Last week we travelled to Hong Kong to attend a global investment conference and conducted several meetings with – Hong Kong listed companies (some of the largest companies with not only exposure to Chinese markets but assets in developed markets), buy side investors, strategists, fund managers and bottom up equity analysts. These trips support our asset allocation and global equities strategy, however the themes are also very relevant for our Australian equity strategies.
China – challenges well understood and reflected in valuations. Clearly China and its growth outlook was a key discussion point. Our meetings with various Hong Kong listed companies with exposure to China highlighted a few points which shouldn’t be new – China is facing challenges (consumers are cashed up but not motivated to spend), China’s political leaders will continue to provide measured support to the economy (but don’t expect a bazooka stimulus package) and importantly companies are reshaping their businesses / supply chains to deal with the new reality. On a positive note, structural growth opportunities in China include technology / AI (industrial tech and robotics), carbon neutrality and consumer products. The adoption of innovation and technology in Asia / China is significantly ahead of the developed world.
There is no doubt U.S. sanctions have slowed China’s chip development and for China to catch up to military grade technology will take some time. But from a consumer technology perspective (what impacts everyday users), China can work around the current sanctions. Companies are selling chips into China which have been specifically developed for China as a work around solution to current sanctions. Domestic chip makers and producers will be beneficiaries as China looks to produce more domestically. It was just announced that US President Joe Biden is expected to meet Chinese leader Xi Jinping on the sidelines of a summit in San Francisco in November for “constructive” talks.
Infrastructure – more consolidation.We had a one-on-one meeting with one of the largest owners of infrastructure assets globally (energy, transportation, water, electricity generation sectors) – Hong Kong listed CK Infrastructure Holdings. We met with the Chief Planning & Investment Officer. Global infrastructure has been a challenging space since Covid started – from 1 Jan-20 to 31 Oct-23 MSCI World Infrastructure Net TR Index (in USD) has delivered -1.22% p.a.
For Australian investors, if you took a beta position via Vanguard Global Infrastructure Index ETF (VBLD) you have delivered a positive return of +2.3% p.a. because of the currency benefits (in USD terms the return is -0.42% p.a.) versus S&P 500 +11.7% p.a. / S&P/ASX 200 +4.3% p.a. We have been out of infrastructure (and Property / REITs) since Jan-20. High level feedback: (1) we expect further consolidation in the sector whilst the industry goes through a material reset due to rising interest rates. It is worth noting companies like CK Infrastructure have the credit rating and balance sheet capacity – CKI told us they could comfortably make 2 acquisitions the size of ASX listed natural gas infrastructure company APA Group (market cap A$10.5bn).
Interestingly, CKI did make a $13bn bid for APA group back in 2018 only to be knocked back by the then Treasurer. (2) Efficient and smart operators of global infrastructure can still drive earnings growth through best practices at the operations level and utilise their balance sheet strength (i.e. top credit rating, balance sheet capacity, relationships with lenders) to navigate the higher for longer interest rate environment. (3) Infrastructure companies are thinking about sustainability and pathway to carbon-free. Natural gas will be part of the solution. The capex will be very significant due to electrification however operators will need to earn a required rate of return (we see back & forth potentially happening with regulators as they try to manage company and community expectations!).
Life Sciences – major growth area. Most investors, including us, have been discussing the potential impacts from the weight loss drug GLP-1 on various sectors and companies (we have seen it play out in share prices already). However, some are calling the obesity market as the next major growth sector. During company analysts’ briefings of global stocks we have attended this year, company management teams from across sectors (supermarkets, healthcare) have provided some qualitative comments on how the weight loss drug could impact their earnings in the future. According to JPM, the obesity market is projected to be on par with artificial intelligence (we take this with a grain of salt). We are doing more work in this space and our initial research does highlight that this is a growing sector which warrants attention. However, we would be cautious chasing stocks during the initial euphoria.
Japanese Equities – momentum to continue but need to be selective now.We have material exposure to Japanese equities which have performed very strongly over the past 12 months. One of the key themes driving the Japanese market is the corporate governance reform. Driven by the Abe government legislative reforms such as improvements to Japan’s Stewardship Code and the introduction of Japan’s Corporate Governance Code (CGC) is driving a more shareholder friendly environment in Japan.
