February marked an abrupt shift in global markets, as volatility rose markedly and markets corrected downwards. Emerging markets (EM) stocks pulled back 4.61% during the month. This was a marginal underperformance versus the United States (S&P 500) and the developed market indices (MSCI EAFE), which traded down 3.69% and 4.50%, respectively. This performance was despite positive earnings revisions across EM (+0.5%) and the ACWI universe (+2%). Total EM equity funds had another month of net inflows, while EM Asia funds saw slight net outflows. Volatility picked up and was especially pronounced in the United States, where the market fluctuated over concerns about rising inflation and Fed tightening intentions. The Dollar Index (DXY) had its best month since November 2016 on the Fed’s relatively hawkish FOMC minutes, and almost all EM currencies depreciated. Within EM, Asia was the worst performer (-5.39%) versus Latam (-3.57%) and EEMEA (- 1.77%). Commodities were also broadly weak during the month with the S&P industrial metals index down 2.88%, although steel was a relative outperformer. Brent crude also traded off, closing down almost 5% to close at $65.78 per barrel.
The top country performers in February were Thailand, Russia and South Africa, which were also the only markets to notch positive absolute returns during the month. Thailand’s strength was driven by a strong rotation into energy and petrochemical stocks as well as encouraging signs of private investment and a hike in the minimum wage. Russia saw strong earnings upgrades during financial reporting season, with 2018E EPS up by 5%. South Africa benefited from the news of pragmatic appointments to new president Ramaphosa’s cabinet. The weakest countries during February were Greece, Mexico and India. India’s underperformance was attributable to the introduction of a 10% tax on long-term capital gains in the FY19 budget and concerns over rising inflation, leading to the largest monthly capital outflow since August 2017. Greece saw the resignation of its Minister of Economy as it also approaches the end of the bailout program and elections are nearing. Mexico was weak as NAFTA talks underwhelmed and Trump ramped up talk of tariffs in the steel and aluminum industries.
From a sector perspective, the top performers were Health Care, Energy and Utilities. Conversely, Real Estate, Industrials and Information Technology lagged during the month. Within Technology, which was down 5.5% in the month, the Internet sub-sector was an underperformer, notching a 6.73% correction on particular weakness in Tencent (-6.82%) and Alibaba (-8.88%).
The fund outperformed the benchmark in February 2018, offering the downside protection we would anticipate in such a market pullback. This is consistent with the fund’s historical outperformance in flat and down markets, and meaningful participation in strong up markets such as January 2018. The top country contributors in the month were our stock selection within China, our over-allocation to Russia, which was a strong country performer, and our appreciating position in Vietnam, which is not a benchmark constituent. Our country detractors included India, where we are modestly overweight, Thailand and South Africa. We are underweight both Thailand and South Africa, and they were strong performers during the month. In terms of sector performance, we benefited from our underweight to Information Technology companies, whereas our over- allocations to Materials and Industrials were beneficial. Our weakest sector performers in February were Financials and Telecommunications, both on stock selection grounds.
- Nine Dragons (China, Materials) – Nine Dragons outperformed during the month on the back of strong earnings results by the company. FY1H18 EPS grew 127% YoY despite a slight decline in sales volume as a function of the company’s focus on preserving ASP and margins. The company grew its dividends 100% on a YoY basis. Nine Dragons remains well-positioned to benefit from a resilient and growing demand for corrugated packaging in China, as well as from rationalization in production due to the Chinese government’s supply-side reforms. It has been granted sufficient import quota to be able to import the majority of its OCC requirement from overseas markets, which currently have a better cost structure. We remain confident in the company’s ability to offer incremental returns to its shareholders and continue to rerate.
- IGG (Singapore, Technology) – Online game developer IGG outperformed for the month of February after continued growth in its Lords Mobile franchise. Additionally, the company is making a push for growth by targeting Andriod phone users in China. IGG currently receives about 10% of its revenue from Android users for its flagship Lords Mobile game whereas, on average, Android revenue makes up approximately 50% of mobile gaming revenue in China. We feel that the company is well-positioned in 2018, as it plans to release a slate of new games in the first half of the year.
- Xinyi Glass (China, Materials) – Xinyi Glass outperformed for the month after announcing solid full year earnings. Revenue and earnings growth were both up double digits after strong sales of auto and construction glass. Xinyi uses natural gas in its manufacturing process, whereas a number of Xinyi’s competitors use coal and were unable to obtain the required environmental licenses to continuing operating. Hence, the Company continues to be well-positioned to take advantage of a reduction in competition due to the government’s supply- side reforms. We continue to like the company’s outlook for 2018, its undemanding valuation and its dividend yield of almost 4%.
- Value Partners (China, Financials) – Shares of Value Partners underperformed during the month since they corrected after a significant rally in the month of January. Last month, Value Partners issued a profit alert, indicating a huge jump in performance fees, as well as an announcement of a special dividend that far exceeded market expectations or historical payouts. These declarations resulted in the stock gaining app. 20% and hence, the stock normalized a bit in February as the news got priced in and some investors realized gains. The stock did not underperform due to any company specific news and we remain confident in management’s capability to deliver continued growth.
- ICICI Bank (India, Financials) – ICICI Bank underperformed during the month on the back of results from another quarter of declining earnings growth. On a relative basis, 3QFY18 was better than the last two quarters, both in terms of domestic loan growth as well as NPA recognition from the drill down list. 85% of slippages this quarter came from the previously identified drill down/high risk list instead of from the overall loan book. Moreover, corporate loan book showed healthy growth despite the availability of a narrow pool of viable borrowers. The stock de-rated primarily as a function of ongoing concerns around existence of high bad debts in the Indian banking system. It may take some time for a complete clean-up, however, progressive steps are being taken through recapitalization and better recognition practices.
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Cullen Capital Management LLC