Investment Manager Report
Dear Valued Investors,
Those of you who know Matthews Asia well, or have visited us in San Francisco, may know that the most important piece of furniture on the investment team floor is our pool table. It has survived now for about 15 years and is in surprisingly decent shape. Its presence on the floor is a product of the Asian Financial Crisis of 1997–98, when Matthews Asia was still finding its feet. With markets collapsing around the region, our chairman Mark Headley decided that what Matthews Asia needed was a pool table to serve as a center of gravity, pulling analysts and portfolio managers away from their flashing red computer screens and getting them to discuss Asia in a more relaxed manner.
Back then, the U.S. dollar rallied while many Asian governments and corporations were laden with dollar debt. A few years later, however, a weakened dollar and strong global growth accompanied Asia’s comeback from 2000 to 2007. Conversely, over the past couple of years, the slowdown in growth in the region has been concurrent with the gentle rise in the dollar.
Towards the end of the second quarter of the year, indications that monetary policy might be tightened by the U.S. Federal Reserve, even as growth increased only moderately, caused a sudden liquidation of Asian assets and a rush to cash. As the greenback has strengthened, bonds, gold and equities have all fallen. Fortunately, however, Matthews Asia has some experience reflecting on volatile markets with the composure of a seasoned billiard player.
Investors appear to be rushing to hold cash—particularly in U.S. dollars—or, in some regards, shrinking their investment time horizons. As those timelines shorten, the opportunities lie further into the future. However, with money tightening in the U.S., Japan and China, economic activity could certainly be squeezed in the short term. I expect near-term GDP figures to be weak even as I aim to avoid a game of “guessing the quarterly GDP growth.” So, it may be time again to step away from those computer screens and consider the longer-term developments of Asia’s economies.
Media pundits exclaim that China’s shadow banking and wealth management products are “sub-prime,” casually comparing the current China liquidity squeeze to a “Lehman event,” a “Minsky moment” or a U.S. housing bubble repeated (all of which simply replaces analysis with catchphrases). China does not have a sub-prime mortgage market—people buy houses with cash. Nor are its households highly leveraged or the central government highly indebted. The average Chinese household still has a positive savings rate and the country as a whole runs a current account surplus. To be sure, China’s credit has grown rapidly in the past few years and the government has been acting to slow it, which will impact growth. But China is entering this liquidity squeeze with a market trading at 8.4x forward 12-month earnings* and one that has already fallen by nearly 70% since its peak in 2007. And it is not as if China lacks investment opportunities either at home or abroad that could cause it to get stuck in a rut as the U.S. has since the global financial crisis five years ago. So, whatever the current situation, it is not simply a replay of the U.S.’s recent woes.
Whereas the current monetary policy is bad for economic growth, policymakers already seem to be walking back on their hawkish comments while markets appear to have had some cushion from low valuations. There is no doubt that moves by monetary authorities can have a profound impact on growth; if everyone increases demand to hold cash just as the central banks slow the growth in the supply of that cash, spending will fall. And because, generally speaking, your spending is someone else’s income, we all end up poorer. But self-defeating spirals tend to end. I wonder how prolonged such a spiral could be this time. It seems strange, even bizarre, that monetary authorities in the U.S. and Japan would want to deflate expectations when inflation rates remain below 2% in the U.S. and are still negative in Japan. In my mind, this was much too quick on the draw! For, given the already reasonable valuations that markets were trading at before the sell-off, real value has emerged for the long-run investor. Even some of the high-yielding stocks, which had performed well in the recent past and had become somewhat expensive relative to history, were sold down aggressively on the back of rising U.S. yields and have since returned to reasonable valuations. I suspect that either growth will be stronger than we expect and support equity valuations or there will come a point in which the downwardly revised expectations of growth put a halt to the rise in bond yields.
So, whilst our pool table sees little action these days, we do appeal to the same sentiment that made it a Matthews Asia institution. Asia is still a region of strong demand in a world that seems stuck in a rut, with high unemployment and tighter money. Asia, too, has the potential to continue to grow at rates in excess of the developed world, due to its fast-growing rates of productivity. The region suffers in the capital markets, of course, from being seen through the prism of the U.S. dollar.
So, what to do in this environment? The strategies we employ to manage portfolios tend not to change. But we do have to be ever more alert for possible dislocations in market prices. This is to say that some stocks may be sold down over the short term. We may wish to trim other positions to add to holdings that have sold off aggressively or even to initiate new positions. But this should not be considered a change in our approach or a desire to “time” market movements. It is merely that our long-term view will seem relatively fixed in comparison to the short-run gyrations of market prices as speculators run to cash. Such price moves are likely to be unevenly distributed across countries and sectors, in our eyes, and we may have many new opportunities with which to implement our long-term view.
We would also like to inform you that, as of July 19, 2013, there were portfolio management changes to the Matthews Asia Dividend Fund. The Fund is now co-lead managed by Yu Zhang, CFA, and myself. Jesper Madsen, CFA, has decided to leave Matthews Asia, as of October 31, 2013, in order to pursue personal interests outside of finance.
As always, we feel privileged to be your investment advisor for Asia, and thank you for your support.
*Forward earnings are calculated by dividing market price per share by expected earnings per share.
Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC