Photo: World Economic Forum. ECB Action Could Create Buying Opportunities
Mario Draghi last week signalled that the European Central Bank (ECB) stands ready to counter the threat of weak inflation in the eurozone. A top official has also been reported as saying that new measures are currently being considered, which may include a long-term refinancing operation, or a programme of asset-backed security buying.
News flow indicates that the European Central Bank is clearly worried that deflationary pressures are building and that growth is slowing. Recent gross domestic product (GDP) figures from France and Italy were disappointing and, in the case of Italy, showed a small year-on-year contraction relative to expectations for a small expansion. If you marry this with other macroeconomic headlines, and with what the companies are telling us about growth across a range of industries in Europe, it paints a pretty disappointing picture. Our assumption had been that this would be a year of growth across the eurozone, albeit tepid in nature. With yields tumbling across the eurozone, and indeed globally, bond market investors are starting to bet on a growth disappointment and equity investors are now readjusting their expectations. This helps to explain some of the intra-sector moves in markets that have been witnessed in mid-May and especially in certain stocks.
The Henderson Global Equities Team are bottom-up stock-specific investors, trying to identify stocks that we think are 50% mis-valued as we look forward 2-3 years, so such moves can potentially create buying opportunities. Any action from the ECB may also support a rise in European equities from current levels. There are a number of stocks that we currently favour in Europe. These include Italian bank UniCredit, where self-help measures are resulting in bad debts falling and costs being lowered. The company may also potentially benefit from Prime Minister Renzi’s reform agenda. We also have positions in Belgian bank KBC and Greece’s Alpha Bank. The latter is interesting because of the potential for rising margins, following the tremendous consolidation that has taken place in the Greek banking sector.
Outside of financials, we own Mediaset, which along with some cost-cutting related self-help would like be a beneficiary of any GDP recovery in the Spanish and Italian media markets. We also own Rexel, the French-listed electricals distributor. This firm would be a beneficiary of any European capital expenditure recovery, which you would think likely given the strength of corporate balance sheets and the increased tendency for this to be deployed to drive growth, as per the recent wave of announced mergers & acquisitions activity.
Matthew Beesley, Head of Global Equities at Henderson Global Investors
Please note: references to individual companies or stocks should not be construed as a recommendation to buy or sell them. These are the fund manager’s views at the time of writing and may differ from those of other Henderson fund managers.
Bill McQuaker and Paul O’Connor, Co-Heads of Multi-Asset, Henderson Global Investors. Three Factors That Might Shape Global Markets
Markets are in the midst of a transition away from a world in which central bank liquidity boosted all assets, to a world of more limited policy support. The road back to ‘normality’ is likely to be bumpy as investors adjust to this new landscape. Here are three areas that we are currently watching for potential risks that could disrupt global markets.
Upside/downside surprises to US growth
The polar wave effects will soon work their way through US data, and with that we will start to get a much clearer picture of underlying economic growth in the US and what that may, or may not, mean for monetary policy. Undoubtedly, stronger US growth in 2014 would be a tailwind for risk assets in the long run. However, if data surprise strongly to the upside, this could produce a period of more significant market volatility in the short run as it would necessitate a rethinking of the profile for the federal funds rate, and inevitably other interest rates around the world. On the flip side, if it becomes evident that the weather was not to blame for economic weakness, we may once again see rallies in safe haven assets and vulnerability in cyclical regions and assets. Although our central scenario is that the US will resume a modest pick-up in growth this year, we remain alert to the possibilities of a different outcome.
China’s rebalancing act
China is in the midst of a tricky re-balancing act as it moves deliberately away from being an economy that is export-led towards one that is more domestically focused. China’s vast growth over the past couple of decades has been driven largely by the mass mobilisation of capital and labour, rather than growth in consumption. As the government undertakes unprecedented structural reforms and necessary financial deleveraging, the risks of a policy error are increasing. There is an outside chance that a financial crisis precipitates in China. A mistake in judgement in reigning credit, for example, could have dramatic knock-on effects not only locally in Asia, but in the worst case could trigger a global systemic shock.
