This is the second in a series of short posts focusing on whether incoming economic news supports or contradicts the forecast of a global “hard landing” suggested by monetary trends.
The US ISM manufacturing new orders index rose to a 13-month high of 49.2 in September, apparently supporting soft landing hopes.
A post in July flagged the possibility of a near-term rebound but suggested that this would prove to be a “head fake” preceding a move back below 45.
The main reason for expecting a recovery was that the stockbuilding cycle was judged to be moving towards a low, i.e. a drag on new orders from customer inventory adjustment was likely to abate.
The reason for expecting the recovery to be brief and followed by a relapse was that US real narrow money momentum remained heavily negative, suggesting that a stockbuilding boost would be outweighed by weakness in final demand.
Historical instances of ISM new orders recovering through 50 when real money contraction was negative include 1957, 1970, 1980 and 1990. The orders index subsequently fell back below 45, with the relapses associated with recessions – see chart 1.
Chart 1
Six-month real narrow money momentum has recovered since mid-year but remains significantly negative.
The earlier suggestion of a recovery in ISM new orders was supported by a sharp rebound in Korean FKI manufacturing expectations between February and July – Korean exports are sensitive to changes in global industrial momentum. FKI expectations relinquished most of the February-July gain in August / September.
Verdict: inconclusive.
french
The CC&L Foundation is pleased to announce a contribution to Canadian Blood Services, exemplifying our commitment to community and creating a positive impact. With the successful conclusion of our August blood drive, we extend our appreciation to participants who supported this important initiative, led by one of our own employees Mohammad Shakeri.
Mohammad is a Specialist on the Corporate Actions team at Connor, Clark & Lunn Financial Group in Vancouver and is passionate about blood donation. He has been a blood donor for ten years, and like over half of Canadians, his close friends and family have been recipients of blood transfusions in the past. Mohammad championed the Partners for Life collaboration between the CC&L Foundation and Canada Blood Services, raising awareness of this service that can affect so many. This was the first blood donation activity at CC&L in recent years and the participation reinforces our firm-wide dedication to giving back to the communities we live and work in.
Quick facts
Each blood donation can save up to three lives.
It can take multiple donors to save a patient’s life.
Given that each process requires less than 30 minutes of each donor’s time, this an excellent investment.
There is a constant demand for blood and blood products. Rolling up your sleeves to donate at anytime is appreciated. As active participants in the Partners for Life program, our collaboration with Canadian Blood Services further strengthens our dedication to community support.
Regulatory risk is nothing new to investors, but it has gained prominence in the current geopolitical climate. Companies globally, especially those with operations or manufacturing facilities in China, are closely monitoring actions their government might take to undermine diplomatic relations. In the banking sector, the situation with SVB has led analysts to expect stricter regulatory frameworks for regional banks. Additionally, the ongoing Hollywood strikes have spotlighted AI as a contentious issue; actors are advocating for regulations that restrict studios from using their likeness for AI-generated content. And the list goes on.
In the 1990s and early 2000s, a laissez-faire attitude prevailed in developed countries, particularly in the US. It was the proof that the capitalist business model was sustainable, a perception supported by the slow pace of regulation during the quickly developing dotcom bubble and the pre-financial crisis housing market. In a hegemonic global environment, smaller nations found few reasons not to strategically align themselves with dominant powers, leading to accelerated deregulation in many developed countries. However, this framework began to shift as the US-led global world order faced challenges from competing political and economic ideologies.
Enter the cycle of protectionism. The consequences of protectionism are well-documented: higher prices due to lack of competition, which leads to persistent inflation; weaker economic growth since international trade isn’t fully offset by domestic consumption, and a more fragile labour market as a result. When various stakeholders voice their discontent with a worsening economic environment, democratic governments often respond by enacting policies, introducing regulations or applying other short-term solutions in an attempt to alleviate the problems they created. These often penalize high-performing industries or companies and may involve levying taxes or setting price ceilings. Such changes catch both company management and shareholders off-guard.
Our clients know that Global Alpha uses a bottom-up approach to stock picking. However, our team also recognizes the increasing need in being risk aware about changes in regulatory frameworks, both at the industry and company levels.
