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AlphaShares Monthly Letter: May 2012

AlphaShares Indexes May 2012 2012 1 Year 3 Year
AlphaShares China All-Cap Index (NYSE: YAO) -10.77% 1.76% -21.53% 3.71%
AlphaShares China Small-Cap Index (NYSE HAO) -8.65% 3.66% -28.56% 1.46%
AlphaShares China Real Estate Index (NYSE: TAO) -8.62% 13.45% -15.53% 2.24%
AlphaShares China Technology Index (NYSE: TAO) -9.83% 4.83% -25.97% 8.70%
AlphaShares Yuan Bond Index (NYSE: TAO) -1.02% 0.27% NA% NA%
FTSE/Xinhua China 25 Index -12.12% -3.53% -24.20% -1.06%
CSI 300 (A-Shares) -0.62% 11.36% -9.51% 0.79%

China News:

China's reported April economic numbers came in surprisingly weak and pointed at broad-based weakness in economic activity. The month started with China's official purchasing managers index (PMI) rising to a 13-month high of 53.3 in April from 53.1 in March - though slightly less than market expectations of 53.6 (PMI readings above 50 signal factory expansion while those below 50 point to contraction). Other economic data that keeps growing, just less than expected, include: Chinese exports, industrial output, retail sales, and fixed investment growth.

The People's Bank of China (PBoC) signaled to the public markets that they are aware of slowing growth by cutting its banks' reserve requirement ratio by 0.50%. This is the third cut so far in the current cycle of monetary-policy loosening with the first two being in November and February. Inflation-wise, China's April CPI inflation rate eased moderately to 3.4% year-over-year compared to 3.6% in March - bringing the 1-year real deposit rate back into positive territory and giving room for possible cuts as the country continues to try to cool inflation while sustaining economic growth. Just before the RRR cut, the central bank announced in a statement that it will make its monetary policy more targeted, flexible, and forward looking. The PBoC said it will maintain a prudent policy and appropriately fine-tune when necessary.

The World Bank cut its economic growth forecast for China this year from 8.4% to a still robust 8.2% - but would come in at its slowest pace since 1999 at 7.6%. It recommended fiscal stimulus over monetary policy (as real interest rates are negative) which would "ideally" be less credit-fueled, less local government-funded, and less infrastructure-oriented. Instead, it suggests fiscal measures that support consumption (such as targeted tax cuts), social welfare spending, and other social expenditures. During a visit to six provinces over the May 18th weekend, Premier Wen Jiabao said that the economic situation is stable overall, and growth is still within expectation, but warned that the government should "give more priority to maintaining growth" - a comment that was seen as a signal for bolder fiscal spending plans.

China Equity Markets:

After February, China equities were among the best performing global markets, but reversed the early 2012 trend with a sharp down move in March. Even so, the broad-based AlphaShares China All-Cap Index (ACNACTR Index) was able to post its best quarterly return in over a year (up 11.01% in Q1). Local equities continued higher in April, advancing 2.73%. The index is now up 14.04% YTD.

On April 13th, the National Bureau of Statistics (NBS) announced that China's economy expanded to 8.1% in the first quarter of 2012, though slowing from the 8.9% expansion in the fourth quarter of last year. It was the country's slowest expansion in 11 quarters. However, the contribution of consumption-to-GDP growth was 60.3% noted the NBS, adding that indicated domestic demand played an increasingly important role in the country's economic growth. Also, retail sales, the major gauge of consumer spending, rose 15.2% in March year-on-year.

Small cap stocks (represented by the AlphaShares Small-Cap index: ACNSCTR) lagged their large cap counterparts (represented by the FTSE China 25 Index) during the month, gaining 1.87% and 3.51% respectively. However, small cap stocks have performed better so far in 2012 as their respective YTD returns are 13.48% and 9.77%.

Global equities sold off violently during the month on renewed concerns that China's economy is slowing down, resurfacing European debt woes, and a possible Greece exit from the Euro zone. The AlphaShares China All Cap Index (Bloomberg: ACNACTR) lost -10.77% in May, but remains up so far in 2012 with a positive 1.76% year-to-date (YTD) gain. After trading as low as 19.95 on April 27th (its first time below twenty since July 2011), the AlphaShares Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), traded as high as 28.75 on May 24th, before finishing the month at 27.63 - or 34.52% higher than April as contagion fears hit the options markets.

A popular H-Shares gauge is the Hang Seng Index, which dropped -10.76% this month (its worst monthly performance since September 2011 and its worst May finish since 1998), but is still up +2.66% YTD. However, with the May sell-off, Price / Earnings (P/E) valuations for the Hang Seng ended the month at 8.81x - its lowest since global equities bottomed in March 2009. Perhaps indicating how segregated Chinese investors are from the rest of the world, the A-Shares benchmark CSI 300 Index slipped only - 0.62% in May to bring its YTD return to 11.36%.

Small cap stocks (represented by the AlphaShares Small-Cap index: ACNSCTR) actually fared better than their mega-cap counterparts (represented by the FTSE China 25 Index) during the month, falling -8.65% compared to -12.12% in May. China's small cap stocks continue to performed better in 2012 as their respective YTD returns are 3.66% versus -3.53% YTD.

No China sectors were immune from the violent May sell-off, as all ten sectors posted negative returns, with a range of -6.09% (Utilities) to -16.86% (Energy). PetroChina (857 HK) and CNOOC (883 HK) had the largest negative contribution to index returns as they returned -16.53% and -15.15% in May. In terms of valuations, however, the downward move in the two stocks brought both Chinese energy giants' 12- month dividend yields to nearly 4% by month's end.

After being China's largest contributor of index returns in April with its 12.65% gain, Tencent (700 HK) shares reversed and was the third largest detractor to index returns this month. One month after China's biggest internet company closed at an all-time high of 243.80 HKD, shares fell -12.50% in May. The AlphaShares China Technology Index (ACNITTR) stocks were off -9.83% in May, but remain up 4.83% YTD. On the other end of the return spectrum, Huaneng Power International (902 HK) was the largest positive contributor to May index returns, gaining 7.13% this month. Shares of the publicly traded unit of China's largest electricity producer climbed as coal prices fell and news that the government will subsidize energysaving appliance purchases.

Sincerely,

Jonathan J. Masse, CFA Dr. Burton G. Malkiel
Senior Portfolio Manager Chief Investment Officer

Disclaimer text

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