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RiverCircle Weekly
China Property Managers ...
5 Feb 2024
  • China property managers have fallen further than any other industry in China’s equity market rout. In most cases management companies have fallen in percentage terms further than their property developer parent companies.

  • In addition to concerns about the deterioration of the property market, the property managers have fallen due to concerns that ailing parent companies will use their management arms as lifebuoys to keep them afloat in these difficult times, sacrificing them if needs be.

  • As we have argued, not all property managers are created equal. Not all have parents that need to use their managers as a bail-out fund. In fact, some are incentivized to favour the management company over the parent. In this note we run through the list of property managers and isolate the better-quality names.

RiverCircle Weekly
Active versus Passive ...
30 Jan 2024
  • Assets held by passive investment funds and ETFs now exceed those held by active funds. The dominance of passive funds will increase in coming years due to cost and performance advantages, especially in large liquid stocks.

  • However, passive funds do not have it entirely their own way. Research by Morningstar shows that actively managed equity dividend funds significantly outperform passive peers. Active managers outperform passive funds because they have an information edge when it comes to assessing the sustainability of dividends.

  • Over time the increasing dominance of passive funds means that markets are becoming less efficient at processing information. As market efficiency falls, scope for active managers to exploit informational opportunities will increase.

RiverCircle Weekly
The Outlook for China Real Estate ...
15 Jan 2024
  • Many investors have written off the Chinese real estate sector given the seemingly bleak outlook for prices and volumes in coming years, the maize of connected party transactions, and the lack of transparency in the industry as whole.

  • These objections are very real and we certainly have no interest in the developers at this point. The property managers, however, are a different story. Properly run, they are simple cash cows with powerful moats. They appear cheap, pay good dividends and we are drawn to them.

  • As with the sirens that drew Ulysses, however, they might be dangerous. Step one in managing this risk is to understand the outlook for the Chinese real estate.

RiverCircle Weekly
EM Small Caps in 2024 ...
8 Jan 2024
  • Market outcomes in any given year depend on the element of surprise. Markets begin the year priced for certain outcomes and prices shift as expectations change.

  • As we begin 2024, markets expect that a significant decline in inflation will enable aggressive Fed rate cuts in combination with a soft landing. Since wage inflation will not fall appreciably in a soft landing, and may even rise, we think market expectations are too aggressive.

  • The greatest likelihood in our view is that inflation will disappoint, meaning capital will flow from assets that benefit from disinflation to assets offering better protection from inflation. The more the Fed eases the stronger this rebalancing will be. The primary loser in such an outcome will be the US$. The biggest winners will be emerging markets, small caps and commodities, especially as growth re-accelerates.  

RiverCircle Weekly
Are Carbon Markets Sustainable?
18 Dec 2023
  • Value investors love markets in disarray because disorderly markets provide the perfect environment for extreme mis-pricing.

  • One is hard-pressed to find a market in greater disarray than the voluntary market for carbon offsets. Voluntary carbon markets have collapsed more than 90% from their peaks. A tonne of carbon offsets in these markets are trading at a discount of more than 99% to the cost of carbon in the EU compliance market.

  • The voluntary carbon market is clearly failing. Given time, the problems will be fixed and there will be opportunities for value investors in the rubble. In the meantime, however, the future supply of carbon credits will be much less than previously expected, meaning that carbon offset prices are likely to rise sharply in the lead-up to emission pledge targets in 2030.

RiverCircle Monthly
Opportunities in Healthcare …
4 Dec 2023
  • We see huge investment opportunities in healthcare due to demographics, shifting spending patterns and the impact of technological change.

  • Technical change due to artificial intelligence, blockchain and robotics will revolutionise healthcare in coming years, creating winners and losers.

  • Successful investing in healthcare requires an understanding of the changes that technology will bring about. We believe technical change will mostly benefit healthcare providers, insurers and pharmaceutical companies. Of these, the clearest beneficiaries will be hospitals.

RiverCircle Weekly
2024 Investment Outlook …
28 Nov 2023
  • The bulge bracket US brokers have issued their forecasts for 2024. The three most influential houses have broadly similar outlooks – a US soft landing; US stocks to rise modestly and enough to outperform most markets except potentially Japan, India, and Mexico; equity markets to be soft in the first half but better in the second half as the Fed starts easing; and overweight high-quality bonds.  

  • The one factor underpinning this central message is the idea that the US dollar is set to remain strong. If the US dollar remains strong, Japan typically does well, EM struggles, and commodities languish. We doubt the US dollar will remain strong. 

  • However, even if the US dollar holds steady, this US-centric view of the world ignores the size and resilience of the emerging markets. Emerging APAC markets are at the traditional threshold of exponential growth in mutual fund AuM. This prospect makes the emerging APAC markets far more interesting to us than the US market.  

RiverCircle Weekly
Time for Asia to Rally …
6 Nov 2023
  • Weaker-than-expected US non-farm payrolls have triggered an important shift in investor expectations. Investors are now confident of a softer trend in US economic growth.

  • US bond yields have peaked and will fall further. This expectation should spur a strong equity rally across all markets into early 2024. But the decline in yields will be limited. Ultimately, this restricts the upside potential for US equities with important implications for the US dollar. Impetus for US dollar strength is finally broken.

  • A turn in the US dollar means that prospects for EM outperformance are now excellent, although weak Chinese growth and the risk of an eventual hard landing in developed markets suggest that excess returns might be a slow burn. We expect inflows will strengthen once a bear market in the US dollar is fully confirmed.

RiverCircle Weekly
Don’t Fret About Support Lines …
30 Oct 2023
  • The Shanghai Composite Index is testing a marathon 18-year support trendline.

  • We suspect the Index will eventually break support and there will be much hand wringing when it does. But the significance will be less than most imagine.

  • Only earnings drive equity markets over the longer term. Our expectation is that Chinese EPS will match or exceed that in the remainder of EM in coming years. If a break of support results in panic selling, it will be a longer-term buying opportunity.

RiverCircle Weekly
Chinese Industrial Policy and SoEs …
16 Oct 2023
  • Chinese state-owned enterprises have languished at the bottom of the global stock market league table for a number of years. It is difficult to imagine a less loved segment of global equity markets.

  • This reflects poor financial performance and an expectation that industries dominated by SoEs are no longer central to Chinese industrial policy as it attempts to escape the middle-income trap.

  • We think that SoEs are more central to Chinese policymakers today than they have ever been. This centrality, combined with reform efforts associated with the 14th Five-Year Plan, should see a revival in SoE profitability and investor appeal in the coming years.

RiverCircle Weekly
The Whole-nation System and Stocks …
9 Oct 2023
  • Chinese equities face three concerns: disappointment with the pace of economic recovery, disappointment with the extent of policy stimulus, and anxiety that the government is more actively using the equity market as a tool for economic policy.

  • We view the first two concerns as relatively minor. From autos to semiconductors, China is taking market share in high-value-added industries and it dominates in the drive for lower emissions.

  • The use of Chinese equities as an active policy tool, however, is worrying because investors do not like it and it will have an impact on expected equity market returns. However, not all companies will be impacted equally. It is entirely possible that SOEs, which have languished for years, will benefit. Moreover, small and medium-sized companies will have a free hand to seek profitable opportunities. In our view, the case for Chinese small caps and SOEs is getting stronger.

RiverCircle Weekly
The Outlook for Shipping …
26 Sep 2023
  • The fortunes of commodities, Asian equities and global cyclicals are closely tied to the global trade cycle. Of the cyclical industries, none is more closely tied to trade than shipping.

  • Last week we argued that the global expansion has peaked, meaning that economic growth will slow from here. This means that the best phase of the expansion for cyclicals, that being the recovery phase from recession, is behind us. However, it does not mean that cyclicals have no upside.

  • As we noted last week, in the late expansion phase, we typically see a second wave of strength in commodity prices. This pattern also applies to shipping rates. We expect shipping stock to exceed expectations in the coming 12 months, but we do not think that these companies offer enough juice for our long-term investment style.

RiverCircle Weekly
GenAI, Healthcare and Education …
18 Sep 2023
  • We return to the AI theme because we believe the extent to which companies embrace automation technologies will be the biggest driver of relative stock performance within industries in coming quarters. Companies that exhibit early adoption are already outperforming.

  • When it comes to automation, most investors think of tech, advanced manufacturing, and banking. We think that healthcare and education will be the industries most impacted from an operational standpoint.

  • From a stock picking perspective, operational impact matters most because this is where automation will be a big differentiator. That is why we are sharpening our focus on early adoption tendencies within companies in these sectors.

RiverCircle Weekly
The Business Cycle has Peaked …
11 Sep 2023
  • Our most important measure of the global business cycle has peaked. If we follow the normal cyclical pattern, commodity prices and emerging market equities will experience a late-cycle rally before the outlook turns truly sour later in 2024.

  • Based on current trends, the best phase of the cycle for small-cap relative performance can be expected around mid-2024.

