Asset Allocation Q4 2020

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COVID Update
With rolling lockdowns now scouring Western economies and every news article devoted to it, we would like to highlight just a few points by way of update:
• The UK is absolutely not representative of the course or impact of the virus globally. With poorly recorded cases, deaths and recoveries, its statistical prowess is now a laughing-stock and should be disregarded when attempting to compare with global stats.
• The mortality rate has stabilised for countries with good access to good healthcare at under 2%.
• Countries which controlled the virus early show slightly higher cumulative mortality rates, probably because less was understood about how to treat the disease in Q1.
• Across all of Asia, despite having pioneered knowledge discovery about the disease, the total cumulative number of officially recorded COVID deaths represent fewer than 5 single days’ normal mortality.
• Over 250 vaccines are now under development globally, increasing the chances of a credible, scalable one being found soon – maybe even, as politicians are suggesting, by year end.

Asian Asset Allocation Summary

Asian countries continued to see economic recovery throughout the summer from their lows in Q1, with the strongest reported numbers coming from Taiwan (beneficiary of the tech boom) and China. It is notable, however, that with the exception of Taiwan, the countries whose data normally corroborate China’s official data (Korea, Vietnam and Hong Kong) all remained in contractionary mode. Global trade remains weak, but for each of Vietnam and Korea, their exposure to smartphones is more pronounced than to PC’s or Work from Home (WFH) equipment than Taiwan’s. Hong Kong continues to suffer from a perfect storm, as a second wave of COVID-19 exacerbated tensions surrounding the introduction of a draconian new Security Law. Elsewhere, there are some signs of economic fade, after initial pentup demand was fulfilled and evidence of corporate COVID-fatigue is growing everywhere.

Source: Marlborough Fund Managers

Along with their economies, Asian stock markets appear to be pausing at present, with earnings revisions running into resistance, but we only expect a temporary pause. Uncertainty surrounding the US election, timing of potential vaccines and Brexit are uppermost. The world is waiting for the results of the US election and in China, the 5th Plenum of the Communist Party is about to meet, setting its agenda for the next five years. The 14th 5 Year Plan (145YP) is to promote the concept of “Dual Circulation”, which will tip the balance of economic drivers to the domestic economy, whilst seeing the external economy as a linked, but separate and lesser entity. Investors should pay particular attention to the speeches on China Standards 2035 as well. Diplomatically, China herself appears beset by dark clouds on every front at present (albeit that many are of her own making), but the economy has returned to normality far faster than anyone expected. Whether these levels of activity can be sustained through the coming winter as many international trade partners deal with rolling waves of COVID will have to be seen, but the coming quarter promises a raft of high profile Initial Public Offerings (IPO’s) in all China’s many and proliferating stock markets. Of these, the highest profile will be the Ant Financial twin listings, which are set to value the company at US$250bn at the start of trading and it is a near certainty that patriotic investors will push that valuation to exceed JP Morgan’s $290bn market cap and take the number one slot in global financials. So, with the inexorable rise of Chinese stock markets within the region set to continue, what next for the rest of the region?

In ASEAN, economies are also recovering, albeit somewhat more tentatively than China. ASEAN needs tourism and an improvement in oil, gas and palm oil prices to sustain its recovery. We believe that it will get all three of these, but possibly not until 2021. Unless there is a credible, globally available, affordable vaccine developed and circulated before the October start of ASEAN’s 2020 tourist peak season, which we think highly unlikely, it looks as if at least Q4 2020 will be lost. However, in the rush to China and the tech-heavy markets of the North, investors seem to have forgotten that ASEAN has a huge and (with the exception of Thailand and Singapore), very youthful population (>625m people, with an average age of just 28). Many of the countries are home to 50-100m+ people and have sufficient domestic demand to sustain their own growth. The region, along with Japan and Korea, is pushing hard to get the giant RCEP trade treaty signed before year end and if this can be achieved, it will catalyse trade between nations accountable for 45% of the world’s population, creating around a third of global GDP and 40% of global trade. 2021 should prove a much better year for ASEAN (and indeed all of us), however, it seems prudent to remain underweight until then, adding only to the most egregiously oversold stocks.

India, as ever, stands apart from the rest of Asia. Its handling of COVID has been erratic and capricious, with astonishingly harsh lockdowns imposed at just hours’ notice and self-created shortages of food driving inflation. However, Prime Minister Modi’s style is to create reform via a string of sudden and unexpected hardships and this time appears no different, as he uses the pandemic to push through a series of farm bills which will reform the country’s supply chain and possibly pave the way for modern retail to take hold. If successful, the moves could improve profitability for the country’s
businesses substantially.

