent to tourism, and to some extent investment, in the Western countries.

Now let us look at Asia. Among the major countries in which we invest are India, which has just under 200 million Muslims; Indonesia, with nearly 252 million; Pakistan, 185 million; and Bangladesh, 158 million.  Broadly speaking, all these countries have been peacefully developing economic prosperity over the past several years and decades.  There are, of course, Islamic extremists, but they have not disrupted life in a major way.  China, too, has a large Muslim minority of 1.8% or between 25-50 million, mainly in Xinjiang, which is predominantly the Uighur minority.  The Chinese government has been extremely tough on cracking down on extremists in this area.  In Singapore, after 9/11, Lee Kuan Yew imposed a draconian control of the mosques so that no radical preachers were allowed, and every member of the congregation was monitored.  They have had no problems since then despite the Malays being 20% of their population.  India, most impressively, has managed to co-opt and control their Muslim minority, despite Mr. Modi being, himself, a devout Hindu and leader of the BJP, which has an avowedly Hindu message.  There has been far less intercommunal tension in the past few years than there was under British rule 70 years ago.

The point is that the Asian governments have taken an extremely tough line on extremism and are not prepared, as some European countries are, to “tolerate the intolerant”. Although Indonesia and Malaysia have become more conservative (for example, wearing veils) in their practice  of Muslim religion and culture than they were a generation ago, the recent elections in Jakarta, for example, indicate that the extremists do not have much popular support.

Meanwhile, the business mood of the Asian countries in the first quarter of 2017 has been fairly robust. The accompanying table indicates how strong the current account surplus is in China, Japan, and all the other major trading countries.  Even India has now boosted its exports to the highest level in several years, growing 17% in February and has also achieved a new record of foreign direct investment of over US$40bn annually.  Contrary to the rather bleak view of world trade which we had a year ago, the situation has reversed itself and Baltic freight rates are now climbing; exports are growing; and the deflationary trend in Japan and in China (where producer price inflation had been negative for almost 5 years) has now been reversed, and we are seeing inflation in raw materials prices and wages for the first time in several years.  This is obviously good news for commodity producers in Australia, Brazil, Southeast Asia, and elsewhere and encourages further capital investment.

 

For investors today, the USA, which is 54% of the world stock market, has a magnetic attraction; but if we look beyond the short-term, surely it is clear that the tremendous positive changes occurring, in countries such as India and China, will produce outsized investment returns over the longer term. The technological changes which we see in America, such as electric cars, solar power, medical breakthroughs, and financial technology are quickly followed and mirrored in the Asian hemisphere.  India has, possibly one of the most modern banking system in the world with its new digital on-line transactions and instant personal identity by fingerprint.  What is perhaps less well appreciated by Western investors is that many of these financial groups in the Indian Ocean region are selling on less than 10 times earnings.  We have, for example, invested in a bank in Sri Lanka which sells at 0.9 times book on a P/E of 4.8 times, a dividend yield of 7%, with earnings growth of 40%.  Small and illiquid as many of these counters are, we believe that the chance to make long-term investments in under-researched, and neglected markets are our forte where we can produce outstanding alpha.

Returning to the geopolitical situation, we have growing tensions between Russia and the USA after the Syrian missile strike; the North Korean crisis continues; and gold has reached $1,275 an ounce. We have to expect some setbacks in world stock markets over the summer, as valuations are becoming stretched, volatility is very low, and expectations of Trump’s tax cuts and world growth may be too optimistic.

China’s decision to support, or even strengthen, the Yuan against the dollar, has many consequences. Domestic interest rates are rising in China, in tandem with the Federal Reserve policy tightening, and this will put pressure on Chinese borrowers, as well as smaller banks; NPLs will rise.  In addition, the clamp down on Chinese citizens and companies taking money out of China since December has also had unintended consequences.  The unexpected 25% jump in real estate prices in Shanghai and Shenzhen, for example.  President Xi Jin Ping’s directive to the PBOC and other authorities was, above all, to “maintain stability” in 2017 before he is re-elected for a second 5-year term in October.  The question is whether some external event, or internal pressures, may intervene to destabilize this happy prospect in the next 6 months.