  • The scope for economic policy to offset the slowing economic outlook is negligible because the US and China are running large fiscal deficits.

RiverCircle Weekly
Nuclear Disruption …
4 Sep 2023
  • Nuclear has long been the poor cousin among the zero emission power generation alternatives. Thus far the industry has failed to enjoy the tailwinds provided by climate change investment.

  • However, this situation might soon change. Small modular reactors (SMRs) are making waves and could become a disruptive force in the clean energy space.

  • China is at the forefront and is building the world’s first commercial SMR. China Nuclear Energy Technology Corp (611 HK), China’s main listed play in nuclear plant construction, has languished for years but will be a major beneficiary if SMRs begin to excite investor attention.

RiverCircle Weekly
Re-thinking Japanification …
29 Aug 2023
  • Almost as soon as it began, observers have drawn comparisons between the Chinese economic miracle and the Japanese post-war economic miracle, questioning whether China might go the same way as Japan.

  • Beijing has asked the same question and has studied the Japanese experience exhaustively with the object of avoiding the same mistakes. Thus, despite following a similar development model, China has avoided some of Japan’s most serious excesses. Unlike Japan, there is no bubble to burst in China.

  • This does not mean, however, that China’s problems are necessarily less severe than those faced by Japan. If China fails to reform with sufficient vigour, it could face its own unique brand of Chinafication.

RiverCircle Weekly
Solid Little Companies …
22 Aug 2023
  • Search “China” on YouTube and you will find endless stories about economic demise, social distress, environmental disasters, and looming collapse.

  • We are not going to sugar coat it; China is in an economic bind. But, in our view, China’s economic woes are no worse, perhaps somewhat better, than we observe elsewhere. China is just part of a gloomy overall picture.

  • But there is good news: difficult times promote innovation and structural change. Solid little companies often prosper in difficult times while large companies, trapped by their high market penetration, face limited prospects.

  • We are seeing a strong recovery in Perfect Medical’s (1830 HK) earnings which are now higher than pre-covid levels. Whilst most of this has been driven by their Hong Kong operations, we expect Chinese operations to normalise in 2024

RiverCircle Weekly
Time to Sell Hua Hong Semi …
15 Aug 2023
  • Things don’t always pan out as one expects. In early 2023, we really liked the prospects for China’s semiconductor industry: the global cycle was bottoming and the upcycle for Chinese pure play foundries promised to extend well beyond the usual 24-to-36 months due to the rapid rise of local fabless chipmakers and Beijing's push for self-sufficiency in semiconductor supply chains.

  • We began acquiring Hua Hong Semiconductor (1347 HK) from 4 April onwards based on this promising outlook, a cheap valuation, and a clean set of accounts. The company’s counter-cyclical investment strategy appeared bold and well-timed, while an imminent A-share listing offered a potential catalyst for re-valuation.

  • Sadly, China’s economic recovery is proving weaker than we foresaw and global chip demand appears likely to disappoint, leaving Hua Hong with a probable capacity overhang into 2024 and considerably lower-than-expected margins. Our rationale for holding the stock is gone.

RiverCircle Weekly
Electrification and metal scarcity …
7 Aug 2023
  • Electrification and GenAI are the two great investment themes of the coming decade. Investors need to be aware of developments in each.

  • The US Department of Energy just released its 2023 Critical Materials Report, which evaluates supply chain security in materials needed to facilitate electrification. Key within the detail of this report is news that the supply risk has worsened significantly for copper, nickel, and lithium.

  • Most materials on the critical supply list, however, are subject to technological disruption. We prefer the core materials of copper, lithium, and nickel. If Toyota Motor’s announced breakthrough in solid-state batteries proves a commercial success, demand for lithium will benefit while graphite and cobalt will suffer.

RiverCircle Weekly
Yes, the US$ is breaking down …
20 July 2023
  • After consolidating through the first half of 2023, the US dollar Index recently weakened to new lows.

  • Further support levels need to fall before a fresh downtrend can be confirmed but this is just a matter of time because US dollar drivers are all pointed in the right direction.

  • Once a pattern of lower lows is confirmed investors will conclude that the US dollar is on a weakening trend, opening the gates for sustained inflows into emerging markets. Under a weakening US dollar, quality small caps offering value and dividends will outperform.

RiverCircle Weekly
Trade and Asian Markets…
12 June 2023
  • China’s exports fell 7.5% YoY in May, confirming that Asia’s export machine is faltering. Meanwhile, China’s CPI for May rose a mere 0.2% YoY, arousing fears that China could be entering a Japan-style deflation.

