Asia Small Companies: December 2020 Quarterly Commentary

Asian equity markets for small to mid-sized stocks ended the December quarter up by 13.8% in USD terms and up 5.7% in AUD terms, the latter being a much lower return due to strength of the Australian dollar. In the year as a whole the regional market for small to mid-sized companies increased by 14.0% and 3.8% in USD and AUD terms, respectively, with the strong Australian dollar again accounting for the difference in returns. The strength in regional markets in the past quarter was largely derived from continuing strong sentiment associated with news regarding the development of various vaccines for Covid-19 and the economic recovery that is being observed across parts of the region.

The recent trend of tension between China and Taiwan continued throughout quarter with and increased frequency of US warships through the Taiwan Strait. Beijing responded in December with a strongly worded statement accusing the US Navy of provocation and a “show of force”. In her New Year speech, Taiwan’s President Tsai Ing-wen provided an offer of a change of tone for the relationship with Beijing by suggesting that Taiwan is ready to hold meaningful talks with China. President Tsai had previously offered an olive branch to China with her National Day speech in October. The position adopted by China since 2016 when President Tsai was elected, remains that talks with Taiwan must be contingent on an acceptance that Taiwan is part of China. Despite the geopolitical tension Taiwan performed well during the quarter rising 19.0% in USD terms. Taiwan has achieved impressive control of the Covid-19 virus, with just 812 confirmed cases and 7 fatalities during the year. Companies in Taiwan continue to benefit from the trade tensions that exist between China and the United States with their electronics sector being an obvious alternative to companies based in the Mainland.

The strongest market during the quarter was South Korea which increased by 24.6% in USD terms reaching an all-time high. There has been a strong recent trend in economic data reported in South Korea, with exports rising at their fastest pace in 26 months in December up 12.6% year on year, this number was more than double the market consensus with semiconductors being the strongest component. The improvement in economic activity has been the key to dramatic strength in the local stock market, rising 10.2% in the month of December for an overall gain to 32.6% in USD terms for 2020.

Japan, China, Hong Kong and Singapore have lagged other markets in the region during the month of December and the year as a whole. For the December quarter, Japan achieved a return of 10.5% bringing the annual return to 7.6% in USD terms following the very weak March Quarter. Economic numbers stalled in December together with rising reported Covid-19 infections which hurt sentiment in the stock market. Factory output in November was flat versus a 4% rise reported in the previous month, the key driver was a decline in production of cars. The December factory output number is expected to show a small decline while the January figure is expected to rise more than 7% which should have a positive influence on the stock market. We remain positive regarding Japan as an investment destination in 2021, with the economic recovery, improving corporate governance and strong company balance sheets expected to boost market sentiment and returns.

With a market increase of 11.9% during the quarter in USD terms, China slightly lagged the regional index, however, the annual return of +34.2% was the strongest of the major markets in the region. China has continued to report strong data associated with an economic recovery. The Purchasing Managers Index remained above 55 for the month of November. Profits for industrial companies in China increased 15.5% in the year to November, the seventh consecutive month of gains. This economic strength was driven by a sharp increase in demand for exports in particular industrial robots up 22% and integrated circuits up 16%. Data from Nomura indicated that China’s share of global exports stood at 13% in the third quarter of 2020 versus 11% in 2019. Increasing demand is beginning to feed through to local investment decisions, manufacturing investment which had fallen by 3.5% during the first ten months of 2020 showed a rise of 12.5% in November. While the private sector is performing well, profits in the public sector remain on a downward path that will continue to put pressure on the authorities to undertake ownership and management reforms.

The portfolio remains fully invested with five new positions acquired during the quarter. We purchased three new positions in Korea, semiconductor materials maker Tokai Carbon Korea, online games developer DoubleUgames and food manufacturer Orion Corporation. In Japan we purchased mobile phone carrier Okinawa Cellular and online games developer Gungho Online Entertainment. All of the new additions to the portfolio score well in our assessment of value, momentum and quality.

We will continue to invest in Asian small to mid-sized companies with strong value, momentum and quality attributes together with accounting, strategy and governance standards that meet our requirements. Long-term returns will be generated by the ability of our companies to deliver growing profits and dividends.