Developments in Ukraine
News headlines have been dominated by the crisis developing across eastern Ukraine following Russia’s annexation of Crimea. At the moment, the immediate impact on the global economy of the crisis appears limited in that Ukraine accounts for only 0.2% of global GDP. A more genuine threat is posed, however, by the potential disruption of energy supplies to Europe and any retribution visited on Russia through trade embargoes. The conflict as it currently stands is not driving our positioning, but it does contribute to our wider sense of caution about risk assets and our preference for developed markets over emerging markets.
Column by Bill McQuaker and Paul O’Connor, Co-Heads of Multi-Asset, Henderson Global Investors
Passive investing ranks among the most successful innovations of modern finance. We do not deny that is an appealing concept. In fact, we fully acknowledge that:
a passive manager is likely to outperform an active manager chosen at random, assuming the latter involves higher fees and costs
passive investing is highly transparent, as performance can be evaluated against an index that is independently calculated by a third party
a passive approach can be applied on a large scale because of its high liquidity
passive investing may be considered a safe choice, because by pretty much guaranteeing a return close to the index it eliminates the risk of having to explain a large underperformance sooner or later
However, we also have some serious concerns with regard to passive investing. We argue that if these concerns are also taken into account, the case for passive investing is not so clear-cut anymore.
Concern #1: passive investors are free-riders
Lorie and Hamilton (1973) already noted that the market can only be efficient if a large number of investors actually believe it to be inefficient, the so-called efficient markets paradox. In other words, the existence of a large number of active investors is a necessary requirement for efficiently functioning capital markets. Active investors continuously trade on perceived mispricings, thereby ensuring that the price of each security always reflects the market’s best assessment of its (unobservable) true value, and that the market is highly liquid. As such, active investors play a vital role in financial markets. Passive investors, on the other hand, are basically free-riders, as they do not make any attempt to assess the fair value of a security. Instead, they assume that active investors have done their homework properly, which enables them to simply accept and mechanically follow the observed security weights in the capitalization-weighted market portfolio.
Active investing: a moral responsibility?
A famous quote from Benjamin Graham is that the market can be compared to a voting machine. This is a useful analogy, because, similarly to passive investing, voting in a parliamentary democracy involves a big free-riding problem: voting is basically futile so long as millions of others vote. Free-riding appears to be a rational alternative: instead of going out to vote, spend the time on a more useful activity, such as family or a hobby. Interestingly, however, most people are well aware of this logic but still choose to put time and effort into voting, arguably because they see this as a moral responsibility in a parliamentary democracy. In the same spirit, active investing may be seen as a moral responsibility that comes along with a market economy. An efficient and liquid market benefits everyone, but because this can only arise as a result of large-scale active investing, perhaps every investor should feel obliged to contribute.
Concern #2: passive investing goes against proven factors
Our second concern with passive investing is that it goes against proven factors. The literature provides extensive evidence that securities with certain factor characteristics tend to exhibit a very poor performance, while other characteristics appear to be rewarded with better returns. Because passive investors simply buy the capitalization-weighted market portfolio, which contains all securities, they basically choose to ignore such evidence. In other words, a passive approach involves intentionally investing large parts of one’s portfolio in segments of the market that are known to be associated with disappointing historical performance characteristics.
If you believe in factor premiums, passive investing does not make sense
The logical implication of factor premiums is not to adopt passive investing and thereby intentionally invest large parts of one’s portfolio in segments of the market that are known to be associated with very poor historical performance characteristics, such as growth, past-loser and high-volatility stocks. In fact, it makes more sense to actively avoid unattractive segments of the market and seek more exposure to attractive segments.
David Blitz, PhD, isHead Quantitative Equities Research at Robeco.
Most developed markets have long offered numerous and diverse channels for asset management products—except in South Korea. Until very recently, there have really been just two primary channels in South Korea—banks and brokerage companies, which suffer from conflicts of interest, as they are motivated to sell products run by their affiliates. As of late last month, investors got a new option: Korea’s first online fund supermarket.
The newly launched online fund platform, known as Fund Online, seeks to confront the proprietary sales approach of the big bank and brokerage firms by providing an alternative that is more neutral and widely available. Additionally, Fund Online, which serves smaller, independent asset managers, aims to reduce costs for investors, and create a more competitive distribution landscape.
