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ETF Overview
The VanEck SME-ChiNext ETF (CNXT) is an ETF that tracks the ChiNext Index, a free-float adjusted index intended to track the performance of the 100 largest and most liquid stocks listed and trading on the ChiNext Market of the Shenzhen Stock Exchange (SHE). Established in 2009, the ChiNext Board is a secondary market on the SHE behind the Main Board, which usually attracts listing from more innovative early-stage companies with higher growth prospects.
Holdings
Seeking Alpha
The ETF is heavily weighted toward industrials and healthcare, as well as tech. The following are some examples of holdings in the ETF that are from these categories.
Industrials
Contemporary Amperex Technology (SHE:300750)
- Weight – Highest at 18.45% more than double the weightage of the second company
- Market Cap – US$208 billion
- Core Businesses – As one of the domestic market leaders in the supply of EV batteries, CATL was a huge beneficiary of Tesla’s expansion into China, at one time being the sole supplier of batteries to Tesla. Going forward, it has secured much more EV battery supply deals with the likes of Hyundai, Honda, BMW, Daimler AG, Toyota, Volkswagen, and Volvo.
Healthcare
Shenzhen Mindray Bio-Medical Electronics (SHE:300760)
- Weight: 4.09%
- Market Cap – US$66 billion
- Core Businesses – The company offers patient monitoring and life support products, such as patient monitoring systems, electrocardiographs, defibrillators, anesthesia machines, ventilators, infusion pumps, surgical lights, operating tables, medical supply units, endoscopes, and accessories, as well as emergency care, peri-operative care, critical care, and IT solutions.
Technology
Shenzhen Inovance Technology (SHE:300124)
- Weight: 3.26%
- Market Cap – US$28 billion
- Core Businesses – The company engages in the manufacture and sale of industrial automation control products in China. The company offers industrial automation products, including AC drives, PLC, HMI, power automation CNC, sensors, industrial internet, and industry-specific drive and control systems; motion controls comprising servo drives, servo motors, and robot motion controller; passenger and commercial car powertrain; industrial robots and industrial robot components; mechanical modules; and railway traction and control systems.
Additional Information
| AUM | US$37.41M |
| Expense Ratio | 0.65% |
| Dividend Yield | 10.16% (2021 was a special year for the ETF as VanEck decided to redistribute its “long term capital gains” from investing in the index. In other years, the dividend yield is close to 0%) |
With my thesis of a $55 price target in 2023, I will first be explaining whether the headwinds and tailwinds that the ETF has faced in 2021 will continue or not going into 2023. Then, I will be detailing the previously mentioned cost pressures the ETF could face in 2022 and how they could change going into 2023.
Projecting CNXT’s 2021 Performance into 2022 and 2023
Putting CNXT’s 2021 Performance into Context
TradingView
2021 was a good year, with the ETF being one of the bright stars in a region otherwise decimated by internal regulatory crackdowns from Beijing as well as a rally in US 10-year treasury yields which dampened flows into EM. Even then, it still underperformed similar benchmarks in the US, such as the Nasdaq.
To better understand how the ETF is going to perform in 2023, we would first need to understand the headwinds and tailwinds it faced in 2021, and whether or not they will continue into 2023. This will provide us with a more comprehensive understanding of the likelihood of outperformance in 2023.
Headwind: China’s COVID-19 Outbreaks
When you look at the chart, you would see a steep drop in December 2021. This primarily attributed to the rising COVID-19 infections in major cities such as Xi’an. The knock-on effect for many of the mid to small-cap companies such as those in the ETF was the disruption in their fragile supply chains, which disproportionately impacted the heavily industrials-weighted ETF.
In Xi’an and Tianjin, where many major companies’ ((VW, Toyota, Ford, BYD)) EV battery production is based, COVID-19 forced many of these companies to shut down their factories in December 2021 and Early January 2022. This is impacted not only the highest weighted CATL, but also many other smaller firms in the ETF that operate down the EV and clean energy supply chain.