A striking example occurred around this time last year with one of our holdings, Norway Royal Salmon (NRS). The Norwegian government unexpectedly announced a 40% tax rate on resources, which included salmon. Although the company had a solid business model and shareholder satisfaction was high, the stock dropped over 20% in a day, making it one of our worst performers for that quarter. Nevertheless, it was widely understood that NRS was set to merge with one of its competitors, Salmar. We believed this merger would provide for shareholders as it would create one of the largest players worldwide in fish farming and significant advantages, especially given that the larger entity could more effectively adapt to this new tax than smaller competitors. As of March 2023, the Norwegian government lowered its proposed tax rate to 35% to facilitate legislative approval, and we remain happy shareholders of Salmar.
Another recent case involves CVS Group (CVSG LN), a UK-based integrated provider of veterinary care. In early September, the UK Competition and Markets Authority (CMA) announced its review of competitiveness in the veterinary sector, causing CVSG stock to drop more than 25%. Investors immediately assumed that CVS, as the largest player in the space, would be the review’s primary focus. However, our analysis suggests these concerns may be exaggerated. Reviews by the CMA do not always lead to material industry impacts, as shown by its review of UK grocers earlier this year. Furthermore, while CVS has been a major player in consolidating the UK veterinary industry, it has not led to unreasonable price hikes. Average increases for CVS products and services hover around 3% net, which is unlikely to be seen as an outlier. There are minor areas, like lack of transparency in cross-selling and customer awareness regarding chain ownership, where CVS might face some hurdles, but we do not anticipate a substantial impact on the business model.
Lastly, it is worth noting that regulatory and policy shifts can provide positive effects. The waste management industry is expected to benefit as recycling becomes increasingly crucial in creating more sustainable societies. Our portfolios include waste management companies like Casella Waste (CWST US) and Renewi (RWI LN). We expect that new recycling requirements across various commodities will improve margins in what has historically been a low-margin industry.
While no one on Global Alpha’s investment team is a policy expert, our job requires us to consider two important angles: the potential threats to a business model arising from policy shifts, and the actual impact on our investment thesis when a regulatory change happens. One reason for our cautious stance on AI investment opportunities is the level of uncertainty regarding when and how governments will implement regulations. Salmon farming and veterinary care may not capture the public imagination like AI does, but we are confident in our ability to navigate regulatory risks in these industries more successfully.
An Opportunity to Foster Mutual Benefit and Support Sustainable Development
This article was originally published in Issue 33 of the Journal of Aboriginal Management (JAM), it focuses on the theme Infrastructure: Building a Better Tomorrow.
ABOUT THE AUTHOR
Peter Muldowney Head of Institutional and Multi-Asset Strategy at Connor, Clark & Lunn Financial Group
Peter Muldowney is Head of Institutional & Multi-Asset Strategy at Connor, Clark & Lunn Financial Group, and heads the firm’s Strategic Exchange initiative. Peter has over 20 years of investment experience in Canada, the U.S., and the United Kingdom. Prior to joining the firm in 2011, he spent his earlier years in consulting, which included leading two of the major Canadian firms and then moving to the investment management business in 2008, when he established a new investment operation for a Canadian insurance company. Peter completed both the 4 Seasons of Reconciliation from First Nations University of Canada and the Sustainable Investment Professional Certification (SIPC) from Concordia University in 2022.
Indigenous participation in infrastructure projects promotes the economic empowerment of communities while also contributing to a project’s overall success and sustainability. In this article, we delve into some of the ways Indigenous communities can participate in infrastructure investments, and we highlight the benefits that such partnerships can create.
Infrastructure projects are typically large-scale physical assets that meet a basic human need. These assets are essential to the well-being of communities and critical to the functioning of local economies. Infrastructure encompasses projects such as roads, bridges, schools, hospitals, water distribution and treatment as well as power generation and electricity transmission. The development and construction of these assets require significant investment and involve numerous stakeholders. The importance of infrastructure projects to communities, and their long-term nature and size, necessitate a responsible investment approach to secure and maintain a social license to operate.