  • Since Asian equity performance is tied to export growth, and since deflation is deeply negative for equities, Asian-focussed investors are rightly troubled by recent data.

  • This is especially true because export growth will weaken further as the slowdown in advanced economies intensifies, and as the export boost afforded by the pandemic is unwound. However, Asian equity markets are already priced for this eventuality. Deflation in China, however, would represent a much more serious problem.

RiverCircle Weekly
Decision time for bonds …
10 July 2023
  • In our note of 22 April, we said that US Treasury yields would, “continue to rise through 2023 and 2024, even in the event of a mild recession”. In a higher interest rate world we said, “Asian growth will strongly exceed DM growth, Asian equity markets will outperform, and EM bonds will outperform US Treasuries.”

  • We retain high conviction in this assessment even though it is unfolding slower than expected. Recent events provide a glimpse of how we expect markets will develop.

RiverCircle Weekly
Recession, what recession? 
3 July 2023
  • Although early signs of recession are becoming apparent in Europe, similar evidence remains absent in the US and Asia.

  • Meanwhile, AI-related stocks continue to surge despite 500 basis points of Fed rate hikes since March 2022.

  • Against this backdrop, what are investors to deduce? Is the strength of the US equity market evidence that the risk of recession has dissipated or is some kind of hard landing still a risk? In our view, the risk of US recession remains high and is still our base scenario.

RiverCircle Weekly
The Case for Small Caps (Part 2) 
26 June 2023
  • In this second part of our series, we explain why alpha generation from active stock selection in small gaps will greatly exceed that in large caps in coming years.

  • Small caps always offer superior alpha generation due to their sheer numbers, the superior growth potential of new versus established companies, and the wide range of quality among small-cap companies. The discrepancy between well-run and poorly-run small caps means that the breadth of small-cap performance is always narrow. The narrower is the breadth, the greater the scope for alpha generation.

  • The prevalence of zombie small caps after years of low-interest rates means will widen the performance gap among small caps even further in the coming years. Positive trends in investor activism due to ESG investing, and the megatrends of Artificial Intelligence and aging demographics, will further accentuate these differences. A lack of research after years of neglect means there is unprecedented potential for price discovery in Asian small caps. This potential will be unlocked as the small-cap indexes begin the passively outperform.

RiverCircle Weekly
The Case for Small Caps (Part 1) 
20 June 2023
  • The stars are aligned for a sustained period of out-performance by active investors in Asian small cap companies, especially value companies.

  • The investment case for small caps rests on two pillars. First, there are strong economic reasons to expect passive outperformance by small cap indexes in the coming 3-to-5 years. Second, there are reasons to expect even greater active outperformance from stock selection in small versus large companies in the evolving investment environment.

  • In this, the first of a two-part series, we explain why we expect passive small cap outperformance. In the second installment, we explain the reasons to expect greater returns from active stock selection.

RiverCircle Weekly
Trade and Asian Markets…
12 June 2023
  • China’s exports fell 7.5% YoY in May, confirming that Asia’s export machine is faltering. Meanwhile, China’s CPI for May rose a mere 0.2% YoY, arousing fears that China could be entering a Japan-style deflation.

  • Since Asian equity performance is tied to export growth, and since deflation is deeply negative for equities, Asian-focussed investors are rightly troubled by recent data.

  • This is especially true because export growth will weaken further as the slowdown in advanced economies intensifies, and as the export boost afforded by the pandemic is unwound. However, Asian equity markets are already priced for this eventuality. Deflation in China, however, would represent a much more serious problem.

RiverCircle Weekly
Demographics Favour Small Caps
5 June 2023
  • East Asia’s economic miracle, and the equity bull markets that ran with it, owed much to favourable demographics. Sadly, East Asia’s demographic dividend is now turning into a tax.

  • East Asian companies with large domestic market shares face shrinking markets, including those in eCommerce. In this environment, investors can: 1) look for a demographic dividend in other parts of Asia; 2) find thematic opportunities where a market is expected to grow; and 3) invest in smaller companies with growth opportunities.

  • However, countries offering a demographic dividend are increasingly rare, likely not where most investors expect, and typically expensive. Thematic opportunities, typically, are even more expensive. By comparison, small caps offer by far the cheapest access to growth.

RiverCircle Weekly
China: Matter of When
29 May 2023
  • The performance of the HK/China markets thus far in 2023 has been poor. Since the start of the year the HSI is down 7% and the CSI300 is down 1% while the S&P is up almost 10% and the Nikkei has breached 20%.

