The disconnect between market perception in relation to the Chinese market is not sustainable


21 Oct 2015


In September the MSCI China and CSI300 declined by 3.05% and 4.9% respectively. Disappointing SOE reform plans and macro data triggered further selloffs. The market hovered around the low level throughout the month, suggesting initial support has been found at near crisis market valuations. We started to see divergent performance across sectors. Technology, auto and insurance sectors were up while cyclicals like banks and oil majors continued to slide.

August’s industrial profit of large enterprises was down 8.8% yoy (widened from -2.9% yoy in July). PMI also dipped below 50 to 49.7. Industrial activity was again a disappointment to the market. Nevertheless, consumption seemed to have held up reasonably well. August retail sales growth accelerated slightly to 10.8% from 10.5% in July, suggesting limited negative wealth effect on consumption post the stock market correction. This was supported by recovering auto sales and robust mass market consumption (e.g. strong air traffic and box office) based on the Investment Adviser’s channel checks.

Value has emerged with the market trading at a distressed valuation comparable to that of 2008. We finally saw differentiation of share price performance among stocks during the month. There was bargain hunting on stocks with strong fundamentals that were overly punished based on macro concerns. Take the auto sector for example; sector valuations were significantly punished to as low as 3-5x P/E at one point. The sector staged a strong comeback in September with share prices of major auto players up 40-50% in general on better than expected car sales numbers. Insurance stocks also declined, to trough valuation levels despite up-cycle movement in the industry. Market sentiment then rose as the result of an unexpected car purchase tax cut and the lowering of mortgage down-payment requirements announced by the government in late September. It seems that the government is determined to combat macro headwinds by stepping up policies beyond monetary easing. The Investment Adviser is hopeful that the macro trend will stabilise in the fourth quarter following the multiple measures introduced with the aim of stimulating the market.

The Fund outperformed the benchmark index by over 1% in September, however was down in absolute terms. The investment type which detracted most during the period was the Fund’s ADR exposure, which took off 0.8% from the Fund as a whole. Chinese ADRs listed in US were still under tremendous selling pressure as US investors were extremely bearish regarding China, regardless of the stable fundamentals of individual names. The Investment Adviser started to put money to work by increasing exposure to the insurance, auto and internet sectors on attractive valuations. The Fund was fully invested at the end of September, compared to a cash exposure at the end of August of 8.44%.

It has been the Investment Adviser’s view that the big disconnect between market perception and reality (which is not as dire as the market has feared) is not sustainable. It is a matter of time before the perception catches up with the reality and the Fund is well positioned for a relief rally.

The views and statements contained herein are those of LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 13/10/15 and are based on internal research and modelling.