Stakeholder engagement plays a pivotal role in ensuring that investments incorporate a wide range of perspectives and create positive outcomes. Ultimately, responsible investment is about generating financial returns while also considering the broader impact on society and the environment. An inclusive approach to engagement is essential in ensuring that all relevant parties are consulted.
There is a growing recognition of the importance of including Indigenous peoples as key stakeholders in infrastructure projects, ensuring their rights, cultural heritage, and economic interests are respected and supported. This is particularly critical in countries such as Canada where many infrastructure projects directly impact Indigenous lands and territories, as well as their peoples and communities.
This increased awareness – combined with more intentional inclusivity on behalf of government and business – should help to facilitate greater participation in the responsible development of further sustainable infrastructure projects in Canada. However, it is important that these efforts are focused on a desire for true understanding of Indigenous perspectives and priorities, as well as genuine relationship building that seeks to achieve mutual benefit. Such an approach fosters transparency while also promoting collaboration and consensus-building, which can lead to better decision-making and outcomes.
Collaboration Fosters Mutual Benefits and Sustainable Development
Positive partnerships provide a promising path towards more inclusive investment opportunities that facilitate the economic empowerment of Indigenous communities while also supporting the development, construction, and operation of high-quality and sustainable infrastructure projects.
Increased Indigenous participation can contribute to reconciliation efforts by encouraging Indigenous business development, self-determination, and positive socio-economic outcomes. The steady cash flows generated by infrastructure investments can provide Indigenous partners with funds to address any number of objectives such as housing, healthcare, education, recreational facilities, community centers, economic development and cultural revitalization – or anything that the community values and sets as a priority.
Engaging Indigenous communities also helps to protect the value of infrastructure investments by mitigating some of the associated risks, helping to avoid or address conflicts and legal challenges early while supporting smoother and more efficient project development and operations.
Scott Munro, Deputy Chief Executive Officer of the First Nations Financial Management Board, highlighted this well in his article on evolving ESG standards (JAM 32): “How well a business considers and respects Indigenous rights will determine how its enterprise value is impacted. As well intended and beneficial as these projects maybe, if corporations fail to demonstrate to investors and lenders that they have the free, prior, and informed consent of the Indigenous people who are being impacted, conflict is a certain outcome. Projects may get delayed or encounter costly litigation, and businesses will face reputational loss and discontent shareholders.”
In addition to mitigating some of the risks associated with infrastructure projects, the active involvement of Indigenous communities from the beginning stages of project planning brings valuable local knowledge and perspectives to the table. Indigenous communities possess deep understanding of their lands, resources, and traditional practices. These perspectives contribute to better project design, deeper insight into areas of archaeological significance, sustainable resource management, biodiversity preservation, and more robust environmental impact assessments while also promoting effective environmental monitoring and maintenance.
Collaboration enhances the sustainability of projects and strengthens stewardship efforts by incorporating Indigenous perspectives and practices that have been proven to be environmentally harmonious and resilient over generations. It can lead to more successful outcomes for both the project and the communities involved, fostering collaboration, trust, and shared prosperity.
Indigenous Opportunities in Infrastructure
There are several different ways in which Indigenous communities can participate in infrastructure projects. This includes direct involvement through equity ownership stakes, revenue sharing and other mutually beneficial arrangements, as well as less direct participation through financial investments in public infrastructure companies or private infrastructure funds.
Most commonly, participation is formalized through some form of a negotiated benefit agreement that governs the relationship between the Indigenous community and the infrastructure project. These agreements outline specific benefits and compensation that Indigenous communities will receive in exchange for their support or consent for a project, ensuring their interests are codified and acknowledged as part of the project’s ongoing operations. Successful agreements facilitate community consultation and approval by addressing community social, economic and environmental objectives while also ensuring an equitable distribution of project costs and benefits. Benefits can include financial compensation, employment opportunities, skills training, and community development initiatives.