The concept of investing as a long-term means of wealth generation is slowly developing within Korean households. When I first started working in the industry in Seoul in 2005, investors were beginning to build unrealistic expectations because of the performance of the Korea Composite Stock Price Index. Retail investors typically held high expectations for substantial double-digit returns, so fees of a few percentage points were less of a concern. At the time, fund firms charged fees as high as 2.5%. Particularly popular at the time was a so-called “installment-type equity fund,” which investors could buy into with a fixed contribution deducted from their monthly paychecks. It was a notable phenomenon, as the average Korean found equity funds to be novel new instruments for savings.
After the Global Financial Crisis of 2008, retail investors became more cautious and, not surprisingly, fee-sensitive. Consequently, the average total expense ratio of actively managed equity funds in Korea dropped to 1.41% in 2012. Of that, commissions to distribution channels lost the biggest share.
Fund Online, which is privately held, hopes to allow retail investors more investment choices and also provide better transparency over fees. The fund supermarket says it has halved sales channel commission to approximately 0.35%. In a related development, the Korean government has introduced the concept of Individual Financial Advisor (IFA) to help provide unbiased investment advice to retail investors. Currently, the average Korean investor is accustomed to getting advice for “free” from their local bank branch, where they hold bank accounts; but, as previously implied, few things come for free. A symbiotic relationship between the fund supermarket and the IFAs, if it develops, should lead to greater transparency for the industry, and may promote the virtues of long-term investing—a welcome development for Korea’s capital markets.
Soo Chang Lee, CFA, Research Analyst at Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Foto: Arild Vågen. Una historia de dos continentes
Monetary policy in the US and in the eurozone is increasingly heading in different directions, with corresponding implications for fixed income markets. In truth, differences in monetary policy owe more to the stage in the economic cycle at which their respective economies are at – the eurozone arguably still in the recovery stage, some way behind the US which is in the mid-to-late cycle stage.
Divergence in eurozone and US 10-year yields
Source: Bloomberg, 10-year core government bond yields, US and eurozone, 02 May 2009 to 02 May 2014.
We expect that the US economy will continue to build momentum and that existing forward guidance will come under greater pressure this year. The first quarter gross domestic product growth figure of 0.1% (annualised) was disappointing but needs to be put into context. Unseasonably bad weather clearly hurt consumption, net exports are a notoriously volatile figure whilst the inventory build slowdown that negatively impacted first quarter figures augurs well for a rebuild over coming months. The second quarter, therefore, is likely to see a resumption of stronger growth data.
We are employing a number of strategies to take advantage of this divergence. This includes having exposure to interest rate risk in Europe
What is more, the jobs market is buoyant. Unemployment is dropping and associated wage pressure may not be far off. Vacancy rates, which are at high levels, suggest growing labour market tightness. Whilst inflation pressures are still muted, wage push inflation could be a concern and this will allow the market to consider interest rate hikes earlier and quicker than are currently priced in.
The US Federal Reserve (Fed) also appears committed to tapering its asset purchases (quantitative easing – QE) by an additional $10 billion at each Federal Open Market Committee (FOMC) meeting. If tapering is maintained at this pace, this would see additional QE end by the fourth quarter of this year.
In contrast, we have an outright short duration position in the US to mitigate the expected rise in yields
Assuming economic data remains robust, the Fed has suggested that rate hikes could come as early as six months after the current round of QE ends. Absent very weak data or another crisis, we therefore expect the first rise in interest rates to take place in the first half of 2015.
In contrast, eurozone growth is still anaemic and deflation remains a threat. The latest April flash Eurozone annual consumer price inflation rate came in at 0.7% versus 0.8% consensus. German inflation did not bounce back as strongly as expected and Spain is hovering close to outright deflation. This is helping to raise expectations of further policy easing measures such as negative deposit rates, revitalising the Asset Backed Securities market or QE.
We expect the euro to underperform the US dollar
Although the European Central Bank (ECB) has so far refrained from outright QE, Mario Draghi, the president of the ECB has been keen not to rule it out. Even Germany, which has been the most vocal opponent of QE, has softened its line somewhat. In late March, Bundesbank President Jens Weidmann stated that he could back QE under certain circumstances.
