In April, markets rebounded some 10%, recovering substantially from downturn in March. The bulk of the advances came from higher-beta stocks outperforming in April.
The Chinese economy is on a recovery path. While prospects for Chinese export aren’t improving, domestic consumption is picking up. One white goods manufacturer we spoke to is confident demand will return.
In terms of company results, Asia was in the eye of the storm in the first quarter, while in other emerging markets it will mostly be Q2. Asian countries have generally handled the pandemic quite well, while Latin America, for example, was slow to react. However, there are unresolved questions about how Chinese security legislation should apply to Hong Kong.
Earnings per share in emerging markets are down by some 20% in Q1. Around half of the companies have reported the first-quarter earnings so far this year.
In terms of earnings, Asia and the information technology sector are significantly better off than Latin America and cyclicals.
Portfolio review and positioning
When markets shoot up like they did in April, the mtx Emerging Markets Leaders portfolio tends to underperform. This is what happened in April, and a similar pattern could be seen during some of the seven aggressive upward moves in financial markets in the past seven years.
Moreover, we have a lower beta than the market, so the advances of higher-beta stocks hurt us somewhat in terms of relative performance.
In such circumstances, as a rule, it would take us on average about three to six months to recoup the relative underperformance. We would expect the same to happen again.
We also had stock-specific issues in Brazil and China. Our Brazilian financial holdings such as Bradesco held us back. Brazil is really behind the curve in terms of Covid. Some Chinese and Asia-focused insurance companies such as AIA Group were also laggards. These are strong companies, but the discussions around Hong Kong hurt performance.
The portfolio had a good start in May but lost some ground mid-month. We saw some weakness in Chinese real estate and some utilities company in China and India.
We have had India on the radar for a while but the prices for good companies were too high. But valuations have come down to attractive levels. We have built a position in HDFC, the leading private bank in India, one of the best-managed banks in India and probably across Asia. The share price had halved before we made the move.
Indonesia and Brazil, where we are overweight, now lag behind other markets. We have put both on a watch list for a possible downgrade.
We haven’t been active in healthcare, but we expect a healthcare investment rather sooner than later. We’re also looking at energy. We now have a strong recovery in the oil price, and we hold two energy companies, one of them being Russia’s Lukoil. We would have to see substantially higher oil prices of 50-60 USD per barrel for these stocks to possibly kick-start a rally.
One of our single-biggest overweights is in Taiwan Semiconductor, which holds a de-facto monopoly on 5G telecommunication chip manufacturing for the world’s leading tech giants. The company reported very strong first-quarter results, benefiting from its unique industry position.
Taiwan Semiconductor will probably lose some business from Huawei because that company is compromised by the Sino-US trade conflict. However, it wants to build a plant in Arizona to circumvent some of the sanctions the US has imposed on it.
We have an exposure of about 10% to the gaming industry, whose online offers saw increased demand from people stuck at home during the pandemic.
But we have an even bigger exposure to areas boosted by the Covid-19 crisis such as working from home, e-commerce, video-conferencing and home improvement. E-commerce giants JD.com, and Alibaba, among others, have benefited from this development.
According to consensus estimates, earnings per share will decline by 7%-8% for the full year. Given that they are now down some 20%, there may be a gradual recovery as the year progresses. For next year, consensus sees EPS growing by 15-20% again.
The weakness in the Chinese manufacturing PMI could continue because there is less appetite for Chinese exports, but at the same time, there is an ongoing shift to a more service-based economy in China, reducing the dependence on manufacturing. Chinese domestic consumption is picking up but there are also signs that Chinese consumers may want to reduce household debt before going shopping again.
Regarding the discussion around shifts in supply chains, we expect such a process to take up to two years. That said, there will be some relocation, and beneficiaries could include Vietnam or India. This will also help diversification as Apple, for instance, was heavily dependent on China production. A more modular approach to manufacturing could be another consequence of the supply chain shift. This goes hand in hand with automation.
One of the biggest risks globally is another escalation of the US-Chinese trade war. Could China retaliate by banning Apple products, for example? Apple posts around 12% of its sales there.
Another question is whether Chinese American depository receipts (ADRs) may be delisted in the US if relations go sour. A new Holding Foreign Companies Accountable Act that would tighten the screws on foreign companies with an ADR listed in the US is being discussed in Washington. However, if this law passes, there would be a three-year grace period during which such companies could adjust.
Our ADRs include Alibaba, JD.com, and NetEase, which together account for 13.1% of our portfolio. Alibaba already has a secondary listing in Hong Kong, and the others could consider a similar move.