  • In recent days commentators have blamed China’s underperformance on disappointing economic growth since China re-opened, whereas US and Japanese growth has surprised on the upside.

  • While economic surprise contributed to the relative performance, the reality is more complex and the outlook for Chinese stocks is better than currently anticipated.

RiverCircle Weekly
SEA small caps will outperform…
22 May 2023
  • The global performance of growth versus value matters to Asian small cap investors because Asian small caps are a high beta play on global value. If value is outperforming, Asian small caps are typically a good way to play it.

  • Longer term equity market trends depend on earnings. The earnings outlook supports a view that Southeast Asian markets will outperform in the next several years.

  • A widening economic growth differential in favour of Southeast Asia versus the US largely underpins this assessment.

RiverCircle Weekly
Five questions…
15 May 2023
  • This week we offer our quick take on five questions that almost everyone seems to be asking us.

  • The questions are: Should I worry about the US debt ceiling? What kind of slowdown should I expect? Should I wait to buy Asian equities? Mega cap growth stocks are still winning, shouldn’t I focus on these? What’s your view on private versus public equity.

RiverCircle Weekly
Ownership and size
8 May 2023
  • We alternatively hear that China is either ‘uninvestable’ due to volatile industry policy or ‘unavoidable’ due to its global importance.

  • Neither tag is helpful to the task of investing.

  • However, both tags convey the idea that Chinese investment is unattractive, which is unfortunate because many investors have closed themselves to opportunities at a time when attractive investments are difficult to find.

RiverCircle Weekly
Only earnings matter…
2 May 2023
  • Synchronized monetary tightening since early 2022 is widely expected to cause a recession in the major developed economies by early 2024.

  • We agree with this assessment but don’t believe a recession in the developed economies will cause a recession in Asia or a bear market in Asian equities.

  • We are constructive on Asian equities because we are positive on Asian earnings and bearish on the US dollar. Provided Asian earnings are growing in US dollar terms, there is no reason to expect a bear market.

RiverCircle Weekly
Bond yields won't fall much further…
2 May 2023
  • Consensus and market expectations for the Fed imply that the decline in US bond yields is almost over. If true, investors will soon need to look beyond bonds and mega cap US growth stocks for investment opportunities

  • Investors’ most likely next port of call, in our view, will be EM Asia and Asian small caps, particularly in consumer discretionary, health and tech equipment.

RiverCircle Weekly
Our cash +5% portfolio
17 April 2023
  • Small companies are illiquid. Since we hold concentrated positions, even a boutique manager such as ourselves can influence the share price when transacting.

  • Investing long term helps. Even so, we must hold significantly larger cash positions than a large cap fund. In case of emergency, we never want to sell in a hurry and we must have cash on hand when an opportunity presents itself.

  • The problem with holding excess liquidity is the opportunity cost of holding cash. To lessen this problem, we hold up to 20% of the fund in a cash+5% portfolio.

RiverCircle Weekly
The status of the US dollar
11 April 2023
  • The status of the US dollar as the world’s reserve currency is eroding. While the shift to a multi-polar world appears likely to accelerate that erosion, the greatest likelihood is that the dollar’s demise will be gradual.

  • Since investors associate the dollar’s changing status with danger of economic upheaval, we expect the US dollar increasingly will be seen as a source of risk rather than a safe haven.

  • In such a world, best defence will be to hold broad exposure to a range of currencies and equity markets that perform well in a weakening US dollar environment, notably emerging markets.

RiverCircle Weekly
Disinflation isn’t a thing anymore…
3 April 2023
  • Equity markets continue to behave as though 2023 will be a re-run of 2019 with a gentle landing, a sharp eventual decline in interest rates and strong tech leadership.

  • While the mania for growth stocks persists, quality large cap growth could outperform for a while longer as growth initially slows.

  • But 2023 represents a different market environment to 2019.  Disinflation is no longer the key secular trend. Dislocation is now the key theme due to war, de-coupling and the fragmenting global order.

RiverCircle Weekly
Don’t expect a big fall in rates…
26 March 2023
  • Market action since the onset of the banking crisis suggests investors expect a re-run of 2019, when a rapid Fed policy reversal spurred a rally in mega-cap growth stocks.

  • This assumes the economy will be weak enough in 2023 to cause disinflation and substantial rate cuts, but not weak enough to derail mega-cap earnings.

  • However, the looming slowdown will be more severe than in 2019, inflation will prevent a rapid decline in rates and slower early-stage investing will hurt earnings.

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