With this in mind we are employing a number of strategies to take advantage of this divergence. This includes having exposure to interest rate risk in Europe, which we believe will be rewarded given our view that eurozone monetary policy is unlikely to be tightened. In contrast, we have an outright short duration position in the US to mitigate the expected rise in yields, which would weigh on the prices of existing bonds.
In addition, we expect that shorter dated European government bonds will remain anchored, with the European yield curve remaining steeper than that of the US where we expect the yield curve to flatten as short dated yields rise faster than long dated yields.
Finally, we expect the euro to underperform the US dollar. This is because the euro has been relatively strong against the dollar recently but this relative strength is likely to be tested as US yields move higher and any rise in US interest rates draws closer.
Article by Kevin Adams, Director of Fixed Income at Henderson Global Investors
Minas de ópalos en el sur de Australia; Foto de Georgie Sharp. “Down Under”: de las materias primas al consumo
Ever since China’s demand for commodities intensified around 1999, its increased reliance on imported energy and minerals has underpinned Australia’s boom in the natural resources industry. Naturally, as China’s import growth has recently slowed, materials and energy sector firms in both Australia and New Zealand have grown cautious about their business prospects.
As a result, some mining companies are now looking into programs to reduce their operating costs such as driverless trucks to haul such resources as iron ore. Some companies are seeking to cut capital expenditure and exploration budgets by as much as 25% this year. In March, I met more than two dozen companies from Australia and New Zealand. A common theme among them all was how the economic rotation in China is impacting their economies.
But despite the potential slowdown in commodity investment, the economies of Australia and New Zealand appear well-placed given a pickup in other sectors such as housing and tourism. Trade with China is no longer just a resources story.
Big cities, such as Auckland, Melbourne and Sydney, have witnessed such a surge in demand from buyers in Asia that fears of a housing bubble have been sparked. Home prices in major Australian cities rose 9.8% in 2013, the fastest calendar-year growth since 2009, according to the RP Data-Rismark Home Value index. Home prices in Australia have reached all-time highs as measured by household income, and New Zealand also ranks high among pricey real estate markets.
Chinese vacationers have also been reinvigorating tourism Down Under. Visitors from mainland China have been growing at a double-digit pace, and some economists estimate that if the current pace of tourism continues, China could surpass neighboring New Zealand as Australia’s primary source of visitors. A growing class of more affluent travelers is emerging not only from China but all over Asia, eager to travel abroad. Apparently the lure of a pollution-free holiday spent in the lush, unspoiled outdoor beauty of Australia and New Zealand is a strong one for Chinese tourists. In a recent survey by the China Tourism Academy, Chinese tourists ranked New Zealand as the most desirable travel destination out of a survey of 22 locales (Australia placed 4). To boot, New Zealand has plans to open a world class exhibition, casino and hotel project in Auckland that is expected to draw Chinese tourists after its scheduled 2016 opening.
In addition to revenues directly tied to tourism, Australia has also benefited from investment in the hospitality sector; Hong Kong and mainland Chinese investors accounted for 18% of those investments in 2013.
Australia and New Zealand may not have traditionally been thought of as part of Asia. In the recent past, they may have been seen more as just derivatives of Asia’s demand for commodities. But to assume that their relationship to Asia depends only on the commodity-intensive growth of the past is to ignore the attractions that these two countries hold for Asia’s rising middle class. Tourism is but one example of the growth opportunities we find.
Opinion column by Tarik Jaleel, CFA. Research Analyst, Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
The peak of the liquidity-driven market and the rebalancing of global growth will have different effects across developed and emerging markets.
At the close of 2013, investors were perhaps becoming a little complacent about the equity market. The seductive language of all-time highs, instant profits and long-term growth continued to drive flows even as the Federal Reserve (Fed) made it clear it was intent on turning off the taps.
While the crisis years were marked by a coordinated response from the major central banks to stem systemic risks, the journey back from that remarkable place is likely to be one that authorities increasingly take on their own. The Fed’s taper marks the peak of the liquidity-driven market environment and the start of a slow normalisation, but this will not be followed uniformly. Economies face their own unique blend of political, fiscal and monetary challenges which must be overcome to reach the next phase of the economic cycle.
