|AlphaShares Indexes||September 2011||2011||1 Year||3 Year|
|AlphaShares China All-Cap Index (NYSE: YAO)||-18.43%||-24.39%||-23.48%||6.67%|
|AlphaShares China Small-Cap Index (NYSE HAO)||-22.27%||-37.77%||-36.43%||10.18%|
|AlphaShares China Real Estate Index (NYSE: TAO)||-23.27%||-31.42%||-29.29%||7.94%|
|AlphaShares China Technology Index (NYSE: TAO)||-20.22%||-26.26%||-26.60%||15.94%|
|FTSE/Xinhua China 25 Index||-16.82%||-24.25%||-23.21%||-0.64%|
|CSI 300 (A-Shares)||-9.36%||-13.65%||-8.57%||7.20%|
In a global economy dealing with the uncertainties of US recession fears and the European debt crisis, China remains a bright spot for growth. The International Monetary Fund (IMF) cut its China growth estimate for this year to 9.4% from 9.5%, and revised its 2012 forecast from 9.5% to 9.0%. However, these figures remain strong compared to the rest of the world. The IMF cut World GDP projections to 4.0% for both 2011 and 2012. This is down from 4.3% and 4.5% respectively. Its US growth forecast was also revised down to 1.6% and 1.9% from 2.2% and 2.6% respectively.
IMF predictions for emerging economies' growth was reduced -0.2% to 6.1% for 2011 and -0.3% to 6.4% in 2012. Despite the projected slowdown, emerging market growth seems to remain the best game in town relative to developed markets, which are faced with a worsening sentiment and a very challenging environment (heavy debt burdens and stagnant economies).
Still, a slowdown in growth can intensify fears of a "hard landing" (a scenario that sees local growth slumping below 5%) in China. However, we continue to feel that any observed slowdown is not indicative of a decrease in demand from the underlying economy, but rather is the planned result of government targeted inflation taming and its effort to engineer a desired "soft landing." China's Consumer Price Index (CPI) eased modestly to 6.2% in August following a 6.5% inflation reading in July - which has so far marked the peak of the cycle.
September saw interesting activity from the central banks of some "developing" countries. Both Brazil and Israel surprised markets by lowering their key interest rates. These moves marked a reversal of monetary policies from earlier this year, when most emerging economies were hiking interest rates to combat inflationary pressures. The Bank of Israel was the first central bank to raise interest rates back in the summer of 2009 in response to signs of a global economic recovery. Now, in the wake of a slowdown in local activity and increased uncertainty in the global economy, they are among the first to change stance. It will be interesting to see if this marks the front end of a cycle where those central banks that were most aggressive in hiking rates in the past couple of years turn around and cut rates in the face of deteriorating global market conditions.
While the People's Bank of China (PBC) has not formally switched to a looser policy, it certainly appears to be at least "neutral" for the time being, as it has paused any additional tightening. Since it began tightening in October 2010, the Central Bank has raised key rates five times. Its most recent rate hike to 6.56% occurred on July 7, 2011. In that tightening period, it also lifted its required reserve ratio for banks nine times. The anticipated easing of pricing pressures, coupled with rising global market turmoil, are fueling expectations that Beijing may moderate its policy stance in the coming months.
Global equity markets plunged amid the escalating European sovereign debt crisis, an increasing likelihood of the US experiencing a double-dip recession, and a possible slowing of emerging market growth. Literal and figurative storms gripped the Chinese markets during the month of September. Markets in Hong Kong were closed a day before the month-end due to Typhoon Nesat, and when markets reopened for the last trading day of the month, the September "volatility typhoon" continued to rattle equities. When it was all said and done, the AlphaShares China All-Cap Index (Bloomberg: ACNACTR) dropped -18.43% during the month, bringing its year-to-day (YTD) returns to -24.39%. The AlphaShares Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), spiked 43.16% to close September at 47.50, while the CBOE S&P 500 Volatility Index, or VIX, rose 34.38% to 42.96. Global markets began rapidly repricing risk in equities following a mid-month observation by the Federal Reserve Bank noting "significant downside risks" facing the US economy.
Small cap stocks (represented by the AlphaShares Small-Cap index: ACNSCTR) fared worse than their large cap counterparts (represented by the FTSE China 25 Index) this month, falling -22.27% and -16.82% respectively. They have returned -37.77% and -24.25% YTD.
