By La Française and JK Capital
The start of 2015 has been very interesting in China as we witnessed the continuation of the large cap rally on a few stocks while it was losing momentum for most of the market. The dynamic may however find another driver as China is expected to keep relaxing its monetary policy in 2015 to smoothen the slowdown of its economy. The incentive to do so is greatly enhanced by the low oil price, down another 9% in January, which keeps on putting downside pressure on inflation and upside pressure on real interest rates.
It is interesting to see that Tencent contributed to 75% of the MSCI China Index’s +2.2% performance given its 9.7% weighting. China Mobile, the largest mobile phone operator in the world and main play on the growing 4G network in China, gained 13.2% over the month contributing to 52% of the performance of the index. The rest of the market was between down and neutral with no strong driver in January. This fact explains the large divergence between two highly followed indices: the MSCI China gained 2.2% in January when the HSCEI, which does not have Tencent and China Mobile as they are both incorporated outside of China, dropped by 2.2%. It also highlights that the MSCI China index may not be a reliable one when measuring Chinese markets these days. This is certainly part of the reason why Morgan Stanley is looking into reshuffling the index, notably by adding “A” shares and American Depository Receipts later this year.
“A” share market
The Shanghai “A” share index dropped by 0.8% with daily turnover down 50% from its peak and fewer new account openings. Transactions involving margin financing have dropped by 38% following a ban imposed on two of the three main brokers to open new margin financing accounts for three months. These appear like strong signs that the “A” share market is about to cool down.
GDP growth in Q4 2014 was 7.3%, unchanged from Q3, taking the full year GDP growth of China to 7.4%, down from 7.7% in 2013. Even though it missed the official target that had been set at “approximately 7.5%” a year ago, GDP growth in Q4 actually surprised analysts on the upside. Looking at the details, it appears that most of the upside surprise came from the service sector that saw a nice uptick in value-added contribution to GDP, itself driven entirely by the financial sector that saw its growth in value-added shoot up from 8% in Q3 to 14% in Q4. There is no doubt that this is directly related to the strong performance of the “A” share market in Q4 2014, with unprecedented turnover and a high level of activity for brokers.
Looking ahead, the “A” share frenzy of Q4 2014 in unlikely to repeat itself anytime soon and GDP growth will almost certainly decline in 2015.
Another case of PMI divergence occurred in January with the HSBC/Markit PMI rebounding from 49.6 in December to 49.7 in January while the official PMI dropped from 50.1 in December to 49.8 in January. We wouldn’t pay too much attention to this phenomenon other than notice that the economy remains stable, apparently not impacted yet by the monetary loosening that took place in early November. This should give more reasons for the government to step in again either through another rate cut or through targeted liquidity injection. However the Central bank would probably prefer to see the “A” share market correct meaningfully before it steps in again.
Emerging Asian equity markets made a strong start to 2015 on the back of a larger than expected ECB quantitative easing program as well as a falling oil price.
The market enjoyed the best performance (up 6.4%) during the month, matching the strong macro picture we see in the country. Growth wise, the economy rebounded nicely during the last quarter due to a big turnaround in government spending: GDP grew by 6.9% in Q4, well above expectations (consensus was 6%). Full year growth was 6.1% in 2014, which made it one of the fastest growing economies in the region. A further positive to the country has been the collapse in the oil price given the country’s status as a net energy importer that does not subsidize gasoline prices.
On the monetary policy front, the falling oil price kept inflation low, allowing for a pause in the monetary tightening cycle and providing an easing environment for further growth. International investors continue to show strong confidence in the country: we note that the Philippines government sold in January 20-year T-bonds at an average rate of 3.855%, 124 bps lower than the 5.095% quoted when they were last issued in September last year. Despite the lower yield, the issue was almost three times oversubscribed.
The country is heading quite towards the opposite direction when it comes to the impact from a falling oil price as reflected in its currency performance.
We witnessed a significant depreciation of the ringgit in January. In fact, it corrected 7.7% over the past two months and has been one of the region’s worst performing currencies ever since the oil price correction started in the second half of 2014. It is around the level last seen during the global financial crisis.
As a big net energy exporter, Malaysia is the economy in Asia that is most vulnerable to falling energy prices with oil-related revenues accounting for 30% of its budget. In response to a falling oil price and deteriorating fiscal and trade conditions, the government raised its 2015 fiscal deficit target to 3.2% of GDP from 3.0%, and cut its GDP forecast to 4.5-5.5% from 5.0-6.0% as well as its current account surplus to 2% of GDP (from an previous estimate of 4.5% for 2015). The government is now using a new oil price assumption of USD55 per barrel for this year.
Government’s initiatives such as export promotion campaigns, measures to encourage more domestic spending by government-linked companies as well as infrastructure projects should be able to support the new growth target. However the ringgit is likely to remain under pressure for some time.
The country also revised its 2015 budget. The new government led by President Jokowi proposed a new inflation target set at 5% (from 4.4%), interest rates at 6.2% (vs. 6%), oil price at USD70 per barrel (vs. USD105) and a rupiah at 12,200/USD (vs. 11,900 previously) while keeping the growth target of 5.8% unchanged. Overall, the revision improves the government’s funding and flexibility, allowing it to focus on infrastructure spending. Looking back, President Jokowi made an encouraging start to his presidency over the past three months, however investors were spooked by his recent policies to directly intervene in private sectors:
- in mid-January, he forced a state-owned cement company to cut all prices by 5%, forcing all other companies of the private sector to follow through;
- SOE banks were told to be more than adequately capitalized so as to spur infrastructure growth;
- to increase tax revenues, the government proposed to revise 12 fiscal policies including taxes on luxury goods, jewelries and properties;
- to achieve government’s target to build 1m low-cost apartments this year, subsidized housing mortgage rates were cut from 7.25% to 5%, squeezing out the lenders’ margin.
All these measures raised concerns about regulation risks when investing in Indonesia, especially in state-owned enterprises that can easily be the targets of “Robin Hood” policies.
In 2014, emerging markets and among them Asia underperformed the developed markets driving the valuations to interesting levels. We believe 2015 will see a rebalancing between emerging and developed markets driven both by the macro and fundamental analysis.
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