Episodic volatility
Investors be warned: although economic confidence has helped tame volatility, the abundance of liquidity and a diminishing fear of systemic risks have also helped subdue market fluctuations. On the last few occasions when market volatility was this low, namely the mid-1990s and mid-2000s, equity bull markets were being driven by rapid growth and low inflation – we aren’t there yet.
As a result, episodic market flare-ups are to be expected as the return to fundamental-based investing occurs. The recent turbulence in emerging markets (EM) has been attributed to numerous causes, but has undoubtedly been complicated by the lid being lifted on the underlying fragilities of some individual EM countries.
Global growth broadens
The actions and communications from the major central banks will continue to determine how smooth the normalisation process is. Global growth is improving and broadening in the developed world, and we believe this will continue to be a major theme for 2014. For markets to progress, investors must be adequately convinced that policies are being correctly tailored to the strength of economic fundamentals. Each major economy is now at a different point on the curve and will have to act independently from its peers, adopting a certain degree of needful self-interest while not destabilising the delicate balance in global relationships.
Having pursued aggressive and early monetary expansion, the UK and US have seemingly reaped first-mover advantages from their consumption-led recoveries, but must now be careful to manage interest rate expectations. The unexpected vigour of the UK economy has taken many by surprise: the Bank of England (BoE) now anticipates growth of 3.4 per cent this year, the fastest pace in the developed world, and BoE Governor Mark Carney has been forced to row back from linking forward guidance specifically to the jobless rate. We believe it is a close-run call between the US and the UK as to which will tighten monetary policy first.
Risk of policy error
In contrast, Japan is a relative latecomer to quantitative easing (QE), and is only beginning to reap the payoffs from aggressive monetary stimulus – a weakening yen and inflation rising above one per cent for the first time since 2008. It has recently revamped two of its loan support programmes to boost corporate and household borrowing, and we suspect that stronger monetary stimulus is being kept in reserve for times of greater need.
Further afield, the European Central Bank has done an admirable job of damping the flames of contagion from Europe’s financial system, but its hand may be forced in deploying its own form of QE, if falling inflation threatens to derail its recovery.
Given the very different economic challenges that these central banks face, the risks of policy error are undoubtedly increasing. Authorities will need to employ all their skills in managing and communicating change to market participants, whether removing stimulus or choosing to add more liquidity. Thus far, the Fed has largely convinced investors to disassociate incremental tapering from interest rate rises, but if growth surprises to the upside investors could become fearful about policy tightening occurring earlier than 2015.
Diverging fortunes
While improving growth prospects for the developed markets are a key theme for 2014, this also plays into a second leitmotif for the year ahead: a divergence in the fortunes of the G10 versus EM. The growth gap has been falling since 2009 and is expected to narrow further this year. Structural EM expansion cannot continue indefinitely, and in contrast to developed market policymakers, their EM counterparts do not have significant options for regenerating growth.
The most fragile countries must contend with current account deficits that are both negative and widening. The implication for EM equities, which have witnessed extraordinary flows in the post-crisis grab for yield, is that investors may cast a heavy eye on fundamentals and take their money elsewhere. While some of the risks are arguably priced in, potential currency fluctuations must be factored into any investment decision.
Balancing the risks
The risk of volatility flare-ups, the fragmented approach of central bank policy responses, and potentially dormant systemic risks mean that the road back to ‘normality’ may be bumpy: we think it makes sense to keep some firepower in reserve in the form of cash. We remain vigilant to potentially higher market volatility providing opportunities for us to tactically add new positions or increase existing ones on favourable relative valuations.
On a broader view, equities remain our favoured asset class as improving economic prospects and, by implication, policy tightening lead to a slow but bearish re-pricing of government bonds. The caveat remains that equity valuations have risen, placing a greater requirement on an earnings recovery, so we can probably expect lower returns this year than 2013.
After five years of central bank policy experiments, the return to a more balanced outlook for global growth and a more ‘normal’ market environment is unlikely to be straightforward.
Paul O’Connor is Co-Head of Multi Asset within the Henderson Multi-Asset team.
