|AlphaShares Indexes||August 2010||2010||1 Year||3 Year|
|AlphaShares China All-Cap Index (NYSE: YAO)||-2.85%||-3.02%||12.33%||-2.44%|
|AlphaShares China Small-Cap Index (NYSE HAO)||-1.25%||-0.84%||19.33%||-2.03%|
|AlphaShares China Real Estate Index (NYSE: TAO)||-1.81%||-3.38%||10.31%||-3.90%|
|FTSE/Xinhua China 25 Index||-3.95%||-7.67%||1.50%||-5.71%|
|CSI 300 (A-Shares)||0.67%||-18.18%||3.41%||-15.17%|
As global growth continues to slow, investors are becoming concerned with the sustainability of the global recovery. Activity in the US has been disappointing with high unemployment claims, lackluster consumer demand, and a weak housing market. However in China, July macro indicators as well as August manufacturing PMI suggest that the local economy is stabilizing at a healthy paceopposed to cooling as it has elsewhere across the globe. China’s NBS manufacturing index improved to 51.7 in August from 51.2 in July to stay above the expansionary threshold of 50. As reported last month, China’s Q2 GDP slowed to an impressive 10.3% following its 11.9% annualized growth reported in Q1 enough to enable the country to become world’s 2nd largest economy after reports on August 15th that it had eclipsed Japan.
Unseating Japan for the #2 spot (after passing Germany, France, and Great Britain in recent years) underscores China’s growing clout. Experts are predicting that China, whose economy is 1/3 the size of the US today, may become the world’s largest economy as early as 2030. Under the direction of the Communist Party, China has begun to reshape the way the global economy functions by virtue of its growing dominance of trade, its huge $2.4 trillion hoard of foreign exchange reserves, and its voracious appetite for natural resources. Its state-directed development model has allowed it to build a first-world infrastructure and turn its cities into international showpieces. In a March address, Prime Minister Wen Jiabao noted, “The socialist system’s advantages enable us to make decisions efficiently, organize effectively and concentrate resources to accomplish large undertakings.”
In Japan, the mood was one of resignation, as it has benefited from a booming China. Like many nearby countries and larger strategic global corporations, Japanese firms initially located business production there to take advantage of lower wages. As local incomes have risen, many of those “China-linked” companies have also been able to tap into the large and increasingly lucrative market of Chinese imports.
The explosion in Chinese economic growth is also helping old wounds heal. Taiwan split from China amid a civil war in 1949; however, Beijing continues to claim the island as its own. In the past two years, the sides have built trust by resuming regular air and sea links after a 60-year hiatus, and have ended restrictions on Chinese investment in Taiwan. Most recently, on August 18th, Taiwan’s legislature approved the Economic Cooperation Framework Agreement (ECFA) that was signed seven weeks prior by both governments. The pact slashes tariffs on hundreds of products, allows both sides wider access to each other’s financial industries, and has warmed Cross-Strait relations to their closest point in six decades.
The AlphaShares China All-Cap Index slipped -2.85% and is down -3.02% so far in 2010. The AlphaShares Chinese Volatility Index (CHIX) finished August at 22.69, up 8.44% from its 20.82 July close its lowest level in the previous 40 months. Meanwhile, the CBOE S&P 500 Volatility Index (VIX) gained 10.85% to finish August at 26.05 as the S&P 500 Index posted its worst August decline since 2010, falling -4.51% during the month. Not only has the CHIX traded less than the VIX every day in August, the CHIX discount widened against the VIX to -12.92%. The CHIX had started at a +23.51% premium to its US counterpart at the beginning of the year.
Smaller Chinese companies (as measured by the AlphaShares Small-Cap index) managed to weather a difficult August month for global markets better than their larger capitalized counterparts (as measured by the FTSE/Xinhua Index), falling -1.81% versus -3.95% this month to bring their respective YTD returns to -0.84% and -7.67% respectively. Not helping the larger cap indexes were their heavy weights in financial stocks China’s worst performing sector in August falling -5.51%. The FTSE/Xinhua has 47.46% of its holdings in Financials, while the AlphaShares Small-Cap index has only 12.00% of its assets invested in the sector. The AlphaShares China All-Cap Index uses a 35% sector maximum cap in its index methodology, and has a 32.07% holding dedicated to financials.
The selloff in local financials was likely due to the spook in the global markets, more so than a selloff on fundamentals. The big state-controlled banks ICBC (1398 HK), Bank of China (3988 HK), and Agricultural Bank of China (1288 HK) reported strong year-on-year earnings growth of 27%, 27%, and 40% respectively. The banks’ management each noted improving asset quality and a positive outlook for the second half of 2010.
On the positive side, consumer stocks were the best performing sector this month. Consumer discretionary returned 1.13% in August, while consumer staples gained 0.58% this month. The AlphaShares China All-Cap Index has 6.15% and 5.76%, and the AlphaShares China Small-Cap Index has 15.00% and 7.09% dedicated to those respective sectors.
|Jonathan J. Masse, CFA||Dr. Burton G. Malkiel|
|Senior Portfolio Manager||Chief Investment Officer|