To give a broader perspective on the impact of the new outbreaks on small and mid-cap Chinese firms, December’s PMI for smaller Chinese firms further contracted.
Bloomberg
While many may think that these COVID-19 outbreaks are likely temporary, I do believe that going into 2022, with new variants, these outbreaks could actually be more secular in nature and be a permanent drag on the performance of the ETF. The only thing standing between the threat of these outbreaks and the performance of the ETF is how the central government deals with it. Fortunately, the government’s actions have shown positivity going forward.
Apart from the recent December 2021 flare-up in cases, the other prominent flare-up was in January 2021, and we can look back at how the government controlled the spread to better understand whether the government’s actions right now are adequate.
The January 2021 outbreak occurred in Northern China, partly attributed to rapid spreading in the rural areas and aided by a “super-spreader.” The actions that the government took then in one of the cities, Shijiazhuang, is an outline of the government’s timeline of action during the January outbreak.
CGTN
Conversely, the Beijing’s response to the December outbreak has been far more aggressive, highlighting its COVID-zero policy. In the major city of Xi’an, immediately after mass testing, a city-wide lockdown of over 13 million people was imposed. This time, regulations were much stricter, with many Chinese living in Xi’an complaining about the lack of food and denial of access to hospital, which even resulted in the death of a pregnant woman. Suffice to say, the government is seriously stepping up its response in a bid to reach zero COVID-19 cases in the coming weeks.
Given all this, it is likely this headwind will still be temporary and the continued slump in the ETF as the December outbreak continues on represents a buying opportunity.
Tailwind: PBOC’s Accommodative Monetary and Fiscal Policy Regime
Bloomberg
In December, the PBOC cut the 1-year loan prime rate by 5 basis points. On Jan. 17, the PBOC also lowered 1-year policy loans by 10 basis points, while also cutting the 7-day reverse repurchase rate. On Jan. 19, the PBOC finally cut its benchmark 5-year loan prime rate by 5 basis points.
Although it would seem like China is going into an easing regime, the consensus perception is that it is more of a dampener for the property-led slowdown in growth. Furthermore, anymore aggressive cuts would drive inflationary pressures in the second half of the year, with the bond markets in the US pricing in 4 rate hikes. In any case, the pivot to a short-term dovish outlook by the PBOC provides an accommodative environment for Chinese equities, especially those in the ETF whose core businesses are based in China.
The following are economists’ calls for 2022:
| Maggie Wei at Goldman Sachs |
– PBOC will also likely cut the RRR by 50 basis points at some point to support the economy. – Strong foreign capital inflows may continue due to elevated goods trade surplus and foreign buying of yuan assets, and yuan depreciation and capital outflow pressures remain low. – This also implies room for PBOC to ease further despite U.S. monetary policy tightening this year,” they said. |
| Iris Pang at ING |
– There’s still room for China to cut interest rates further even though the Fed is likely to hike rates later this year, because the rate differential remains wide. – PBOC will cut the one-year medium-term lending facility rate by 25 basis points in each quarter starting from the second quarter, amounting to another 75 basis points in total by the end of this year. – Further RRR cuts will depend on how big an impact the omicron variant will have on economy during the Lunar New Year. – The PBOC could also use the daily open-market operation injections to replace RRR cuts. |
| Lu Ting at Nomura |
– “We expect another 10 basis point rate cut before mid-2022.” – The PBOC could choose to increase foreign exchange purchases significantly in the coming months, Lu said. This would contain the yuan’s appreciation, ease concerns over Chinese companies’ offshore dollar bond defaults, and add liquidity to the economy, according to Lu. |
| Xing Zhaopeng at ANZ | – Another RRR cut is possible as the PBOC acts to prevent a market rout caused by developers’ defaults, according to Xing.