Labor market conditions in Japan are tightening. In February, unemployment fell to 3.6% while the job offer-to-applicants ratio rose to 1.05—levels not seen since mid-2007 for either metric. I was in Japan recently to meet with the senior management of about two dozen companies to gauge how changing labor market conditions could affect business sentiment and consumption.
Manufacturers still appear quite relaxed over the availability of labor while service sector companies appear quite concerned. This was the expected response as manufacturers have the option to move overseas where labor costs are a fraction of what they are in Japan. On the other hand, you can’t really move a restaurant to China. Service companies are impacted not only as a result of wage costs, but also construction costs. Japan’s labor shortage is particularly acute in the construction sector where job openings outnumber job seekers three to one. Faced with higher store opening costs, some companies have had to curtail expansion plans.
Domestic Japanese companies have typically controlled wages in the past by increasing temporary labor. Temporary workers as a proportion of the overall labor force has increased from 26% in 2000 to almost 38% at the end of 2013. This has been a primary reason why wages in Japan have been stuck in neutral since 1997. This long-term trend may be turning a corner, however.
Recently, two major Japanese consumer discretionary companies have announced plans to incrementally transition their temporary staff to full-time workers. They cited benefits from reduced staff turnover and training costs as main drivers for the change. But this shift also likely reflects the difficulty, even among prominent companies, to hire and retain the necessary workforce for their operations. These firms, considered leaders in their respective industries, may set the tone for others to follow. After all, if you were a worker looking for a job, where would you rather go? A top company offering permanent positions? Or another firm offering a temporary job?
There has been much concern that Japan’s consumption tax hike, which began this month, may derail the country’s still-fragile growth prospects. Though a short-term decline in demand seems highly likely, I believe the strong job market may offset some of the negativity surrounding this change.
Service sector companies are responsible for 65% of Japan’s overall workforce—in jobs that cannot be shipped overseas. If current labor market conditions continue, there may be considerable pressure to raise wages going forward. The annual spring wage negotiations between employers and unions have resulted in a modest win for workers who will see a base wage increase of roughly 2.2%. Still, this year, there was considerable pressure from the government to raise wages. The government even pushed up a scheduled corporate tax cut to fund the wage increases by a year. Tight labor conditions are not fully reflected in wages yet, leaving the possibility for future wage increases. I believe this could be the catalytic development that the Bank of Japan has been working toward in its inflation targeting policy. Wage growth is crucial to convincing both consumers and investors that inflation in Japan is here to stay.
Opinion Column by Kenichi Amaki, Portfolio Manager at Matthews Asia
The views and information discussed represent opinion and an assessment of market conditions at a specific point in time that are subject to change. It should not be relied upon as a recommendation to buy and sell particular securities or markets in general. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. In addition, single-country funds may be subject to a higher degree of market risk than diversified funds because of concentration in a specific geographic location. Investing in small- and mid-size companies is more risky than investing in large companies, as they may be more volatile and less liquid than large companies. This document has not been reviewed or approved by any regulatory body.
Wikimedia CommonsHAVAL H9, SUV by Great Wall Motors Company. Bedrock of Investment in China: Rising Domestic Consumption
The rise of domestic consumption is the bedrock of the investment case for China. As overall Chinese economic growth slows after years of rapid investment-led growth, consumers enjoying the benefits of compounding mid-teen income growth will become more and more important to the economy. Many investors believe that western multinational companies are the best way to tap these new consumers. We have sympathy with this view and recognise that some companies like Yum! Brands, which own fast food chain KFC, are well positioned. Yet we believe that investors are missing a huge opportunity to tap into local companies that really understand the dynamic, and often regional, consumer tastes. These strong brands often have superior long-established deep distribution networks that give them an enduring competitive advantage over foreign brands.
One example of a successful privately-owned home grown brand is the Great Wall Motor company. Coming from Baoding in Hebei Province, it has emerged as China’s leading sport utility vehicle (SUV) brand. Just as in the west, rising incomes lead consumers to want larger cars, so SUV sales have jumped from an annualised rate of 1m units in 2010 to over 3m in 2013. As the industry leader, Great Wall Motor has delivered strong growth in the expanding market as well as a strong five-year run for the stock. However, in the last six months the company has hit growing pains. Profit margins have fallen while research and development is stepped up, and the new H8 model launch was delayed. These hiccups have caused investor sentiment towards the stock to cool dramatically. Valuations are back to attractive levels for a strong brand, with proven home grown management, which is well positioned for a multi-year trend of growing SUV popularity.