We are seeing increasing shareholder returns via dividend growth (year on year growth in dividends). What’s exciting investors further is that dividend payout ratios in Japan are still very low relative to other developed markets (e.g., US and Europe) suggesting significant upside growth in yield. This will be further supplemented by more share buybacks. As of June-23 this year, according to SMBC Nikko Securities, of the over 2,000 major companies listed on the Tokyo bourse, over 370 have announced plans for share buybacks in 2023.
We have conducted a quick review of the companies in the Nikkei 225 Index. According to consensus data and our analysis, there are 77 companies listed on the Nikkei Index – i.e., approximately 34% of the companies – which are in net cash position (negative net debt) and therefore have capacity to announce shareholder friendly capital management initiatives.
According to an external source (chart below), the number of companies trading in Japan with net cash position is much higher at 48% versus U.S. 15% and EU 19%. The point we are making is that regardless of how you slice and dice the data, there is still plenty of scope for shareholder return going forward in Japanese equities, all else being equal.
Going forward, in my view investors need to be more selective in Japan and look at the mid-cap / small cap space. The rally in Japanese equities from Jan-23 has been driven by large cap stocks (with most investors focusing on the Japanese banks which are beneficiaries of higher rates) whereas small and mid cap stocks have lagged. Further, consideration also needs to be made around currency given Japanese equities tend to be more global earners (export market & leverage to manufacturing cycle).
From 1 Jan-23 to 31 Oct-23 (in JPY)
MSCI Japan Index +22.2%
MSCI Japan Large Cap Index +23.1%
MSCI Japan Mid Cap Index +19.8%
MSCI Japan Small Cap Index +17.4%
Indian equities – long-term opportunity and near-term risks. We have been positive on Indian equities for many years now and price performance across Indian equities (large, mid, and small caps) has been stellar over the past 3 years both in relative terms and absolute terms.
However, investors need to be aware of both risks and opportunities.
India opportunity – watch the consumer. In the chart below we have provided the GDP per capita for India, China, and Australia. GDP per capita is a good measure of economic performance and is also a good indicator of average living standards and economic well-being. Firstly, it should be noted the staggering increase in China’s GDP per capita over the past 15+ years – no surprise why consumer brands from high end luxury to everyday items have targeted the Chinese consumer market (not just in China but Chinese tourists in developed markets!). According to historical trends, the US$2,000 GDP per capita level has typically been an inflection point for any economy. In the chart below, China reached this point in 2006 and India has just hit this point. We believe discretionary spending could be a major beneficiary in India going forward.
Further, anecdotal and our discussions with investors on the ground suggest there is real momentum in the Indian middle class – there is motivation to spend (perhaps some Covid restrictions hangover) and upgrade to higher end products and services. India is also enjoying significant success on the global level, with companies looking to the Indian market as a diversification away from China (consumption and production).
India risks – upcoming national elections in April 2024. We do believe this risk is being under appreciated by the market and represents some near-term risk for Indian equities. Leading up to the main show in April 2024, there are regional elections which could provide some indications of how Prime Minister Narendra Modi’s BJP (Bharatiya Janata Party) is tracking. From our discussions with people with knowledge in India, the BJP party could potentially lose some of these elections, but it shouldn’t be viewed as a precursor to the national election in April 2024.
PM Modi has a very strong standing, has delivered strong reforms (like attracting global supply chains) and we believe his re-election would go a long way in maintaining the momentum in India’s economic growth. The alternative in the April 2024 election is the Indian National Developmental Inclusive Alliance (INDIA), which is a political alliance of 28 parties in India led by the Indian National Congress. Mathematically they can win.
We would view a BJP loss as negative given an alliance of 28 parties in power (with ranging vested interests) is likely to lead to some policy deadlock. We can use the experience of 2004 to see how the market may react toa potential BJP defeat in 2024. In May 2004, after the BJP-led government was dealt a surprise defeat at the national election, the Indian market fell close to 20% in one month. Given the strength in Indian equities (relative and absolute) over the past few years and elevated valuations, we cannot fully discount history potentially repeating itself. All else being equal, we would see this as buying opportunity.