– But the window for monetary easing will be limited as the Fed looks ready to start hiking soon, after which the PBOC will pull back and focus on financial stability later this year, Xing said. |
| Chen Xingdong at BNP Paribas |
– Expects another cut of the one-year MLF rate by 5 basis points in April or May – He forecast a 50 basis point reduction in the RRR in the first quarter and another cut in the second half of the year, even though the Fed’s potential rate hike could narrow the PBOC’s easing window. |
| Liu Peiqian at NatWest |
– “This is a decisive dovish tilt as the policymakers acknowledged the importance to stabilize short term growth,” said Liu. – Liu expects the PBOC to cut the one-year MLF rate by another 20 basis points and the RRR by 100 basis points by the end of the year. – However, the PBOC is “unlikely resort to ‘flood-style stimulus’ of consecutive and aggressive rate cuts,” she said. |
| Julian Evans-Pritchard at Capital Economics |
– The PBOC to cut policy rates by another 20 basis points in the first half of this year as economic momentum remains weak. – “The upshot is that policy easing is likely to soften the economic downturn rather than drive a rebound.” |
| Chen Jinyang at HSBC |
– “We expect more policy easing to come in the coming months, including two 50 basis-point across-the-board RRR cuts… – larger fiscal bill to support manufacturing, infrastructure and green investment this year.” |
(Source – Bloomberg)
Chen at HSBC’s call on Beijing’s possible fiscal spending on infrastructure is echoed by ex-PBOC advisor Yu Yongding. If the government does decide to go ahead with infrastructure spending, there is a high chance that many of the companies in the ETF would benefit, especially if infrastructure spending at the municipal level is focused on clean energy and healthcare facilities.
Tailwind: Shielded from Beijing’s Regulatory Crackdown
Reuters
Under the “Common Prosperity” regime, many companies in industries which tended to generate disrupt the desired Chinese social fabric e.g. private education and gaming, suffered regulatory crackdowns. Dominant tech firms with offshore secondary listings such as Alibaba and Tencent also suffered badly.
As for the ETF, this doctrine is likely a strong tailwind, as:
1. None of the companies in the ETF hold any dominant positions in any of their markets, arguably apart from CATL, which although is a market leader domestically, are crucial in the government’s EV and clean energy push. Moreover, the reduction in EV-related subsidies over the years have already invited enough foreign competition into the market.
2. Almost all of these companies are enablers of the Common Prosperity regime, especially companies which provide healthcare services and equipment, as well as pharmaceutical drugs (the pharmaceutical industry is extremely fragmented in China, as compared to Big Pharma in the US), even companies which provide stock market information.
Goldman Sachs recently published their “Common Prosperity Model Portfolio”, which highlights the top 50 companies which would likely benefit from the Common Prosperity era. Unsurprisingly, 10 out of 50 companies in the portfolio can also be found in the ETF.
Cost Pressures from Rising Commodity Prices Presents Buying Opportunity in 2022
With many of the companies in the ETF being industrials in renewable energy, such as EV battery and solar cell companies, as well as semiconductor companies, the rise in key raw metal prices which have already been felt in 2021 will likely persist in 2022, presenting a buying opportunity.
While other market leaders such as BYD and Gotion High Tech already hiking their battery prices, it is likely that CATL will follow suit if cost pressures continue to squeeze operating margins in 2022.
Why I say this presents a buying opportunity is that the consensus forecast is that there will likely be a surplus in essential metals such as copper and nickel going into 2023, with both Bank of America and Citigroup forecasting a surplus in 2023 that will drive earnings growth and greater profit margins in 2023.
Bloomberg
This is in line with the rise in lithium-ion batteries in 2022 followed by a fall in battery prices as supply is able to better catch up with demand.
Bloomberg
Overall, if semiconductor, EV battery and solar energy companies were to announce lowered profit guidance in 2022 as a result of supply crunches which put downward pressure on the ETF, I would take this as a buying opportunity.
Verdict and Conclusion
Overall, the headwinds faced by the ETF are likely transitory, while the tailwinds are far more secular in nature, with most strategists highlighting the first order effect of friendly regulation on the performance of Chinese equities going forward. I will reiterate my 2023 price target of $55, representing roughly 25-30% upside.
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