Looking forward into 2021, we believe that we will see a world with COVID under control – either through the availability of vaccines, or better treatments, or just that we all learn to live with it – and with that backdrop, we anticipate a continued recovery in the global economy.

Market valuations are high on average, but dramatically polarised internally, with concentrated leadership. Companies all across the world are cutting capex and costs now, so we expect those which survive to do so with better margins and for this tighter capacity to squeeze prices upwards off ultra-low bases in 2020. By year end, China’s new 5 year plan will be clear; the US election winner will be known and Brexit will either have a deal or not (we think some kind of deal is most likely). With so many vaccines in development, it also looks likely that the fear of COVID may recede, leaving the world free to look ahead. That scenario looks likely to generate a strong rotation away from tech (although we do feel that demand for back-up WFH infrastructure will be retained) and North Asian markets, back towards the tourist destinations, leisure and services which are suffering so badly now. The end of 2020’s horrors may be in sight, but before we get to this happy recovery, a bumpy winter lies ahead.

Regional Market Valuations

Source: Bloomberg
Source: Marlborough Fund Managers

Regional Fund Flows

Performance Across Asia

Source: MSCI, Morgan Stanley Research. Past performance is no guarantee of future results.

In the second section of our extracts from our quarterly asset allocation reports, we have chosen to highlight Korea, where we might be seeing the start of a new cycle emerging now.

Korean Economics

S. Korean Economic Indicators

The Korean economy appears to be improving a little from the lows seen in April to May, but remains weak on most measures. Trade remains tough, with so many trading partners under rolling lockdowns, but is unequivocally better than it was; industrial production and fixed capital formation appear to be softening again and consumer confidence is continuing to reflect the recent rise in unemployment. Despite this and the undoubtedly poor consumer sentiment, Quarter on Quarter Personal consumption data show that private sector reaction to the current crisis maybe looks closer to the short, sharp shock to sentiment seen in the GFC, rather than the protracted shock of 2003-5 post SARS. Korean industry is showing some signs of rebounding, albeit not yet healthy.

Domestic tourism is restarting, but remains exceptionally nascent and there are still practically no international arrivals, because all visitors must quarantine for 14 days after arrival. We do expect tourism to return to Korea, but international visitors look unlikely to arrive in any numbers before Spring.

There has been better news this year from the shipyards, where Qatar has placed the largest order for LNG tankers in history, placing an order so large that it will be split between China and Korea and will fill the capacity of all the Korean yards together. On top of this Mozambique has also signed a massive order for more LNG tankers to satisfy Asia’s demand for greener fuel than coal over the coming decade. Our discussions with the Korean shipyards have shown that they anticipate finalising the paperwork in Q4 this year and then expect to start hiring additional staff en masse from Q1 2021, with the principal additional manpower requirement coming in 2022. So, whilst exceptionally good news for Korea, there is still a hiatus to fill between now and then.

Source: Ministry of Economy and Finance
Source: Ministry of Economy and Finance

Faced with this sector-wide weakness, President Moon’s government has renewed its efforts to stimulate the economy. The newly announced budget for 2021 has been set at W555trn, up 8.5% from the original 2020 budget of W512trn, which was up 9% on the previous year and later increased to W546trn by three supplementary budgets. The new budget will be funded by W90trillion of debt, extending new expected fiscal deficit for 2020-21 to between 5.5 and 6% of GDP.

Almost every sector of the economy will receive enhanced spending (even including reunification efforts), but the most recent stimulus – the New Deal – may prove the most controversial. “The New Deal” will pour W160trn into three areas: the Digital New Deal – new industries in the BBIG sectors (Batteries, Bio, Internet and Gaming); the Green Economy; and further personal income support.

As it does so, this package will create a new investment fund to channel monies into a limited number of beneficiary stocks, chosen by the government, which will champion the BBIG sectors (Battery, Bio, Internet and Games). Financing is expected to be financed by the State (W3trn), the State Banks (W4trn from KDB and EXIM Bank), private financial institutions and private investors (W13trn in total from the private sector). These industries are expected to create 1.9m new jobs in the coming five years. The fund is exceptionally controversial, as the stocks suggested have already appreciated dramatically this year and contrary to current financial law in Korea, the fund will provide guaranteed minimum returns and will cover any losses up to 35% made investing in the fund, encouraging investors in the stocks now to sell and buy the guaranteed version instead. In addition to the New Deal Fund, there will also be a New Deal Infrastructure Fund, which will primarily invest in infrastructure related to big data, digitalization, and green energy. Investors into this fund will have tax incentive of having to pay lower dividend tax of 9% rather than the original 14% and lastly, there will be a Private Sector New Deal Fund.