In stock specific news, Industrial and Commercial Bank of China (1398 HK) was the 2nd largest negative contributor to index returns, dropping -25.38% in September. The world's most profitable lender and biggest bank by market value represents 4.81% of the AlphaShares China All-Cap Index. Despite first-half profits hitting a record and analysts raising forecasts for next year, ICBC's stock was not immune from a selloff that took Chinese banking stocks down -23.30% in September. The tumble in bank shares surprised equity analysts, who have more positive recommendations on the Asia country's financial stocks than any of the world's other 10 biggest markets.October
As China's third quarter GDP growth slowed to 9.1% after expanding 9.5% in the second quarter, top Chinese authorities announced a series of pro-growth initiatives geared towards funding rail infrastructure projects and small and medium sized business programs. Chinese inflation cooled slightly in September, as its consumer price index increased 6.1% in September from a year earlier, slower than the 6.2% rise in August. At the end of the month, Premier Wen Jiabao announced the government may fine-tune its economic policies as needed - fueling speculation the central bank is ending a two-year policy tightening campaign, as economic growth slows, inflation eases, and property sales slump. Tax breaks and easier access to loans have already been announced to help smaller companies.
The yuan appreciated 0.42% this month against the dollar after September's depreciation of -0.05%, which marked the first time in over a year that it did not appreciate monthly versus the greenback. The yuan has gained 3.97% against the dollar so far in 2011.
The AlphaShares Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), finished October at 34.38, down 27.62% from the month prior's close of 44.34, but not before peaking on October 4th at 53.35 - a level of "fear" not seen in China since March 2009 during the apex of the financial crisis. Anxiety over Chinese equities grew when a controversial bill was approved by the US Senate earlier in the month aimed at forcing China to appreciate the value of its yuan currency. After a violent end-of-summer selloff, local equity markets rebounded sharply as investors were reassured by the government stepped in to buy shares of bank stocks - showing confidence in bank valuations, which had been battered as of late, and essentially setting a short-term floor in a equity market desperately searching for signs of a bottom.
Fears spiked on the last day of trading before the holiday of Chung Yeung on October 4th as the AlphaShares China All-Cap Index (Bloomberg: ACNACTR) cratered to its lowest points since spring 2009 - reaching levels that brought its 2011 year-to-date returns to -30.42% respectively. However, just days after locals returned from the Golden Week national holiday, local stocks were reinvigorated by a unit of China's sovereign wealth fund boosting its holdings in the "Big Four" lenders. Central Huijin Investment, a unit of the $400 billion China Investment Corp, said the purchases were aimed at supporting the state lenders, whose share prices have tumbled due to increased lending restrictions and capital requirements this year. By the end of the month, the Chinese equities were able to stage a most impressive rallying 17.18% in October, bringing their YTD return to -11.40%.
Huijin is already the largest shareholder in the big state lenders: Industrial and Commercial Bank of China (1938 HK), China Construction Bank (939 HK), Bank of China (3988 HK), and Agricultural Bank (1288 HK). Those banks' shares gained 29.61%, 21.56%, 15.36%, and 37.90% respectively in October. The financial sector makes up 31.26% of the AlphaShares All-Cap Index.
China Mobile (941 HK) was the largest detractor from index returns as it slipped -2.96% this month. The world's largest phone company by subscribers reported earnings on October 20th that rose 5.4% in the first nine months of the year amid fierce competition in music downloads and other online businesses. Its profit growth has slowed from double-digit levels following a government-orchestrated reorganization of phone companies in 2008 that created three groups, each with mobile and fixed-line assets. China Mobile said it had 633.5 million subscribers at the end of September, up 3% from the end of June.
Baidu (BIDU US) is China's biggest internet company by market value and was the largest positive contributor to index returns in October gaining 31.12%. It reported that third-quarter profit rose 80% as revenues from search-engine advertising surged. CEO Robin Li, named by Forbes magazine as China's second-richest man, is boosting investments on services, such as wireless and travel features, to meet competition from rivals Alibaba Group (1688 HK) and Tencent Holdings (700 HK).
Large cap stocks (represented by the FTSE China 25 Index) lagged their small capped counterparts (represented by the AlphaShares Small-Cap index: ACNSCTR), gaining "only" 16.43% compared to 17.41%. They have returned -12.90% and -26.94% respectively so far in 2011.
