Dear Valued Investors,
The last quarter of 2019 brought some promise to the markets—a potential partial resolution of the U.S. –China trade dispute as well as denouement in the violence on the fringes of the Hong Kong protest movement, after pro-democracy candidates won in local elections. The strong rally in the market was also backed by better economic news coming from the U.S., which appeared to have skirted a recession, and renewed hopes for continued moderate fiscal and monetary stimulus across the Asian region.
In some respects, however, 2019 was a difficult year for investors with the highly concentrated nature of the market's returns within large-cap growth companies, particularly in the technology and consumer discretionary sectors. For example, companies like Tencent and Alibaba—already large positions in the MSCI All Country Asia ex Japan Index—had particularly strong final quarters to 2019. In turn, many of the smaller, more cheaply valued stocks and many small company stocks lagged far behind the indices. These effects were a drag on some of our portfolios. China's A share markets rallied in the final quarter, too, albeit not as powerfully as they had in the first three months of the year. Indeed, it was China that led the year-end rally: India and Japan both lagging. So the concentration of market performance was not just in sectors, but also in countries, and that meant just a few stocks have driven the majority of the benchmark performance over the past three years.
The performance of “large-cap growth” in Asia over the past few years in one sense it is unsurprising—as growth expectations decline and the yield curve flattens, large-cap growth stocks tend to outperform. And yet the scale of this outperformance—particularly acute in the latter stages of 2019—has been surprising. In addition, the duration of the outperformance of growth over value in Asia has been unusual. The so-called “jobless recovery” in global economies caused a gradual, incessant flattening of the yield curve and a frustration of growth expectations that pushed investors to pay higher and higher multiples for growth and to declare value investing to be dead. It is perhaps not too much of an exaggeration to say that some investors were rewarded over the past year for almost entirely ignoring valuations. That made the markets playgrounds for the speculator and the momentum trader—it made them a much harder environment for the fundamental investor.
At Matthews Asia, we have always focused on fundamental investing. None of our portfolios fit easily into momentum-driven or trading markets. However, we do have portfolios that invest a higher portion of their assets in emerging businesses and sectors; indeed, the best performing portfolios were those that focused on faster-growing companies with less tested business models, often in technology and health care. We do not seek to time style swings—only to try and understand them and so we are in a position to be more mindful of some of the risks and the opportunities in the markets. As some stocks were beaten down or ignored due to a combination of trade worries, Hong Kong politics and slow growth, valuations in parts of the market became noticeably cheap, as cheap as other areas of the market seemed expensive. The overall level of the region's price-to-earnings ratio, a little above average, masked the underlying polarized nature of valuations. So, as we look to 2020, being mindful of some of these disparities, trading in portfolios may rise as we manage risks and take advantage of new opportunities.
An important question as we go into the new year is whether these trends are likely to continue. Over the closing weeks on 2019, there were hints that some of these trends may be losing steam. The disparity in valuations between fast- and slow-growing companies had become quite stark. Some popular and high-flying stocks faltered badly as they marginally missed earnings forecasts. A reversal in the yield curve, which had inverted but then started to steepen, suggested that the economic environment might be changing. Fiscal and monetary stimulus from China, joining that from other countries across the region, could drive rising margins and a broadening of earnings growth that will make growth seem less scarce and investors less willing to be cavalier about valuations of some companies.
I am optimistic overall about 2020. Slow growth in the global economy outside of Asia, may simply work to create a moderately softer U.S. dollar. That softening of the dollar ought to create a beneficial environment for Asia's economies to continue their stimulus measures. Even though Chinese stocks had a strong 2019, that may just mean they have momentum going into 2020 and the continued favorable environment means that the rally has a good chance of continuing. For now, it is being led by China. Given the fact that the Japanese rally is much longer in the tooth and the Indian economy is suffering from weakening nominal demand, it would not be too optimistic to expect China's leadership continue their stimulus into the New Year. But should growth broaden across the region, it would bring back the kind of liquid financial conditions that have traditionally favored smaller capitalization stocks. What is less certain is whether global asset allocators yet believe in this trend, and so they appear to be staying on the sidelines. If this bullish trend is to continue, it must climb that wall of suspicion.
We will remain dedicated to finding the best companies that, based on our intuition and knowledge of the region, we believe will dominate their industries in years to come. As always, we will temper our enthusiasm for the region's growth with a proper focus on the quality of each company's governance and the price we are being asked to pay.
Robert Horrocks, PhD
Chief Investment Officer