Equity ownership stakes provide a means for Indigenous communities to share directly in the economics of infrastructure investments. By having ownership in a project, communities receive profits and participate in aspects of the decision-making processes. Revenue sharing agreements are another way in which Indigenous communities can participate in a share of the profits generated by an infrastructure project and can provide an important source of revenue. Both of these types of agreements can empower Indigenous communities economically, foster job creation, and improve resource access.
In addition to equity ownership stakes and royalty payments, there may also be other mutually beneficial arrangements that can be explored. It’s important to recognize that the needs, values and ambitions of each Indigenous community are unique in the same way that each infrastructure project is distinct. While there are benefits to leveraging past experience and best practices, there is no one-size-fits-all approach. Each discussion needs to begin from a place of respect for Indigenous communities and a willingness for open dialogue to reach a place of understanding and productive collaboration.
CC&L Infrastructure’s Focus on Shared Value and Strong Partnerships
CC&L Infrastructure invests in infrastructure assets with attractive risk-return characteristics, long lives, and the potential to generate stable cash flows on behalf of a wide variety of clients — including Indigenous trusts, public and private pension funds, life insurance companies, financial institutions, foundations and endowments, and high-net worth individuals.
As long-term asset owners and stewards of client capital, CC&L Infrastructure focuses on managing its assets responsibly. This includes a systematic approach to evaluating material environmental, social, and governance factors. We believe this approach improves our ability to manage risk, protect the value of our investments, and enhance long-term investment returns.
Our firm has a long history of working alongside Indigenous partners. We worked with local First Nations on our first investment more than 15 years ago, and today over half of the Canadian infrastructure assets in our portfolio collaborate with Indigenous communities in some fashion. This includes several run-of-river hydroelectric facilities and solar projects where our Indigenous partners have a direct equity investment alongside us.
CC&L Infrastructure is a part of Connor, Clark & Lunn Financial Group Ltd., an employee-owned, multi-boutique asset management firm whose affiliates collectively manage over CAD$110 billion in assets.
This is the first of a series of short posts focusing on whether incoming economic news supports or contradicts the forecast of a global “hard landing” suggested by monetary trends.
Flash results suggest that the global composite PMI new orders index – a timely indicator of demand momentum – fell for a fourth month in September, consistent with the monetary signal of a slide into early 2024, at least.
The flash results, available for the US, Japan, Eurozone, UK and Australia, imply a decline through 50 to the lowest level since December, assuming no change in all other countries in the global aggregate – see chart 1.
Chart 1
Weakness in the flash surveys was driven by a further slowdown in services new business, with manufacturing new orders little changed – chart 2.
Chart 2
Any hopes of manufacturing stabilisation, however, may be dashed by full September results incorporating China and other emerging economies. The equity analysts’ earnings revisions ratio correlates with Chinese manufacturing PMI new orders and weakened sharply this month – chart 3.
Chart 3
Renewed deterioration in Chinese / Asian manufacturing is also suggested by the Korean FKI survey for September, showing a relapse in the assessment of business prospects to the weakest since February – chart 4.
Chart 4
The profound and enduring love people feel for their pets is a testament to the unique and cherished bond between humans and animals. Across cultures, generations and geographies, this affection runs deep and is driving unprecedented demand for high-quality pet care, products and services. There is no doubt that pets occupy a special place in our hearts. But should they also occupy a special place in your investment portfolio?
When it comes to investment strategy, recognizing the remarkable growth within the pet industry is paramount. At Global Alpha, our preference is to invest in large and growing markets, and the pet industry perfectly aligns with this approach. As part of our meticulous investment process, it is essential to delve into the underlying factors propelling this industry’s expansion, as these drivers often vary by theme – such as demographics, innovation and environment.
How big is the pet market in North America?
As of 2023, data from the American Pet Products Association reveals that pet ownership in the United States has reached a remarkable milestone, with 66% of households, equivalent to 86.9 million homes, proudly welcoming pets into their lives. This figure marks a substantial increase from the 56% recorded in 1988, underscoring the enduring trend of pet ownership. So, how important are these pets to their owners? An astounding 85% of dog owners and 76% of cat owners affirm that their pets hold a special place as bona fide members of their families.