Robert Lloyd George

17 April 2017

Hong Kong

 

 

 

The Incredible Mr Modi

In speaking at the Access Alts Asia-Global Hedge Fund Summit in New York recently, I referred to Mr Modi as the “Trump of India,” but with a greater degree of humility. I believe that it is still true to say that Mr Modi is an unknown quantity in the West; and even though he has been in power for almost three years, it is worth explaining his character and philosophy, in order to justify our enthusiasm for investing in Indian shares today.  Since independence in 1947, India’s population has grown from around 400 million to 1.3 billion today, of whom 79% are Hindus.  Narendra Modi is a devout Hindu from a humble background in Gujarat.  His father sold tea on the street; and Modi, rejecting an arranged marriage at the age of 18, became a devout Hindu and adopted the practice of ascetic yoga, with an austere lifestyle, no immediate family, and frequent fasting.  In the opinion of one of the top business leaders in Bombay, he is “the greatest prime minister India has ever had,” even compared to Nehru, who was Prime Minister from 1947 to 1964.  Nehru was, of course, a Fabian socialist whose guiding philosophy held India’s progress back for many decades.

Modi’s philosophy is very much pro-business, as well as freeing the vast rural population of his country to participate in real economic progress. In order to achieve this, Modi has set a high personal standard of ethics, of integrity, and a bureaucratic efficiency.  In doing so, he has attempted to cut out the middlemen, the bribes, and the “black money” that has plagued India for a long time.  This was the reasoning behind his shock demonetization in November last year, which has been successfully completed in two months.  He has also introduced a new national identity card system, called Aadhar, which together with the new goods and service tax (GST), will cut the cost of doing business in India, in our estimation, by almost 20%.  There are also almost 300 million new bank accounts, which have been opened in the past 2 years.  The rules of foreign investment have been greatly eased in defense, banking, insurance, retail, and broadcasting, with the result that over US$63 Bn. of FDI has come into India in the past 18 months.  Mr Modi has personally visited 45 countries in quest of his “Make in India” campaign to boost manufacturing, exports, and job opportunities in India.

The result of all this is that Modi has had a triumph in the recent regional elections in Uttar Pradesh. Nobody in the West might notice a regional election in India, but Uttar Pradesh has nearly 200 million people, so it is at least the size of Brazil and considerably larger than Russia.  Mr Modi’s triumph, therefore, was not an unimportant one because it enables him to continue his radical reforming legislation through the general election in 2019 and, hopefully, until 2024.  India will be transformed.  Not least, it will have a fully operational national grid of electricity reaching all the population by 2019.  India is “the perfect solar candidate” and will add nearly 1 gigawatt of capacity in solar energy at REWA for less than US$1 per watt.

Our Indian Ocean Fund is now US$83M. It has risen nearly 10% since launch on the first of December and is 95% invested, of which 71% is mainly in midcap Indian shares.   We have heavily over-weighted the Indian banks and financials, which account for 9 positions and nearly 20% of the total portfolio.  Our conviction is that the move towards digital payments and on-line transactions will be very beneficial to bank profits.  We have already seen deposits jump 15% since the demonetization; and the private banks, which do not suffer from the NPL problem of the state banks, are gaining market share at their expense.  In addition, we have invested in consumer products, in the automobile sector, in healthcare, in IT, and in food and beverage.

In the rest of Asia, we have seen good economic numbers from China, which has come out of nearly five years of deflation to record positive numbers on its Producer Price Index (PPI). Somewhat more surprising is the strong rise in real estate sales in China, which we continue to believe is a bubble supported by government policy which has pushed prices in Shanghai, Beijing, and the South to unsustainable levels.  Over the past 35 years, I have seen this cycle play out several times in Hong Kong, and it is inevitably followed by a severe correction.  The usual cause is rising interest rates, but the recent clamp down, on Chinese capital outflow, may also have an impact, at least in Hong Kong.

Our Bamboo strategy continues to perform well and is up nearly 5% in the first 3 weeks of March, with strong performance not only in India but in our Chinese shares, and in Malaysia, and in Taiwan. Recent events in the Korean peninsula continue to suggest a cautious approach to that market, although it is interesting that the arrest of the Samsung Electronics chairman has not severely impacted the share price.  Samsung’s business continues to perform well.  Our outlook for Asia in 2017 continues to be positive, although much will depend on events in Europe and the USA.

