Monthly Commentary - June 30, 2023
Chinese equities finally bounced in June as a lull in negative geopolitical news was driven by a visit to China from U.S. Secretary of State Antony Blinken with a goal to smooth out bilateral relations. However, market participants remained underwhelmed with the pace of China’s recovery which has proven to be more ‘slow and steady’ than a ‘consumption led boom.’ At the same time, the property market recovery has been volatile with general market conditions remaining soft. This part of China’s economy continues to be important in determining the stability of the country’s recovery and more monitoring of on-the-ground conditions are required.
Performance Contributors and Detractors
For the month ending June 30, 2023, China Fund, Inc. returned 2.96% while its benchmark, the MSCI China All Shares Index, returned 1.92%. From a sector perspective, the portfolio’s allocation to consumer discretionary, and allocation and stock selection within industrials and health care contributed the most to relative performance. On the other hand, stock selection in communication services and information technology detracted the most from relative performance.
Turning to individual holdings, Midea Group, a dominant white goods manufacturer in China was among the top contributors to performance. Shares of the company have been defensive year to date due to resilient recovery in the sales of Midea’s air conditioning units, buoyed by a low base, pent-up demand and increased appetite for premiumization. Both valuations and dividend yields of the company are attractive as well, and while Midea is no longer growing at a fast pace, its dominance in the market and strong execution offers investors a stable rate of return, which is appreciated in the more volatile market environment we are experiencing today.
On the other hand, duty-free operator China Tourism Group Duty Free detracted from performance. While the company was going through the normalization process of operation after pandemic, its earnings improvement was slower than sales given that discounting and inventory management takes time. This can be a transitionary adjustment process rather than structural challenge as the company’s market share is intact and management continue to make efforts to improve product mix.
Looking ahead, the earnings story should benefit from easier comparables with the second half of 2022. We expect earnings to continue to be a catalyst. However, given weak sentiment, China needs to deliver a very strong set of earnings to re-rate in a meaningful way, and we remain more cautious on that front and expect only a gradual recovery ahead. Variables to be mindful of include whether there will be more stimulus ahead and whether China’s property market conditions continue to improve. Sentiment on the ground remains weak, which could call for more supportive policies. At the same time, we continue to see more companies delivering on monetization and increased room for shareholder return as more companies consider buybacks and dividends. Geopolitics remain a relevant concern, and unfortunately, does not offer much optimism at the moment, leading to continued volatile market conditions.