"I’m not afraid to die, I’m afraid to retire."
The quote above was in a sign held by protestors marching halfway around the world, in Chile. A less morbid version of this statement could just as easily refer to prospects for investment returns in a world with already low but still declining rates, weak inflation, and sluggish growth. After a year where, despite the unpredictability of US President Donald Trump, markets have posted none too shabby returns (MSCI’s Asia-ex Japan index up 13% YTD), 2020 will require balancing risk aversion with risk taking.
Glass half empty…
President Trump’s tweets are unpredictable, both in timing and content, and cause much consternation and hand-wringing by financial market participants. With US elections due towards the end of 2020, more unpredictability is possible, and even likely. As former US Secretary of State Henry Kissinger astutely observed, “To be absolutely certain about something, one must know everything or nothing about it”. And it is impossible for us to know the US president’s thoughts.
Markets in general, notably developed markets, are increasingly dominated by ephemeral attention spans, investment silos, and the rise of passive funds. The proliferation of quant strategies, each deploying some variant of an "AI model" backed by "big data analytics" has impaired the information that can be gleaned from asset prices. And the willingly profligate provision of private capital to perennially loss-making businesses has distorted the perceived price of money and of value: WeWork is a prime example.
Saudi Aramco’s much touted IPO makes the oil price outlook topical. There is only view—the wrong view—as it is impossible to predict the price of oil, not least because of the geopolitical risk premium presented by a potential conflict in the Middle East. It is worth noting too that quietly but significantly, discussions of peak oil have shifted from focusing on the supply side of the equation to the demand side. Admittedly, shale oil in the US will run out at some point, but it is difficult to state with any degree of certainty whether that will happen next year or in five years. Because the largest economies in Asia are net importers of oil and gas, this affects not only their input costs, but also their capital account, and thereby their currency.
…or glass half full?
That said, prospects for emerging markets in general, and Asia ex-Japan markets in particular, are looking up. Abundant and cheap capital is a boon for the region. Further, the region’s two largest economies, China and India, have only recently embarked on the path of monetary easing even as most developed markets are much further ahead. Coupled with fiscal stimulus, notably in India and increasingly in China, economic growth will receive a fillip.
The other consequence of the lowering of the benchmark rate by the Federal Reserve, in light of the commentary on growth concerns there, points towards a weaker US dollar. Historically, this has been positive for risk markets such as Asia, and more broadly, global emerging markets. A weaker dollar has the added benefit of reducing the energy bill that most Asian economies have to foot since they are net importers.
Unlike financial markets in New York or London, their Asian peers are yet to be plagued by passive money or quant-driven strategies, making them fertile hunting grounds for alpha generation.
At a more fundamental level, a number of countries have advanced the reform agenda in a bid to address long-standing structural issues; China, India and Indonesia have each tackled persistent bugbears. Together with a greater awareness of the importance of corporate governance, the multiple benefits to the economy in the longer term far outweigh the dilutive effect on growth in the near term, and has the added benefit of lowering the risk premium associated with these markets.
Navigating this lower growth world requires a disciplined approach, with a finger on the pulse of longer-term structural trends arising from the proliferation of technology driven/enabled change across industries. We remain focused on identifying sustainable franchises with multi-year growth prospects, offering attractive risk-reward trade-offs.
"Things do not change, we change" —Henry David Thoreau
The one unchanging aspect of China over the past three decades has, ironically, been change. Its emergence from a relatively small, closed economy that was one-sixteenth the size of US in 1990, to the world’s second largest economy that is now about two-thirds the size of the US economy, would not have been possible if the government had not embraced change in every sense—political, economic, and social. And yet again, it is changing in response to the ongoing spat with the US. After all, in Sun Tzu’s words, “There is no instance of a nation benefitting from prolonged warfare”.
