SocGen: Asian Equities Are So Awesome, A China Minsky Moment Is "Manageable"

If we’re going to discuss Asian equities in the context of “awesome”, we should begin with Tencent. Tencent, which has more than doubled this year, drove Asian stocks higher during Tuesday’s trading session. Trading on the main board of the Hong Kong Stock Exchange hit a 28-month high of HK$157 billion with one fifth of it in only two stocks – Tencent (HK$21.7 billion) and Ping An Insurance (HK$9.4 billion). It was hardly surprising that shares in Hong Kong Exchanges & Clearing also had a good day, rising 5.5%, the most in more than a year. Tencent’s 2.4% rise pushed it market cap. above the illustrious $500 billion market, granting it membership of an exclusive tech-only club.

Just in case the frenzy in Hong Kong equities in general, and Tencent in particular, is making you a little nervous, Bloomberg reports that one of Asia’s top performing portfolio managers believes that we can expect more of the same in 2018.

One of the world’s best-performing equity gauges is set for further gains in 2018 as tech giant Tencent Holdings Ltd. and consumer stocks drive it higher, according to Shanghai-based money manager Wang Menghai.


The Hang Seng Index has led the charge among Asia’s biggest markets this year, rising 36 percent. Tencent, which has now overtaken Facebook Inc. in market value, accounts for nearly one-third of that advance. Wang, who works for Fullgoal Fund Management Co., has seen his fund beat 92 percent of peers in 2017. He plans to stay loyal to Tencent and boost exposure to companies that may benefit from quickening inflation.


“The Hong Kong benchmark is very likely to perform well in 2018, though the index rally may not be as much as this year,” Wang said in a phone interview. “Some of this year’s best performers are worth holding as long-term bulls.”

Wang’s had 9.68% of his Fullgoal SH-SZ-HK Value Selected Flexible Allocation Mixed Fund invested in Tencent at the end of Q3 2017. Speaking to Bloomberg, Wang noted that he was interested in “food and beverage companies and dairy and liquor producers” going forward because they will raise selling prices in the face of higher rates of inflation. This piqued our interest because the highest profile (and largest) Chinese liquor stock right now is unquestionably Kweichow Moutai. Last Friday, we discussed the highly irregular move by China’s Xinhua news agency which stated that Kweichow Moutai’s share price.

“should rise at a slower pace…short-term speculation in Kweichow Moutai shares will hurt value investing and long-term investment will deliver best returns.


Perhaps investors like Wang don’t want to listen…that’s certainly the case of some mainland investors. After China announced the crackdown last Friday on shadow banking and its $15 trillion asset management products, Bloomberg reports that Chinese citizens don’t believe that guaranteed returns which have underpinned the $4 trillion wealth management products (WMP) Ponzi sector will come to an end.

But for Yolanda Yuan and other individual investors who’ve piled into AMPs issued by banks, insurers and securities firms, the government’s announcement was largely a non-event. The reason: they didn’t believe it. “I don’t think any big banks will dare to take the risk of allowing defaults on AMPs, as that will lead to a flood of fund redemptions,” said Yuan, a 29-year-old sales manager at a state-run financial company in Shanghai. She has about 100,000 yuan ($15,069) of personal savings in products covered by the new regulations.


“It’s very hard,” said David Loevinger, a former China specialist at the U.S. Treasury Department who now works as an analyst at TCW Group Inc. in Los Angeles. “You have to show people that there are no longer guarantees. The only way to show it is to force investors to take losses. They have to see it to believe it.” Chinese savers have come to depend on the stable returns promised by AMPs, most of which offer fixed rates and mature in less than a year. Bank-issued wealth management products, the biggest slice of the AMP pie, have proven remarkably reliable despite investing in volatile assets from corporate bonds to stocks and real estate. Among the more than 184,400 products that matured in 2016, just 88 suffered a loss, according to the government’s annual WMP report.

This is our favourite.

Yang Mo, a 30-year-old public relations professional in Beijing, says she has so much faith in implicit guarantees that she doesn’t bother paying attention to who’s managing her WMPs or what they’re investing in. “Backstage support will stay in place,” said Yang, who has about 100,000 yuan in WMPs. “I have never done much research into the WMPs I bought. I don’t think they will default.”

Chinese regulators seem to realise that investors are so engaged in the bull market that they won’t listening to warnings…so they’ve just issued another warning. In an article “China Fires New Broadside Against Stock Darling Kweichow Moutai”, Bloomberg reports.

A Chinese campaign about the risks of investing in Kweichow Moutai Co. shares intensified on Monday, with reporting that the Shanghai exchange criticized a brokerage for being too bullish. Essence Securities Co. failed to conduct “prudent analysis” on Moutai and fully disclose related risks when the brokerage raised its price target on the liquor maker last week, news portal Sina reported late Monday, citing a notice from the bourse.


A commentary in the state-run Xinhua News Agency on Thursday said the stock should rise at a slower pace, while the company itself issued a statement saying analysts’ share price targets and valuations in the market are “overly high.” Moutai has doubled this year, with Goldman Sachs Group Inc. raising its price estimate on the company 11 times, amid expectations the company could boost profit margins by increasing direct sales.

Which brings us to SocGen, who are very bullish on Asia, even if China is not one of their top picks. In its latest report, “The intersection of growth and returns”, the bank notes that “Asian equities remain a bright spot in equity markets” and Global growth continues to surprise on the upside and has reached its highest level since the Great Financial Crisis”. Within this dizzy level of optimism, the analysts set out to “challenge our bullish bias” on Asian equities.  However, they begin with a recap.

