Monthly Commentary - April 2020
Following negative equity price returns in March, Chinese equities rose in April. China’s economic recovery continued as factories increased capacity, office buildings opened their doors to workers and retail and restaurants began taking in customers. Supply side production increased but demand has been slower to materialize. In terms of reopening its economy, we estimate China’s economy is now operating at around 80% of its pre-lockdown levels. Unemployment has risen in China, as it has globally, but domestic demand remains resilient and we expect domestic travel could resume toward the second half of this year. Notably, China was the first country to experience the global pandemic and also the first to begin its economic recovery. We believe China’s policy makers have the right policy tools to help restart their economy and the right approach to public health policy to continue to contain the spread of the virus. While we are remain concerned about the implication of the pandemic on the global economy, we see China’s economy as having the potential to be more resilient.
PERFORMANCE, CONTRIBUTORS AND DETRACTORS:
For the month ending April 30, 2020, the Fund returned 8.02%, outperforming its benchmark, the MSCI China All Shares Index, which returned 6.60%. From a sector perspective, the Fund’s holdings in consumer discretionary and consumer staples contributed to relative performance. In contrast, the Fund’s holdings in the real estate sector was a mild detractor to relative performance.
A contributor among individual stocks was Galaxy Entertainment Group, a Macau casino holding. The security was previously a detractor from performance, as global tourism came to a halt in March amid the coronavirus outbreak. While the travel and tourism sector may take some time to recover, we remain constructive on Galaxy Entertainment and believe growth could resume as travelers resume their trips. The status of gaming licenses for certain operators would also bode well for companies in this sector should their bids to renew licenses be granted. By the end of April, investor sentiment toward domestic travel in China had recovered and Galaxy’s stock price rebounded in the reporting period.
A detractor among individual stocks was Focus Media Information Technology, one of the largest outdoor advertising companies in China. With access to hundreds of thousands of billboards and digital screens, Focus Media can easily deploy large-scale ad campaigns in China. However, owing to China’s temporary pandemic related lockdowns, advertising spending has slowed. We decided to exit the stock in April and redeploy the capital elsewhere.
From a health care and public policy perspective, China remains proactive about minimizing future outbreaks of COVID 19. We also believe China’s policy makers have considerable fiscal and monetary bandwidth to help support a sustained economic recovery. China’s annual National People’s Congress will convene mid-May with the expectation that the government will lower its 2020 economic growth target or abolish it altogether. In response, market participants expect the government to modestly increase fiscal spending and its government deficit while allowing local governments to increase debt financing. Lastly, we expect that announcements from the upcoming National People’s Congress could include additional minor stimulus, potentially pointed towards small businesses and households.
In our view, the larger risks to China’s economy are related not domestic health concerns or government policy. Rather, they are related to global economic contraction. While China’s economy is primarily driven through domestic consumption, the country remains an export powerhouse and exports continue to represent part of China’s employment engine. A slowdown in global economic activity would present a headwind to China’s near-term growth.
Taking a longer-term view, we remain optimistic about China’s ability to grow its economy over the next three to five years, especially in those sectors driven by services and innovation. As China’s economy has changed and evolved, we find the quality of earnings streams coming out of publically listed company improving. The breadth and range of companies now available to public equity investors in China has expanded considerably. Consider the example of the health care sector. There was a time when we could only invest in a handful of health care product distributors. Now we can invest in a broad range of innovative drug makers, contract research organizations (CROs) and high-end medical equipment manufacturers and suppliers. The growth of innovative companies and a services-based economy present attractive opportunities for generating alpha through an active, bottom-up stock selection.