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Active Minds: China’s recovery drives Asian bull market

Please see below for Jupiter Asset management’s latest ‘Active Minds’ article received by us late on the 22nd July 2020:

Jason Pidcock

Head of Strategy, Asian Income

China’s recovery drives Asian bull market

The bull market in Asia continues, noted Jason Pidcock, Head of Strategy, Asian Income. We’ve seen lots of large index constituents in China and Hong Kong rallying sharply, with some reaching all-time highs. Some people may find this a bit ironic given the negative political news coming out of China and Hong Kong, but this hasn’t prevented capital from flowing into those markets. Jason highlighted that this isn’t just in terms of domestic inflows – foreign capital is also buying Chinese and Hong Kong stocks.

What’s really driving Asian equities is the V-shaped recovery in China’s economy, said Jason. China is in a better position than many other economies, with second-quarter GDP up 3.2% year on year, following a contraction of 6.8% in the first quarter. So, it’s on track with expectations for a full recovery from the decline sometime in the second half of the year. Lots of Chinese businesses are doing well, too. Companies are forecasting profit growth and they’ve got strong balance sheets. While many parts of the world are seeing dividend cuts, many Chinese companies are not cutting dividends, and furthermore, many are actually growing their dividends, partly because of their net cash positions.

There’s been minimum impact from recent geopolitical tensions on Hong Kong, too. The UK symbolically suspended its extradition treaty with Hong Kong and placed it under an arms embargo, and the US has officially removed Hong Kong’s special trade status. Economic impact will be quite minimal though, as it should only affect about 1% of Hong Kong’s total exports. The Hong Kong dollar peg is unlikely (and technically difficult) to change, and capital flows into Hong Kong have gone up sharply since the announcement of the drafting of the National Security Law at the end of May. Hong Kong has had to lock down the economy to a degree because of a new flare up in virus cases, but most people are seeing this as temporary; it’s not having a big impact on most of the larger-weighted stocks listed there.

Overall, Jason expects to see Asia Pacific equities continue to trend higher; within the region, it’s Northeast Asia that’s driving growth.

Chris Smith

Fund Manager, UK Growth

Why aren’t supermarkets making more profit?

The UK has been the worst performing major developed market year to date, said Chris Smith, Fund Manager, UK Growth. That in itself isn’t so remarkable, as the UK has lagged behind major global peers for much of the last five years, but Chris said that the magnitude of the underperformance has accelerated in 2020. The reason for this is partly because the UK stock market has a larger exposure to structurally challenged or cyclical sectors, such as oil majors and financials, than many of its peers, and not much of a technology sector.

So, if the UK market faces so many challenges, where can a stock picker investing in UK stocks look for opportunities? Chris used a couple of examples to illustrate where he does, and does not, find attractive stock ideas in this environment.

At first glance, supermarkets seem like one of the winners from the Covid-19 pandemic, registering record like-for-like sale growth in many cases as shoppers stockpiled ahead of lockdown. Chris, however, sees them as structurally challenged ‘old world’ businesses. Despite that record sales growth, supermarket profits are forecast to be broadly flat year-on-year in the UK. This is because the increased sales were focused on low margin staples, and office workers, tourists etc staying at home means supermarkets are selling far fewer high margin items such as ‘on the go’ convenience food and drink. Online deliveries have gone up significantly, but this also has a dilutive effect on margins, as purchases are again focused on low margin items and the costs of fulfilling orders are higher than for in-store purchases.

Ultimately, Chris doesn’t see supermarkets as an attractive long-term investment for a growth investor like him. More attractive, however, is the testing and certification industry. It is essentially an oligopoly, with three major players all experiencing strong organic growth across the cycle from 2006-2019. The industry is also exposed to a lot of long-term structural growth trends, such as more regulation, higher safety standards, ESG in the supply chain, and cybersecurity, among others.                           

Richard Watts

 Head of Strategy, UK Small & Mid Caps

UK midcaps – go where the growth is

Richard Watts, Head of Strategy, UK Small & Mid Caps, also discussed the UK’s recent underperformance, noting that the domestically-biased FTSE 250 Index is down around 25% year to date, which is significantly worse than the 16% decline of the more international FTSE 100 Index.

In turn, the UK stock market is trading at a 25% discount to its long-term average against the broad global equity market as represented by the MSCI World Index. This valuation trough is at its lowest since World War II, so it does look cheap. The UK market has also hugely underperformed relative to where government bond yields are so, in Richard’s view, the market looks very good value.

Part of the malaise is down to the weakness of the pound and its volatility against a backdrop of Brexit uncertainty in particular hurting many midcap stocks, which collectively are more exposed to the economically-sensitive parts of the economy (housebuilders, engineers, travel companies, pubs and restaurants) than the FTSE 100 Index. More recently it has also reflected the outlook for dividends, as many companies had to cut dividends or cancel them to access government support schemes.

In the small and midcap strategy, Richard and the team have been overweight in structural growth for some time – it’s been clear that the pandemic has greatly accelerated the shift towards online retailing, pulling forward some two to three years of growth. This is having a very positive impact on the earnings of such companies and the strategy. And it’s no surprise that the team is underweight in travel, store-based retailers, pubs and restaurants, as they think consumers are still very nervous. This can be seen in the number of restaurant table bookings (not) being made. The team expects pub like-for-like sales to be down around 40% year-on-year, so they are wary of having too much exposure to these areas. Instead, they are seeking economically-sensitive exposure through those businesses that they believe will emerge from the crisis in better shape and which are not reliant on consumer spending where, in their view, it will take time for confidence to recover.

Joel Ojdana

Credit Analyst, Fixed Income

Don’t miss the double-B boat

Double-B credit offers great opportunities in today’s US high yield market, said Joel Ojdana, Credit Analyst, Fixed Income. Classed as the better-quality end of high yield credit, these businesses are well suited to the ‘new normal.’ In a world where negative real rates imply a slow global recovery, and with enormous debt at both the corporate and sovereign level likely to dampen productivity, these better-quality balance sheets and businesses should benefit.

Unprecedented support from the Federal Reserve also continues to drive spreads tighter, said Joel, and has opened up a financing window to corporate borrowers that is not at all typical during a ‘normal’ recession. With more monetary support expected by the market, BB-credit spreads are likely to further compress, in Joel’s view, offering a great opportunity. That said, it’s important to discriminate, because the pandemic has created both winners and losers within the US high yield segment – the Technology and Utilities sectors have outperformed year to date, while the Energy and Transport sectors have plummeted, for example. Finally, BB-rated corporates also frequently issue 10-year bonds, which is typically the longest duration in the high yield market and therefore should offer the most potential upside if spreads do tighten further.

These articles are useful for breaking down input into sectors, allowing experts of their particular sectors to offer insight within their specified field. This facilitates an all-round view of the markets.

Please keep reading these blogs to keep your own view of the markets up to date.

Keep well and safe

Paul Green

23/07/2020