We previously wrote that Asia equities had been climbing a wall of worries and were a bright spot in equities markets. We listed a strong dollar, the China Congress (would it be the end of the Xi put?) and rising tensions in the Korea Peninsula as the major risks to our bullish scenario. These risks remain, but we do not see any of these factors durably derailing the Asia equity rally.

Mistakenly, in our opinion, SocGen remains sanguine about China and “less concerned about regional risk” across Asia in general. On China specifically, the analysts downplay the risk from deleveraging.

The 19th China National Congress has consolidated Xi Jinping’s power and further defined his policy agenda. Hence the next five years are likely to be a continuity of the past five. This lends an element of predictability to the markets. The most destabilising economic theme in the wake of the Congress is the pursuit of financial deleveraging mostly through regulatory tightening and further macro-prudential measures.


There are some specific country risks, however. We believe investor concerns relative to President Xi’s ascent are that the Communist Party leads the economy. A command economy proved remarkably efficient in averting a currency crisis in 2016 but for equity investors it raises several concerns (including corporate governance and resource allocation issues). Our thesis is that China equities are unlikely to achieve the very strong returns of the last 12 months. But we do not expect the economy’s trajectory to be a destabilising factor for Asia equity markets.

What surprised us most is that SocGen believes that a “Minsky moment” in China would be “manageable”, when that is something that "Minsky moments" definitely are not.

A Minsky Moment? Excessive debt leading to a Minsky moment is the warning of Zhou Xiaochuan, governor of the PBoC to markets and the second risk that we identify. The financial pain should be manageable in our view. The cut in the Required Reserve Ratio to happen in 2018 signals the PBOC's readiness to mitigate downside risk. For SOEs, lower growth in debt coupled with surging profits has reduced the proportion of debt at risk.

So, if we can navigate our way through a “Minsky in the Middle Kingdom”, what are the challenges to SocGen’s bullish bias on Asian equities? The bank states that the biggest risk is US equities and bonds.

We think the major risk to our bullish scenario on Asia equities does not lie in fundamentals (improving), liquidity (abundant) or politics (stable compared to other parts of the emerging world) but in a possible correction of US assets. Our equity strategy team’s take on the S&P 500 is a sideways market view. Although the Fed has removed unconventional monetary policy tools over the last four years, growth has not collapsed and financial assets have not deflated. Earnings have been recovering since the last quarter of 2016 and technology firms, unlike the end of the 1990s, are highly profitable.


But history of equity market corrections teaches us that at this level of valuation (the Shiller CAPE is at 31.2x), even a not so remarkable event can trigger a sell-off. This is not only a story of expensive share prices, the US Treasury market is also in expensive territory, the Fed is in tightening mode, global growth is improving and the gap between FOMC median projections (seven hikes by 2019) and market expectations (two) remains quite wide.


We therefore need to include US asset downside risks in our Asia investment strategy. If the S&P enters a bear market, we believe Asia equities will not be the place to hide as correlation rises in falling markets.

Okay, we agree, US equities and bonds are in a bubble, they could correct sharply at some point and Asian equities will likely underperform…but that’s almost always the case. This is nothing new. To its credit, SocGen crunches some numbers for us on what happens when the S&P 500 declines 20% or more during a 12-month period.

To get a better sense of how equity markets would react in such an event, we have observed the past 30 years (since the inception of MSCI Asia AC ex Japan index). We look at the daily 1-year rolling returns of the S&P, the Nikkei and MSCI AC Asia-ex Japan. Our observations prompt us to make the following three remarks:

  • A 20% or more decline in the S&P 500 over a 12-month period is rare. Over the last 30 years, it has only occurred 6.4% of the time.
  • When it has happened, the S&P has outperformed Asia (in 55% of the cases) and Japan (55%). Positive returns are rare in Asia (12% of cases) and have never occurred in Japan.
  • There have been wide divergences between countries and sectors. In summary, Asia tends to outperform Japan and South-East Asia markets tend to outperform North East Asia.

SocGen notes the wide divergences among the individual Asian markets.

There have been wide divergences between countries and sectors. In summary, Asia tends to outperform Japan and South-East Asia markets tend to outperform North East Asia.

SocGen’s strongest case for Asian equities is probably valuation, where the CAPE ratio remains below average.

However, the bank also pulls out four actionable themes for investors.

We see four major themes emerging as a result of the combination of improving fundamentals in Asia and rising concerns over the sustainability of US asset prices.


Theme #1: Protect portfolios. A sharp correction in US equities would translate into an increase in correlation and greater vulnerability for Asia assets. Hence, one of the themes of this Asia Equity outlook is to protect against the re-correlation of markets. We are long ASEAN equities and we like defensive sectors such as HK utilities.


Theme #2: Asia remains a great consumer story. Recent research from Brookings Institution estimates that of the one billion new middle class entrants, 88% will live in Asia. The problem is that valuations in the consumer sector, notably in China have become very high. We look for more reasonably valued themes exposed to Asia consumers. We find them in Japan, Korea and India.


Theme #3: Reduce momentum exposure. Despite global growth recovering, the value style has underperformed momentum. As a result, the valuation gap between momentum and value strategies has widened considerably regardless of upward revisions to the global growth outlook. We reiterate our stance on value themes including China SOEs reforms.


Theme #4: Recovering capex. Investment growth remains a topical theme in Japan given increasingly acute labour shortage issues. In the rest of Asia, the technology cycle is not likely to fade, creating further investment opportunities in the equity space.

What the SocGen report didn’t focus on was the crucial test which Asian equities are facing as the MSCI Asia Pacific Index is poised to either form a double-top or surpass its previous all-time high in November 2007.