The market has overreacted to the devaluation of the Renminbi


Fund Commentary
18 Sep 2015


The sell-off in HK/China equity markets gathered speed in August, with MSCI China and CSI300 indices tumbling nearly 12%.The unexpected Renminbi depreciation spooked the market and triggered massive sell offs not just in Chinese equities but also across global markets.  

Investors interpreted the move by PBOC (People’s Bank of China) as the prelude to a sharp Renminbi devaluation that may lead to a repeat of the 1997 Asian financial crisis. Hard landing fears dominated the sentiment to an extent that numerous stocks were sold down to nearly distressed valuations. Take the auto sector as an example; valuations of auto stocks in general were sold down to 3-5x 2015 P/E, a level not seen since 2008. Redemption pressure and fund outflows in a down market further intensified the selling pressure. Companies that have reported better than expected results or with strong fundamentals were also hammered indiscriminately. Needless to say, stocks exposed to US dollar risk (such as airline and paper companies) were hit the hardest.

The Chinese economy remains in the doldrums as evidenced by a weak July PMI reading (which further weakened to 49.8 from 50 one month ago) and export number. The government responded by cutting reserve requirement ratio by 50 basis points and interest rate by 25 basis points simultaneously in August. More fiscal spending was also announced by the government to support growth. The markets have now been in an easing cycle for 10 months and the Investment Adviser would expect that the benefits of the stimulus measures should start to show through in the coming months.  

The Fund lost 11% in the month, slightly outperforming the benchmark by 0.08%. The sectors that contributed the most to the loss were internet (-2.1%), properties (-1.5%), auto (-1%) and insurance (-1.1%). The Fund’s cash exposure remained stable at around 8%. The Investment Adviser increased exposure in the internet and insurance sectors as they saw value emerging after the recent sell down.

In hindsight, the Investment Adviser was too complacent about the market’s reaction post the devaluation of the Renminbi as they thought a weaker currency was positive for the Chinese economy. Nevertheless, the Investment Adviser also thinks that the market has overreacted to devaluation of the Renminbi. It is fair to say that the Chinese economy has continued to deteriorate and that the stock market deserves a de-rating. The economy is however far from crisis levels; however price movement in August has already resulted in many stocks trading at distressed valuations. Interestingly, discretionary consumption seems to have remained stable despite the strong macro headwinds. August auto sales numbers were a positive surprise, while air traffic growth and Macau gaming revenue were stable. Besides, most of the ecommerce players have not been subject to the impact of the weak macro picture so far. It seems that the stock market run since June has not created meaningful negative wealth effect on the economy. The Investment Adviser believes the big disconnect between market perception and reality has to narrow and that should stable corporate numbers continue to be released, a relief market rally will follow, it is just a matter of time.

The views and statements contained herein are those of LBN Advisers Limited in their capacity as Investment Adviser to the Fund as of 15/09/15 and are based on internal research and modelling.