Investment Manager Report
Dear Valued Investors,
The past two quarters have been volatile and difficult for Asia's markets. This has led to the usual calls to try and time the market—to jump the gun on monetary cycles and to second guess the headlines. I have always found this a dangerous game. At Matthews Asia, we have found patience to be a virtue at times like this. The headline clamor has been all about trade wars and politics. These, we are told, create an atmosphere of uncertainty within which it is difficult for markets to perform. “Expect more volatility,” the pundits cry. And by this they really mean: “Markets will likely fall!” The sentiment surrounding Asia, which never really turned wholly positive, has once again swung back to one of caution and suspicion.
I've never really liked this way of describing market movements, which seems to border on the metaphysical. Why would the trade scuffles do much from a broad macroeconomic perspective? It makes no sense. Certain industries could surely be impacted. But what may be bad for Chinese manufacturers could be good for those in Malaysia or Vietnam. It is too complex an issue to be treated in a binary way. Is it so complex that people are just throwing their hands up in the air and standing clear until the dust settles? Maybe. But that is potentially a costly move. The actual macroeconomic impact of tariffs is small and investors can largely sidestep it by owning domestically focused businesses. So if that indecision is really driving Asia's stock markets down, it's a bit of a giveaway to long-term investors right now. So is it really true that a swirling uncertainty of trade and politics is causing investors to be illogically nervous about Asia and selling out at ridiculous prices?
If only it were so simple. For then, we could easily take advantage. But I suspect there is a much simpler (and more concrete) explanation for the weakness in Asia's markets: money. Or, rather, the increasing scarcity of money. The monetary cycle has turned. The U.S. Federal Reserve is intent on raising rates, even as the spread between longer- and shorter-dated bond yields narrows (the so-called “two-ten spread,” which now stands at just 0.31%).1 Are we barely one rate rise away from an inverted yield curve and an economic slowdown in the U.S.? The other central banks are not exactly leaning against the Fed's tightening. You can make a case that the Bank of Japan is still pursuing looser money, yes; however, the European Central Bank has stayed pat, even as the European banking system continues to teeter on the brink. The share price of Deutsche Bank—an institution large enough to cause a systemic liquidity shock should it run into trouble—continues to hit new lows. The liquidity conditions in China are tightening, too. And peripheral nations such as Indonesia and the Philippines are already raising interest rates. These are real concerns for investors, as tighter money will impact nominal growth and feed into profit growth for listed companies and therefore impact their share prices. So, it is not illogical that markets are falling, nor is it due to some unspecified funk that investors have gotten into. It's real and it's calculated.
But that doesn't mean we can't take advantage of these calculated fears. How? What do we have that the price-setters in the market lack? Patience. I do not argue that investors that are selling are doing so illogically, but they are doing so with a shorter-term time horizon than we have. It is the marginal investor who sets the price, the investor who is most emotionally driven, the investor who palpably feels Greed and Fear. These emotions are amplified when you look at the short term. I have often thought their calculations are guided by the same kind of thought process that author Douglas Adams taught us was the key to flying: “You must learn how to throw yourself at the ground and miss.… Clearly, it is the second part, the missing, which presents the difficulties.” And for the marginal investors now, they are mostly concerned with trying to miss the ground. You have to focus elsewhere.
I try to remember at times like this that monetary cycles are a “fluttering veil” that can hide or disguise the underlying real forces in an economy. So long as entrepreneurialism, investment, good governance flourishes underneath that veil, it will only temporarily be hidden from view. With that in mind, I do see opportunities arising for the patient investor. For the long-run secular trends in Asia all remain in place. These include high savings, productivity growth, infrastructure spending, openness to trade, and the pursuit of institutional and market reform. The medium-term cycle of credit, profits and wages has largely been subdued in Asia, with the exception of Japan. And so there are not really any cyclical excesses built up in the economic system—not to the extent that corporates are over-indebted or that political and class tensions are awoken, or that banking systems are stretched.
The medium- to long-term cycles both look favorable. It is only the monetary cycle that has brought what I see as a temporary halt to the macroeconomic tailwinds for the region. The focus on short-term rewards has also caused a great divergence in market prices, where those companies that are able to meet short-run expectations and feed those emotional desires have been bid up. Those companies that require patience have seen their share prices languish.
In the reversal of sentiment we have seen lately, therefore, I do believe that opportunities are arising for long-term investors. Parts of Southeast Asia appear to have been unnecessarily acutely sold down. Some of the bank stocks, while always the most vulnerable in a monetary cycle, look quite cheap. There are opportunities, too, in some of the companies that will patiently accumulate returns, as their stocks seem to be trading now at outright cheap valuations. Certainly, I find in my conversations with my investment team colleagues that they see real value and opportunities in some good-quality businesses. We don't focus our attention trying to guess where the bottom of the market is. Rather, we continue to focus on the businesses that we believe will survive through the bad times and prosper in the good, and we take our opportunities where we find them.
Robert Horrocks, PhD
Chief Investment Officer
1 Federal Reserve Bank of St. Louis
The views and information discussed herein are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.