China continues to embrace change by: choosing to focus on quality, rather than quantity; by not resorting to wasteful fixed asset investment to reflate the slowing economy; by allowing state-owned enterprises to go bankrupt (even if it is selective, and sporadic); and by steadily moving up the value-chain, not just in low value-added manufacturing, but also in high technology. The Greater Bay Area master plan is one such example. President Xi Jinping has spoken of China’s need to endure the "long march". We interpret that as a country willingly reforming itself within the boundaries of its fabric, albeit at a faster pace than it would have preferred. This augurs well for the longer term as the market multiple will likely re-rate on improving returns, and better quality growth.
We retain a preference for structural domestic growth proxies such as insurance, healthcare and software. Our bias toward quality at attractive value remains.
"A thing is not necessarily true because a man dies for it." —Oscar Wilde
The size of the crowds at the protests in Hong Kong, and the subsequent vote shift towards pro-democracy candidates in the recently held elections hint at disquiet in what is China’s best known international financial hub. Conspiracy theories abound, and absent any greater insight than the average person, we do not put stock into such rumours. While the damage to the local economy is evident, and repercussions will likely still be felt for years to come, the surprising silver lining has been China's handling of the situation notwithstanding political developments in the US in this regard. All things considered, we retain a cautious stance.
"If India is not too democratic, it will be like China in terms of development." —Dr Mahathir Mohamad
The re-election of India’s Modi government with a stronger mandate, and its proven willingness to push through structural reform can perhaps be the closest that the country has come towards realising Dr Mahathir’s proclamation. The economy appears to be emerging from a cyclical nadir brought on by the less than fortuitous timing of a number of structural reforms, in tandem with the global slowdown in growth. A number of sectors have been in the doldrums, including housing and construction, non-banking financial institutions, and autos. However, the worst appears to be in the past. The Modi government's reform agenda remains in place, and the government is cognizant of the opportunity to play a much larger role in global supply chains as multi-national corporations reconfigure their supply chains and vendors.
We prefer to participate in this growth reflation principally through quality private sector banks and Real Estate. Both sectors will benefit from market share gains driven by consolidation.
"I do not fear computers. I fear the lack of them." —Dr Mahathir Mohamad
Admittedly not everyone will agree with Asimov’s view, but few will disagree that digital technology is increasingly all pervasive—it is in our household appliances, in fabrics, in transports, in our hands, on our feet. All of this technology, at its heart, requires memory, and requires computing horsepower. Following multiple quarters of price declines, these sectors appear to have found a foothold.
The other implication of the redesign of supply chains, particularly those pertaining to technology, is the greater reliance of Chinese companies on South Korean and Taiwanese suppliers rather than those in the US. We still remain concerned about the broader economy in South Korea. But, on balance, with a rebound looking increasingly likely in the technology sector in both Korea and Taiwan, and valuations in pockets offering attractive risk-reward trade-offs, the we favour leaders in niche areas benefiting from long-term trends like healthcare, 5G and energy storage.
"My plans are still in embryo, a town on the edge of wishful thinking." —Groucho Marx
ASEAN is the other region that ought to benefit from the redesign of supply chains currently reliant heavily on China. Indonesia in particular stands out, not least because of its cost advantage; President Joko Widodo’s renewed mandate offers the possibility of real, and long overdue, structural reform. Any progress on labour law reform should be seen as a harbinger of greater foreign direct investment.
Malaysia remains uninteresting except in niche segments such as contract manufacturing. Thailand’s capital account surplus is in fact a liability brought on by the strong Thai baht rather than an asset, and the lacklustre domestic economy leaves little with any allure. Singapore’s stock market, like that of the US, is in fact a proxy for the region, with about 50% of the profits reported by market participants derived elsewhere. While it has seen capital inflows following recent developments in Hong Kong, and the large REIT sector has seen bids for some time now, there is little fundamentally that excites us. The Philippines is perhaps turning a corner but it is still in its early days, and we are content to remain on the sidelines for now.