Robert Lloyd George

22 March 2017

Hong Kong

 

 

The Indian Elephant Wakes

January has been a strong month for the Asian markets, and our Bamboo Fund has appreciated by 6.5%, especially reflecting the rebound of Indian shares after the demonetization shock in November/December. Our Indian Ocean Fund at US$75M has also appreciated nearly 5% since its launch in December.  We remain positive on the outlook for emerging markets, especially for India and the subcontinent but also for the growing consumer markets of the 600 million population bloc of ASEAN.  We are looking afresh at Thailand, Malaysia, Singapore, and Indonesia, as well as the Philippines for opportunities in this sector.  We have a nuanced approach to China, which is clearly experiencing some slowdown in exports and nominal GDP growth, but continues to report strong retail sales, travel and tourism figures, and spending on education, healthcare, and on-line purchases.   (We have added Alibaba and Baidu as two leading companies in this space last month.)

The major question is what will happen to the emerging markets in the era of Trump. Has globalization and free trade peaked?  Our view is that, despite short-term setbacks, the long-term trend towards freer movement of capital goods and ideas cannot be stopped.  It is counterintuitive in the age of the internet for people to turn inwards and buy only domestic products.  Britain will not be able to live without French and German imports, nor will the USA, despite the enormous size of its domestic market, be willing to exist without German and Japanese cars and cheap Chinese consumer goods.  The trend of history seems irreversible, and it is, in the end, consumers who benefit most from the competitive pricing of imported goods.

The first few weeks of the new administration have been somewhat chaotic, with the ban on Muslim traveller from seven countries and the uncertainty about foreign and trade policies. The real economic impact of the change of thinking in Washington will be towards reflation, lower taxes, less regulation, more infrastructure spending, and, in general, a boost to the ‘animal spirits’ of the business community.  We venture to believe this will benefit many of the companies that we visit in the Asia Pacific.

Nevertheless, we have taken a very cautious stance in not buying into the export sectors in Japan, China, and Southeast Asia. Strategically thinking, we have focused on India and its neighbors, which have less to lose than any other major developing countries from a US-protectionist stance.  Even in India, we avoid the software and pharmaceutical sectors, which could be impacted by more restrictive trade policies (especially in the technology sectors) where the H1B visa has become very important to Silicon Valley companies bringing in Indian software engineers.

In January, I made a very interesting journey to Hong Kong through northern Thailand to India and eventually Sri Lanka. China’s influence on the economy of the Indian Ocean region cannot be underestimated.  We visited Pakistan in November, which will see US$50B of infrastructure development in the highways, ports, and power generations.  Even more remarkable is Sri Lanka, where the Chinese are estimated to be investing almost US$10B into an economy whose total size is only US$80B.  The new government, with succeeded Mahinda Rajapaksa nearly two years ago, had tried to find alternative sources of capital; but there has been virtually no investment from USA or Europe, and so after 18 months, they have turned back to the Chinese and are now going ahead again with Hambantota port, the highways, and the airports.  Most striking is the 550-acre port city development in the heart of Colombo, which will include offices, commercial and residential space, as well as the port itself.  We can see the impact of this huge investment on the construction sector as well as consumption and also the banks.

Looking forward, we believe the next few months will see a continued momentum of growth in these Asian nations which are belatedly catching up in terms of technology and infrastructure. The impressive speed with which the Modi administration has implemented reform of taxes, banking, and national ID registration, will impact the country’s economy deeply in the months and years ahead.  We have invested heavily into the private-sector listed banks in Mumbai, including HDFC, ICICI, Yes Bank, Gruh Finance, Kotak Mahindra, and Shriram City Union Finance.  These are the companies which, on the ground, are going to benefit most from loan demand, especially in mortgages and corporate lending at the local and retail level in the regions of India.  The gradual inclusion, in the financial sector of the economy, of the 600 million Indians living in the rural provinces, will have a huge impact, not only on the banks but on the sales of consumer goods, on travel and tourism, and on the gradual spread of the internet.  All of these trends we have seen in China in the past decade we are now beginning to see in the vast Indian subcontinent.

 

 

 

 

Robert Lloyd George

10 February 2017

Hong Kong