In sum, October 2011 will be remembered for the Chinese government making a strong statement that it is prepared to act to shore up the economy and banks if faced with a sharp slowdown in demand. In a marketplace that was full of anxiety at the start of the month, these words were music to investors' ears as evident by the sharp slide in implied volatilities after reaching its apex on October 4th.November
On the inflation front, China prices slowed by the most in three years, as October Consumer Price Index (CPI) rose 5.5% from a year earlier - the least in five months (after peaking at a cycle high of 6.5% in July). Non-food inflation eased for the second consecutive month to 2.7%; while food prices rose 11.9% in October, after a 13.4% in September. The government has (1) raised subsidies for farmers to increase food supplies, (2) reduced transport charges to limit costs, and (3) told some specific companies to refrain from marking up prices. With CPI easing for the third consecutive month, inflation watchers are a bit more assured that the recently hot inflation prices may be contained.
On November 30th, it was reported that China's official purchasing managers' index (PMI) contracted again in November to register at 49.0 - showing contraction for the first time since February 2009. A reading below the 50 level separates expansion from contraction in the manufacturing sector, and marked a significant fall from the prior month's reading of 50.4.
Also on the last day of the trading month, the People's Bank of China (PBoC) said it would cut the reserve requirement ratio (RRR) for the first time in nearly three years by 0.5%. The central bank had raised interest rates five times from October 2010 and boosted banks' RRR nine times to a then record 21.5% in July for the biggest lenders. In its first RRR reduction since December 2008, the PBoC moved decisively to stimulate its economy; in a move that many analysts say could be the start of a campaign of monetary easing aimed at bolstering China at a time when its trade and real-estate sectors are sagging. The move signals that China has put growth at the top of its priority list, rather than concern about inflation - even at the risk of reigniting a property bubble that it has spent months trying to deflate.
The AlphaShares China All-Cap Index (Bloomberg: ACNACTR) dropped -8.55% in November after its strong rebound of 17.18% in October. Year-to-date (YTD), Chinese equities are down -18.98%. Small cap stocks (represented by the AlphaShares Small-Cap index: ACNSCTR) fared better than their large cap counterparts (represented by the FTSE China 25 Index) this month, falling -6.32% versus -8.44%. They have returned -31.56% and -19.25% YTD respectively.
The AlphaShares Chinese Volatility Index, or "CHIX" (Bloomberg: ASCNCHIX), closed November at 31.82, down -7.45% from October's close, after trading as high as 39.91 on November 23th. Fear gripped markets as equities posted negative returns for ten consecutive days between November 14th and 25th. Global markets were extremely volatile with the rising Euro crisis, the failure of the US congressional budget super committee to reach an agreement, and renewed concerns of a worldwide economic slowdown.
In late November, Vice Premier Wang Qishan said that "global conditions remain grim and that ensuring economic recovery is the overriding priority." Premier Wen Jiabao said that economic policies will be "fine tuned" to protect the economy against global turmoil. Policy makers have already announced tax cuts for companies, trial reform of the value-added tax system, and increased credit for smaller companies.
Before the RRR move, some economists had predicted prices of residential property to fall between -10 to -20% in the months ahead. Real estate investment accounts for about 15% of China's gross domestic product (GDP) and is the main driver of growth. The AlphaShares Chinese Real Estate Sector posted a November return of -10.76%, bringing its YTD return to -27.03%.
Consumer Staples were the second best performing sector in November, returning 0.56% behind the Utilities sector which gained 4.71%. The second and third largest positive contributors to index returns came from the consumer staples sector: Tingyi (322 HK) and Want Want China (151 HK). It was announced on November 11th, that both stocks would be added to the widely followed Hang Seng Index effective December 5th. Both stocks outperformed dramatically during the month of the announcement ahead of the index transition event, gaining up 9.17% and 8.22% respectively.
China Petroleum & Chemical Corp (368 HK), commonly called Sinopec, was the largest positive contributor, as the stock gained 5.91% in November. The company agreed to pay $3.54 billion for a 30% stake in Galp Energia's Brazilian unit, giving it access to the biggest oil discovery in the western hemisphere since 1976. Last year, Sinopec agreed to buy a 40% stake in Spanish oil giant Repsol SA's Brazilian subsidiary for $7.1 billion.
The AlphaShares Technology Index stumbled -9.13% this month. Tencent Holdings (700 HK) was the largest detractor from index returns, as the Chinese online game and social-networking company dropped -20.81% this month. It announced a 14% jump in Q3 profit amid a rise in revenue; however, the results missed analysts' expectations because of maturing products in a slowdown in the once-heady growth of China's online community, the biggest in the world by government measurers.
|Jonathan J. Masse, CFA||Dr. Burton G. Malkiel|
|Senior Portfolio Manager||Chief Investment Officer|