In 2022, Americans alone spent $136.8 billion on their pets. Back in 1996, that number was just $21 billion. Even more fascinating is that millennials comprise the highest percentage (33%) of pet owners in the US, followed by Gen X at 25% and baby boomers at 24%.
In Canada, pet industry spending reached $12.9 billion in 2022, up a whopping 486% from $2.2 billion in 1994 according to Statistics Canada.
How is the pet market different internationally?
While the US is the clear leader when it comes to spending on pets, other countries are also seeing the market grow. In the UK, the vet market is worth more than £2 billion ($2.5 billion USD) with almost two thirds of households owning a pet.
At the same time, there are more than 31 million pets in India and this number is growing at an annual rate of over 12%. According to a Bonafide Research report, India’s pet care industry is expected to reach close to a billion dollars by 2025, with a CAGR of more than 19%.
How have our pet industry holdings performed?
Since inception in 2008, we have continuously maintained exposure to the animal health industry. Below are a few highlights.
Number one pet care specialist in Australia, providing both retail and veterinary services
Provided exposure to animal clinics and pet retail stores
Exited in Q1, 2019 as it was acquired by private equity group, TPG Capital
Our current exposure to the pet industry
We are currently invested in UK pet health company, CVS Group. Founded in 1999, the company went public in October 2007.
Business overview
Headquartered in Norfolk, CVS is one of the leading veterinary services providers in the UK with about 10% market share. As of 2022, CVS has about 500 practices across its three markets, including eight specialist referral hospitals and 37 dedicated out-of-hours sites. The company also runs three laboratories, seven crematoria and an online retail business called Animed.
CVS recently entered the Australian market with a small number of acquisitions, bringing the total number of practices outside the UK to 35.
Target market
The total addressable market in the UK for veterinary products and services is over £2 billion. The market consists of six large chains and a number of independent/small chains representing 45% of the market.
On the other hand, according to IbisWorld, Australia has a $5.3 billion addressable market which is growing at 6% per annum. The level of consolidation in the Australian market is just 20% when compared to the UK, adding for future potential growth via M&A.
Competitive advantages
Largest and most comprehensive provider of vet services in the UK, meeting all customer needs
Scale – has developed shared facilities and opportunities to cross sell its products, like lab testing, generic medicines, loyalty schemes, specialist surgeries and pet cremation
Growth strategy
Consolidate large-animal vet practices (delivering equine & livestock care), which is more fragmented
Their laboratory diagnostic business could enter the farm animal diagnostics market
International expansion continues like their latest entry in Australia
Where we’re looking next?
We have our eyes on a few interesting companies operating in the animal health space, ranging from pet insurance and fresh pet food to a diagnostics company. Our ability to be highly selective and nimble in our portfolio holdings leaves us well-positioned to add some exposure to the animal health industry at attractive valuations.
So just one question remains: How much are you spending on your pet?
The Godil family cat
Global six-month real narrow money momentum is estimated to have broken to a new low in August, reinforcing pessimism here about economic prospects and casting strong doubt on now widely-held “soft landing” hopes.
Real money momentum bottomed in July 2022, recovered during H2 but suffered a relapse in early 2023, retesting the 2022 low in April. The relapse has been reflected in a renewed downswing in economic momentum, as proxied by global composite PMI new orders – see chart 1.
Chart 1
A tentative stabilisation of real money momentum over the summer suggested that PMI new orders would bottom out around year-end. The further move down in August, if confirmed, signals deeper and more extended economic weakness.
The August estimate is based on monetary data covering 70% the global (i.e. G7 plus E7) aggregate and near-complete CPI results.
The suggested fall to a new low reflects both additional nominal money weakness and an oil-price-driven recovery in six-month CPI momentum – chart 2.
Chart 2
The ongoing oil price rally suggests a further near-term rise in headline CPI momentum – chart 3. A core slowdown, however, is expected to continue and may accelerate as higher oil costs squeeze spending on other items.
Chart 3
The further fall in real narrow money momentum has been driven mainly by China and India – chart 4. An earlier post attributed Chinese monetary weakness to misguided policy tightening in late 2022, which has since been partially reversed. Chinese August money numbers suggest greater damage from the misstep than previously assumed, implying a more urgent need for additional policy easing.
