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‘A Postcard from China’


Jing Sun, Manager of the PSigma Global Equity Fund, is encouraged by a recent research trip to China…

I have just returned from Hong Kong and Beijing following my annual research trip. I came away encouraged that the excess industrial capacity and real estate worries are not nearly as bad as many have been suggesting in the West. On the other hand, I do not expect any bold policy actions from China in reaction to further problems from Europe if they develop. One key conclusion reached was that the PSigma Global Equity Fund will continue to avoid many exporters based in China that require better overseas growth or domestic stimulus. Instead, we will maintain our focus on world class multi-national companies, in China and elsewhere.
The change in China from my youth as well as when I began my investment career in 1994 continues to amaze me. Anecdotally, traffic in Beijing has become markedly worse from my last visit but the air quality in Beijing seemed somewhat improved and not quite as dreadful as one reads about in the Wall Street Journal. The complaints of ordinary citizens, however, have changed little from recent years; top of the list being corruption, traffic, and high cost of housing. I do sense that inflation has become a bit more of a concern for the Chinese people than it had been in the recent past. The sky-high cost of housing, especially in major urban centres has also moved up the list of major worries for many people with no evidence of softening materially. Other signs of economic robustness include the fact that finding a taxi in Beijing is getting harder, shops and restaurants are quite busy, and the living standards for most ordinary Chinese continue to improve. This last item is the single most important thing for both the average Chinese person and their rulers. The stability of the country and the durability of China’s long-term economic growth are very much dependent on the sustained improvement of the living standard of ordinary Chinese citizens. The most important and exceedingly tricky job for the Chinese ruling elite today is managing the many negative side-effects of the break-neck speed of economic development in China whilst also keeping peoples’ living standards rising. Fortunately, so far, China has performed this high-wire balancing act rather admirably and indications suggest that China will have a fairly soft landing despite global economic sluggishness.
The Chinese economy and stock market are amongst the most policy obsessed in the world; some even suggest that the policies are more important than corporate earnings in deciding market directions as they create the framework for winners and losers. Policies and political leadership certainly play a far more important role in the direction and pace of the Chinese economy than is the case for most other major economies. Politically, 2012 will be a very important year for China, due to the once-in-a-decade leadership change at the 18th National Congress of the Chinese Communist Party. Current President Hu Jintao, Premier Wen Jiabao, and Chairman of the National People’s Congress Wu Bangguo are all scheduled to retire and the all-powerful Politburo and its Standing Committee will be repopulated with the next generation of leaders. This has serious implications not just for China-watchers but also for global equity investors. It is a delicate time for the top leaders in China, both for those who are retiring and for those who will be promoted; all of them prefer the status quo more than anything else. None of them wishes to initiate any new reforms or major policy changes before the completion of the transfer of power in late 2012. The retiring leaders want to leave a legacy of peace and prosperity but will not be allowed to initiate any changes that could make the jobs of the new leaders difficult. Similarly, the new leaders will do all they can to avoid being seen as impatient or otherwise jeopardise their chances of getting the top posts for which they have worked all their lives. The changes will take place not only at the very top of the Politburo but at a number of layers down the power structure, both in the communist party and the various branches of the government. Accordingly, although Chinese policy makers are quite worried about the crisis unfolding in Europe and the slow pace of recovery in the U.S., I do not expect the Chinese policy makers to do anything dramatic, barring a major world-wide crisis of one sort or another, (a regional war here or there, a small country decides not to pay its debt anymore, etc., do not qualify). Moreover, before the new leaders officially take over, they usually give no clues as to their long-term plans and outlooks just in case they upset the retiring leaders.
The top priorities for the new Chinese leaders are quite clear. These are:
1. to move China up the economic value-added ladder,
2. to reduce China’s dependency on exports and increase domestic consumption,
3. to narrow the ever-widening gap between rich and poor,
4. to arrest the serious damages done to the environment by the economic development in recent decades.
Although we do not know how well the new leaders will meet these challenges in the coming years, we are hopeful that they will handle these tasks competently.
In the near term, I do not think that China is in a hurry to cut interest rates yet (barring a major global crisis). The residential property market remains a bit overheated and property prices remain rather unaffordable for the average Chinese citizen. Inflation is still a major concern for China. So, although Chinese interest rate policy has moved from raising rates to holding rates steady, there is no real sign of interest rate cuts yet. Politically, I expect the Chinese leaders to maintain a wait-and-see attitude and to try their best to do as little as possible in 2012. Consequently, the Chinese stock market is likely to stay in a trading range until investors have a better understanding about where the new political leaders and interest rates are going. On the positive side for long-term investors, China is certain to invest heavily in the coming years in the less developed regions inland away from the coastal regions, to put more resources in the areas such as environmental protection, green energy and energy efficiencies regardless of who is running China or how the global economic picture looks at any given time. At some point, these themes will represent some of the many attractive investment opportunities for long-term global equity investors.
For global equity investors, 2011 reminds us once again of the risks of investing heavily in the emerging markets, such as Brazil, Russia, India and China (“BRIC”). The saying that “if developed economies sneeze, developing ones catch the flu” seems to still hold true, despite the great strides made in recent years by developing countries. For instance, despite fairly good economic growth in the BRIC countries, in US Dollar terms, the Russian MICEX Index fell nearly 21%, the Shanghai Stock Exchange (SSE) Composite Index declined 18%, the Brazil BOVESPA Index dropped 27%, and India’s SENSEX Index plunged more than 36%. In sharp contrast, the U.S. S&P 500 index was flat for the year.
This is why we believe that global equity investors should focus on value creators with long track records of good earnings and dividend growth in both good times and bad, investing in companies with strong global foot-prints, especially in the faster growing regions of the world and in countries with positive long-term demographics and owning shares of multi-national companies with strong global brand recognition and well positioned competitively in their respective industries. This is exactly what we do in the Fund. For example, in China in 2011, the Fund has avoided many exporters based in China whilst we made investments in companies such as Tencent Holdings, the leading instant messaging provider and the largest and most used internet service portal in China; and China Mobile, the leading mobile phone network and service provider in China. The Fund also invested in world class multi-national companies such as Daimler and Unilever which are major beneficiaries of the long-term economic growth and positive demographics in many developing markets such as China.

