US companies wrapped up reporting on a solid first-quarter earnings season early in May, then US President Donald Trump stepped in to fill the information vacuum with an escalation in trade wars – initially with China and then with Mexico. Recent progress in US-China trade talks unravelled as Trump tweeted that China “broke the deal” setting in motion a hike in tariffs from 10% to 25% on $200bn of Chinese imports and a renewed threat of tariffs on a further $300bn of imports. China retaliated with an increase in tariffs on $60bn of US imports. The US also placed sanctions on Huawei, the world’s biggest provider of network telecommunications equipment and the second-largest global smartphone firm. The Chinese firm, privately owned by founder Ren Zhengfei, who has close ties with the Chinese government, is suspected of using its vast telecommunications network to gather data for the Chinese government. Trump also announced 5% tariffs on Mexican imports into the US, until the Mexican government stops allowing illegal immigrants to enter the US. Trade wars unsettled investors and saw equity markets drop for the first time this year. Hong Kong-listed Chinese firms led the sell-off, dropping 9% for the month. The tech-heavy Nasdaq fell 8% MoM, with Apple and chip manufacturers leading the collapse. Energy stocks were the worst performing S&P 500 sector in May (down 11%) as Brent crude oil dropped 12% on global growth concerns.
Three years on from the Brexit vote, the UK is still no closer to a resolution with Prime Minister Theresa May the latest casualty. She was forced to resign as prime minister once it became clear that she wasn’t going to get a fourth attempt at forcing her Brexit deal through. Despite this, developed markets (DMs) outperformed emerging markets ([EMs] -5.8% vs -7.3%) as the sell-off in Chinese stocks overwhelmed the positive returns in May for Brazilian, Russian and Indian stock markets. Indian markets were buoyed by Prime Minister Narendra Modi comfortably winning a second term in charge.
Some of the most alarming moves were in the bond markets, where German 10-year bond yields moved decisively into negative territory for the first time since 2016 and US 10-year yields dropped comfortably below US 6-month yields, “inverting” the yield curve for the first time since a brief occurrence in March.
Selling Apple, feels like a divorce albeit potentially temporary
We sold our Apple position in May. We continue to believe that the company’s competitive advantages of a strong brand and switching costs translate into high margins and returns on capital. Furthermore, its financial position remains enviable with over $120bn of net cash on the balance sheet and a target of reaching a “cash neutral” position in the medium term. There are, however, notable headwinds facing the tech giant at present. The iPhone business has slowed down as consumers elongate the replacement cycle. This has been exacerbated by general economic weakness in emerging markets (EMs), particularly China which makes up a fifth of operating income. While we expect services to become an increasingly important part of the business, iPhones remain the largest driver of earnings for now at just over 60% of revenue. The trade war between the US and China has the potential to further compound the iPhone segment’s difficulties. Following the White House’s move to restrict US companies’ commercial interactions with Chinese technology firm Huawei and the Chinese government reportedly drawing up a blacklist of US companies, there is a possibility that Apple may be caught in the crossfire. This could happen indirectly, via consumers in China spurning iPhones in favour of products from local competitors, or directly, from the Chinese government targeting Apple in some manner as a form of retaliation. Naturally, the situation remains uncertain. Ultimately, we continue to feel that the company has several attractive investment characteristics and will monitor the situation closely with the possibility of re-establishing the position if attractive prices present themselves.
Ping An: PING!!! Aaaaaaand its IN!
During May, the Anchor Capital High Street Equity Portfolio took exposure to the structurally attractive Chinese insurance market through a stake in Ping An Insurance Group. Ping An has been on the radar of the Anchor investment process for several years, with the structural demand for insurance in China screening as a very attractive investment theme across the global opportunity set. Our first meeting with Ping An was in China in 2015. It took the investment team a few years to become comfortable with the macro drivers, and the business case, as Ping An is a very large and diversified financial-services conglomerate in China. We missed the run in 2017 but we have used the subsequent risk-off stance towards EM asset prices, and a pullback in Ping An’s share price, as the opportunity we needed to marry the investment case to the business case.
The bulk of Ping An is insurance (both property and casualty [P&C], life and, more recently, health) with adjacent industries such as fintech and investment management paving the way for further diversification and future growth. The numbers and size of the opportunity remains staggering with the current agency force of over 1mn brokers targeting an underserved and underpenetrated Chinese insurance market. The Group should generate in excess of $170bn in revenue this year, representing high single-digit growth and operating profit of $40bn, representing growth of 16% YoY. The return on equity is in excess of 20%. The share is currently trading on 1.2x price to embedded value, and we think the valuation is attractive in comparison to its EM peer set and relative to its own history. With growth set to continue for many years to come, we hope that Ping An will grow into a cornerstone position in the portfolio.