Chart 4
An August estimate of global industrial output is not yet available but a large negative differential between six-month rates of change of real narrow money and output is likely to have persisted – chart 5.
Chart 5
As previously noted, global equities have underperformed cash since this differential turned negative in early 2022 (allowing for reporting lags), despite a rally over the last 12 months.
Why was weakness compressed into the first nine months of 2022, with a subsequent strong rebound?
One explanation is that the Ukraine invasion and associated immediate further upward pressure on energy prices exaggerated the market response to monetary deterioration. Positioning and sentiment reached oversold extremes in late 2022, creating the potential for a relief rally as energy markets adjusted and prices fell back.
Another possibility – admittedly difficult to assess – is that the “excess” money backdrop has been less unfavourable than suggested by the six-month momentum differential shown in chart 5, because of the existence of an overhang from the 2020-21 monetary surge. An excess stock of money, in other words, may have persisted despite the flow turning negative.
The ratio of the stock of real narrow money to industrial output has trended higher over time, with the increase reflected in rising real asset prices and wealth – chart 6.
Chart 6
A huge overshoot in 2020-21 has been correcting since late 2021 but the ratio was still above its pre-pandemic trend at end-2022, i.e. the negative flow differential had not fully offset the prior period of excess.
The stock and flow signals, however, are now aligned: the real money / output ratio moved below trend in early 2023 and its July level was the lowest since February 2020 before the policy response to the pandemic and subsequent monetary surge.
This week, Global Alpha is looking at the increased frequency of natural disasters and how climate change is affecting the insurance industry.
The recent wildfires in Hawaii, the deadliest in over 100 years, is the latest in a long line of severe natural disasters. The town of Lahaina was hardest hit as damage assessment maps indicate over 2,200 buildings were destroyed or suffered some harm. Rebuilding Lahaina has been estimated to cost $5.5 billion.
Just this past Friday, a significant earthquake registering 6.8 on the Richter scale shook Morocco, leading to early estimates of over 2,800 casualties and causing severe damage to historic sites in Marrakesh. This comes after an event in February this year when Turkey and Syria were hit by an earthquake measuring 7.8 on the Richter, followed by aftershocks reaching up to 7.5. In that catastrophe, thousands of buildings collapsed, resulting in thousands of injuries and tens of thousands of deaths. It became the deadliest global disaster since 2010 and ranks as the 11th deadliest event in recorded history. Beyond the loss of life, financial assessments from the government of Turkey, the World Bank, the UN and the EU estimate the economic loss at around $91 billion, making it the 11th most costly disaster globally, after adjusting for inflation. Both events have underscored the need for stricter enforcement of modern building codes. In Syria and Turkey, a number of the buildings that fell, including newer multi-story residential structures, should have had sufficient structural integrity to mitigate significant fatalities.
Closer to home, there has been an extended period of wildfire activity across many Canadian provinces. While many of the wildfires occurred in remote regions far from major population centres, total insured losses are expected to reach several hundred million dollars and thick smoke caused hazardous air conditions in the Northeast. In June, New York and Montreal both recorded the worst air quality in the world.
The end result is that insurers are choosing to limit exposure in some markets. Reinsurance companies are raising their rates to insurers to help cover losses above certain levels. These higher rates get passed on to consumers and other insurance buyers. Recently, State Farm and Allstate announced they are no longer providing insurance in California, the most populated US state. Reasons for their withdrawal include increased catastrophe exposure, construction costs and the reinsurance market. A similar situation is unfolding in hurricane-prone Florida, where property insurance costs are skyrocketing and Farmers Insurance pulled out of the state altogether, citing increased risk exposure.
Global Alpha holds two insurers: RLI Corp. (RLI.US) and Vienna Insurance Group (VIG.AV).