Our central case scenario for both the US and China is that both will be able to “muddle through” the current period of prolonged sluggish global economic growth. Moreover, we are sceptical of a Lehman-like global financial crisis emitting from the Euro-zone simply for the fact that everyone has been talking about it for so long and that we think that Europe has bought itself more time to deal with its sovereign debt problems with recent actions by the European Central Bank and political leaders. Among the emerging markets, we continue to favour those with relatively easy monetary policies and growth prospects such as Indonesia.

Looking back on 2011, we are very encouraged by many of our stock selections in the Fund and how the Fund has performed in 2011. For instance, for the year 2011, among the Fund’s holdings, in US dollar terms, Advanced Info Service of Thailand is up 57%, Gudang Garam in Indonesia is up 52%, AmBev in Brazil is up 16%, Philip Morris International and Intel in the US are up 34% and 15% respectively, and British American Tobacco in UK is up 23%; all outperformed significantly their respective global sectors and local stock markets.
In conclusion, as we start 2012 (The Year of the Dragon in China), we are cautiously optimistic about global equity markets. We think that the soft-landing scenario for China will be a positive factor for global equity markets in 2012. We believe that many of the risks facing equities have already been well discounted in the share prices of most leading blue chips worldwide. We see more attractive investment opportunities as the markets go through their current corrections based upon inexpensive valuations leading to asymmetrical return outcomes. We continue to search and find attractive investment opportunities in various markets across the globe with strong longer term fundamentals both on the macro and micro levels. Overall, the recent volatility in the equity markets offered us opportunities to add to our collection of very high quality companies at attractive prices.

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