China is looking cheap

BY Lilian Co

Fund Commentary
18 Feb 2016

BY Lilian Co

The stock market in China collapsed in the first month of 2016, dragging global markets with it. Similar to the big sell off last summer, the stock market rout was again triggered by Renminbi depreciation and policy missteps (this time the introduction of an index circuit breaker).

The accelerated Renminbi depreciation in the first few days of January and the suspension of the A share market twice, triggered by the newly introduced circuit breaker, spooked investors. Part of the selling pressure was again diverted to HK. The oil price plunging to below US$30 per barrel and the strong US dollar only exacerbated investors’ bearishness on emerging markets, especially China. The MSCI China and CSI300 indices lost 12.7% and 21% respectively in the month, the worst performance since 2011. The market decline was broad based, but defensive plays (like yield stocks and utilities) and exporters with significant USD exposure outperformed.

The fact that the circuit breaker was implemented on the first day of January, only to be withdrawn a few days later was yet another policy misstep and a setback to the credibility of the Chinese government. The circuit breaker was designed to offer a cooling off period to investors by temporarily suspending the stock market when the 5% limit on the CSI300 was hit, but it triggered even more panic selling instead of stabilizing the market. The situation was further compounded by the resumed downward trend of the Renminbi which has lost over 1% in each consecutive month since November. The Renminbi weakness has even spilled over to the HK dollar as the latter also weakened to as low as 7.83 to one US dollar, which was near the upper trading band of 7.85. HK, being a free market unlike the A share market, became the only means for foreign investors to express their negative views on China.

The Fund was down 11.9% in January. Auto, insurance, internet and property were the biggest drags on the portfolio, down 2.1%, 2%, 1.8% and 1.6% respectively. Given the heightened uncertainty, the Investment Adviser has raised the cash level to 28% as of the end of January, versus 5% one month ago.

Most people would agree that China is cheap. With a market P/E of 7.5 times 2016 earnings, the MSCI China index is trading at a level close to the last trough during the 2008 financial crisis. It is the risk of further Renminbi depreciation and more policy missteps that is keeping investors at bay. Currently, the Investment Adviser is maintaining a high cash level in the portfolio, but stands ready to put the money to work once the market stabilizes.

The views and statements contained herein are those of LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 11/02/16 and are based on internal research and modelling.