RLI is a specialty insurance company with more than 50 years of experience serving the property, casualty and surety markets. RLI focuses on niche markets that need deep and unique underwriting expertise. The company operates on both an admitted and non-admitted basis with exposures predominately in the US. RLI had some exposure to the Hawaiian wildfires primarily due to homeowner insurance in the state and recently announced its loss estimates. Although preliminary in nature, RLI estimates pretax net catastrophe losses of $65 million to $75 million related to 200 structures. These losses will be reflected in Q3-2023 results. RLI regularly monitors and attempts to manage exposure to catastrophes by limiting concentrations of locations insured to acceptable levels and by purchasing reinsurance. Catastrophe exposure models can help assess risk, but are inherently uncertain due to the sporadic observations of actual events.
Vienna Insurance Group offers insurance solutions in the property and casualty, life and health business across approximately 30 countries in Central and Eastern Europe. Vienna has a climate change strategy that provides general principles for dealing with climate change and guidelines for investments and insurance operating business. One of the first initiatives was to eliminate investments in the coal sector and significantly limit insurance coverage for new coal mining and coal-fired power plant projects. The company’s scenario analysis highlights the main natural risks as flooding, winter storms and summer (hail) storms. Science is expecting the risk of flooding and hailstorms to increase. The 2021 flooding in Bernd, Germany led to unexpectedly large losses while the same year also saw severe hailstorms in Austria and a tornado in the Czech Republic. As for winter storms, the risk is expected to increase in some countries and decrease in others. Vienna offers insurance coverage in Turkey, albeit in the less affected western part of the country. Nonetheless the company announced an expected gross impact (including active reinsurance) of €170 million.
The world is currently observing a warmer El Nino phase that often leads to shifting rainfall patterns in different parts of the world. For example, more flood-related losses have been reported in Europe, the Middle East and Africa during El Nino phases. Insurance companies have always been concerned with potential losses due to natural risks. Global warming is highlighting the critical nature of this problem. As we confront a world where the frequency and severity of natural events are exacerbated by climate shifts, the question becomes: are insurance models robust enough to adapt, or will we find ourselves financially unprepared for the evolving landscape of risk?
Summary
The MSCI EM Index was down -6.13% in US$ terms for August, led by a negative month for Chinese equities.
Stock picking in China was positive for the portfolio, as value stocks in China pulled back and quality stocks bounced following a run of poor performance through most of 2023 (chart below).
The Materials sector had a down month on softer economic data globally, reflected in the performance of markets with heavy exposure to commodities, including Brazil, Chile and South Africa.
Tech in Korea and Taiwan cooled following a strong run in 2023, fuelled by surging sentiment for AI.
India’s moon landing marks its rise
Stock picking in India was again a contributor for the portfolio, with our Indian equities flat over the month (MSCI India down nearly -2%). India celebrated a successful landing on the moon, a marker of the country’s rapid ascension – it’s the first nation to land a rover to explore the moon’s southern polar region (and on a budget of less than US$74 million). Just days earlier, Russia failed in a similar attempt.
Does BRICS+ matter?
The 15th BRICS summit took place this month, with Russia’s Putin notably absent. As a member of the International Criminal Court (ICC), South Africa would have theoretically been required to arrest Putin over ICC accusations of Russia’s alleged deportation of Ukrainian children.
The concept of the BRICS was expanded with the inclusion of Saudi Arabia, Iran, Ethiopia, Egypt, Argentina and UAE. While the idea of a body to represent and promote the interests of the “global south” is logical, some claims of what this group can achieve are wildly overstated.
Indeed, calls that this meeting marks a coherent challenge to Western predominance of international relations is overstated given the divergent economic and political interests of member states. Of the core members, only the giants China and India – strategic competitors and at times outright adversaries – offer meaningful economic and political heft to the group, while Russia, Brazil and South Africa have all gone backwards since former Goldman analyst Jim O’Neil coined the term “BRICS” in 2001. The introduction of a number of states with equally divergent views risks making the BRICS concept even more amorphous.