The KRX simultaneously announced the launch of five new indices in the BBIG space, promoting these high flying “new deal” beneficiaries. The main new index called “K-New Deal Index” is an equally weighted index comprised of just 12 stocks under the four categories in BBIG, which are LG Chem, Samsung SDI, SK Innovation for battery, Samsung Biologics, Celltrion, SK Biopharm for bio, Naver, Kakao, Douzone Bizon, NCSoft, Netmarble and Pearl Abyss.

Stock in the basket have fallen heavily since the announcement as retail investors switch horses and institutional investors worry about private investment funds being crowded out by this move and businesses with no obvious New Deal aspect losing access to capital. The deal also hopes to divert capital from money market funds as well, by promising returns in excess of both cash and government bonds.

Total Budget

Source: Ministry of Economy and Finance


Source: Bloomberg

South Korea CPI YoY

Source: Bloomberg

In keeping with the ultra-loose fiscal conditions, the Bank of Korea continues to keep rates low. Inflation has shown a slight upward shift in response to rising food prices in August, partly due to a low base effect and partly as Mid-Autumn festival approaches, but remains in highly manageable territory at present.

We do not expect the BoK to take action on this, however. The Won has been appreciating sharply against the USD, making key exports of items like semiconductors, which are typically sold in USD, less profitable, but the exchange rate against the Rmb – by far the most important trading partner now – remains stable.

Prior to the COVID pandemic, President Trump’s policy to reduce the trade deficit with S Korea appeared to be gradually having some effect, with the US increasing its exports to Korea, rather than seeing a major cut in Korean exports to the US. However, the policy has also had the perhaps unintended consequence of increasing the trade between the US’ closest ally in the Pacific arena with China, whose trade with Korea now
amounts to double that between the US and the RoK.

Semiconductors lead that export data, with chips for Huawei a key element within the list. Huawei accounts for some 10% of Hynix’ revenue and the company is a top ten customer for Samsung Electronics. It is clearly intended that this new regime should force US companies to switch from Korean chips to those made by Micron (which in many cases is not possible), but despite Apple’s purchases from Korea, the US has become a small market for semiconductors for Korean makers, taking just $4.2bn of Korea’s semiconductor exports against China’s $22.4bn. The two companies halted their sales to Huawei on 15th September, with Samsung and LG also cutting sales of panels. Samsung was quick to sign a US$6bn order with Verizon for 5G equipment in its place and another with Qualcomm and the company also stands to gain from the increasing antagonism in India towards China, but this is likely to cause increasing friction between the US and Korea over the coming months. At this stage, it is hoped that the US will relax its attitude towards China, or at least to its allies’ relations with China, post the election, but there is no certainty of this.

Exchange Rates

US Trade Deficit with South Korea

Trading Partners

Source: Bloomberg

In the corporate world, recent earnings from Korean companies have remained mixed. However, the majority of companies did report Q2 earnings slightly better than analysts’ expectations and, in what might be a glimmer of hope for industrial activity in the country, the whole utility sector saw better revenue than expected.

The Korean economy appears to have passed its nadir and we are optimistic that 2021 should see strong growth as the impact of all the stimulus packages start to hit just as the natural cycle in LNG tankers also improves. Q4 2020 may be too early to jump onto that trend, but it feels as if the worst has passed in Korea.

Risk warnings
Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. Tax treatment depends on individual circumstances and may change in the future. The fund will be exposed to stock markets. Stock market prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The fund will invest in shares in emerging markets which can be more volatile than more developed markets. Changes in exchange rates may affect the value of your investment. In certain market conditions some assets in the fund may be less liquid and therefore more difficult to sell at their true value or in a timely manner.

Regulatory Information
This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. It’s provided for general information purposes only and is not personal advice to anyone to invest in any fund or product. The Key Investor Information Documents and the Prospectuses for all funds are available, in English, free of charge and can be obtained directly using the contact details in this document. They can also be downloaded from An investor must always read these before investing. Information taken from trade and other sources is believed to be reliable, although we don’t represent this as accurate or complete and it shouldn’t be relied upon as such.
Calls may be recorded for training and monitoring purposes. Issued by Marlborough Fund Managers Ltd, authorised and regulated by the Financial Conduct Authority (reference number 141660). Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Registered in England No. 02061177.