Few Chinese companies have successfully taken their brands global, but PC and notebook company Lenovo has achieved this milestone. Lenovo has used a leading brand at home to generate strong cash flows to invest in savvy acquisitions of foreign brands, which combined with efficient manufacturing, has allowed it to consistently take market share in the global PC market. More recently Lenovo has developed the technology to benefit from the growth of smartphones in China. Furthermore, the new Yoga ultrabook has received good reviews, which makes Lenovo a competitor in the global tablet market. In 2014 the company has been busy announcing sizable merger and acquisition (M&A) deals to buy IBM’s server business and Motorola from Google. Given Lenovo’s excellent track record of integrating businesses we believe the company is now even better positioned to grow in China and abroad as a genuine technology brand.
The reform measures announced at the November 2013 Communist Party Plenum are a major change in philosophy for directing the economy. President Xi has embarked on an anti-corruption crackdown that has seen lavish government spending budgets dramatically cut and is now turning his attention to the waste and inefficiencies in state controlled businesses (SOEs). We are starting to see monolithic SOEs in the energy and telecom sectors cutting capital expenditure budgets and raising dividend payout ratios. In addition to shaking up SOEs, President Xi is introducing more market forces into the economy including the liberalisation of interest rates and financial markets. Private investors in the UK cannot access the local A share markets in Shanghai and Shenzhen, but they can buy shares in Citic Securities, which is China’s largest stockbroker. The company is also listed in Hong Kong, and stands to benefit from financial reforms and any pick up in sentiment in the local market
Opinion column by Charlie Awdry, portfolio manager of Henderson Global Investors’ China Opportunities strategy
Over the last ten years, light emitting diodes (LEDs) have revolutionized the backlighting market for consumer electronics such as mobile phones, tablets and TVs. Further technology improvements and declining costs are now opening up new applications for LEDs. The general lighting segment in particular, offers a tremendous growth opportunity for the LED value chain.
LED lighting consumes up to 90% less power than regular incandescent bulbs and 50% less than fluorescent lights, significantly reducing electricity costs
LEDs currently offer the best combination of characteristics important in lighting: long life, high lumen output, good color quality (CRI), color control, dimming option, precise on/off timing, low heat release and a longer lifetime. In combination, these features offer a key advantage over other light sources: energy efficiency and reduced maintenance costs. LED lighting consumes up to 90% less power than regular incandescent bulbs and 50% less than fluorescent lights, significantly reducing electricity costs.
The case for more efficient lighting is obvious: lighting consumes almost 20% of the world’s electricity
The case for more efficient lighting is obvious: lighting consumes almost 20% of the world’s electricity, yet the current installed base of lighting products is extremely inefficient. At the city-level, LED streetlights provide significant cost savings potential as street lighting can account for up to 40% of a city’s electricity bill.
In addition to improved energy efficiency and reduced costs, LEDs offer multiple other advantages such as the ability to integrate them into a networked infrastructure, making up an integral component of a city’s common infrastructure. Such a network can be leveraged by a plethora of new applications including intelligent traffic lights and electric vehicle charging stations, enabling the proliferation of smart cities and smart homes in developed markets, as well as in the electrification and expansion of the electric grid in developing markets.
“With a market size of close to USD 100 billion – and growing – the global general lighting market represents an enormous opportunity for the LED lighting supply chain”
Companies that are well positioned to benefit from a growing LED lighting market include equipment suppliers Veeco and GT Advanced Technologies, testing equipment supplier Chroma ATE, materials suppliers such as Rubicon, and integrated companies with strong patents, technological capabilities and access to the market, such as Epistar and Philips.
With the expansion of networked lighting, companies offering networking infrastructure and control software – such as Silver Spring Networks and Schneider Electric – also stand to benefit from growth in the LED lighting segment.
Article by Bojana Bidovec, Senior Equity Analyst RobecoSAM Smart Energy Strategy