Early signs of recovery in China’s quality stocks
Our decision to lift portfolio exposure to a modest overweight in China last year as the economy reopened favoured higher-quality names. This reflected the view that China’s reopening would not be a V-shaped boom like what we saw in the West. Money numbers were positive and better than the rest of the world, but not especially strong in absolute terms. The authorities had also refrained from turning on the fiscal and monetary taps through lockdowns and reopening for fear of sparking the inflationary boom we have experienced in the West. Hence, we added primarily to high-quality names with robust and sustainable returns on capital as opposed to more cyclically geared stocks, given the likelihood this recovery would be fragile.
However, as the chart below illustrates, it is quality in China which has been abandoned by foreign investors over the past year. Despite the majority of our holdings posting solid results through the period, investor fears over economic malaise in China and further deterioration of Sino-US tensions saw investors sell indiscriminately as it became clear China’s path to recovery would not be so straightforward.
The chart also illustrates the divergence between performance of quality and value stocks in China, which became particularly stretched in Q2. Their outperformance since early April appears to coincide with the announcement of an SOE reform drive. Beijing is launching yet another push (one of dozens going back decades to Deng Xiaoping’s time as leader) that aims to boost the sub-par returns of these often bloated and highly inefficient companies.
In the absence of other positive stories in China, momentum-oriented domestic mutual fund managers piled into SOE stocks. While this was difficult from the perspective of relative performance for the strategy, we remain happy holders of some very strong franchises that have been posting robust results and now trade at very attractive valuations. In addition, we remain sceptical that the latest reform drive for SOEs will close the wide productivity gap between state firms and private enterprises in any meaningful way.
We remain focused on owning businesses with high returns on invested capital, low debt and management aligned with minority shareholders. This is especially important in the testing economic environment that China is in today. Our businesses should be well-positioned to weather a soft economy, while SOEs inevitably face the risk of being called up for national service by Beijing.
While only over a very short period, it was pleasing to see quality stocks in China bounce sharply in August as policies supporting the economy continue to trickle through.
Steady drip feed of policy support continues in China
Last month’s commentary covered Beijing’s slow and reactive economic management, while noting signs that authorities are steadily getting a policy response into gear. Investors running for the exits may find themselves whipsawed back into China should authorities accept economic reality and act decisively. For us, while sentiment and news flow are undoubtedly poor, we remain focused on the alpha opportunity that lies between expectations and reality. A shift in the narrative from dire to very bad could be enough to spark a rally given how badly beaten up Chinese equities have been this year.
With this in mind, policy trends through the month were positive (although not exactly decisive) in August:
It appears that property stimulus is gathering steam on the demand side, with the PBoC lowering the minimum down-payment ratio for first and second-time homebuyers to 20%/30%, respectively.
The PBoC also cut key policy rates for the second time in three months, which appears to support our analysis that authorities are acting to reverse their misguided policy tightening in late 2022 and early 2023.
This is translating into lower rates for home loans and should provide some support to the property sector – will this help tier 1 city transactions pick up more meaningfully and move the needle for homebuyer sentiment?
Providing some support on the supply side (i.e. struggling private property developers like Country Garden) would also help to shore up confidence, but we are yet to hear anything concrete.
The State Council announced increases in personal income tax deductions for infant and children’s education and elderly care, to help ease the cost of living burden for the middle class.
None of these measures are the policy bazooka that we think can draw a line under China’s slump, but the direction of travel is positive and additional measures to address local debt challenges and ease fiscal policy should emerge in the coming months.
Thailand’s Move Forward blocked from forming government
Former real estate mogul and Pheu Thai party member, Sretta Thavisin, was sworn in as Thailand’s prime minister, having formed a 10-party coalition which includes several pro-military leaders that were previously rivals of the party. The confirmation comes hours after ousted PM and the founder of Pheu Thai’s precursor party, Thaksin Shinawatra, returned to Thailand following a 15-year exile, having fled corruption charges that have now been watered down by the monarchy.
This follows the parliament’s failure to confirm Move Forward’s leader, Pita Limjaroenrat, as the new PM in July. Despite having won the election in May, Limjaroenrat’s confirmation bid to become PM was rejected twice by parliament, driven by opposition to Move Forward’s proposal to reform laws banning criticism of the monarchy. Thaksin’s return appears to signal that a deal has been done with the monarchy to keep Move Forward out of power.
