Investment Manager Report

July 2020

Dear Valued Investors,

I feel like saying something like “It's a funny old world.” That's the kind of cliché that the editors normally strike out of the first draft. But not this time. For the developments in the fight against COVID-19, the increased tensions between the U.S. and China and the performance of the markets appear to be completely out of step. It is, after all, a funny old world.

The virus seems to be spiking again—the hopes that warm weather would slow its progress appear to be unfounded. The rhetoric between the Trump administration and China has picked up—“The China virus” is a common catchphrase. Changes in visa processing in the U.S. and potentially more stringent moves on both the movement of people and goods, as well as measures that may harm Hong Kong's special treatment by the U.S. would all seem to argue for caution. And yet the markets have been climbing ever higher—for Asia ex Japan, we are very close to the high point for the year. It has also been gratifying to see the performance of many of the Matthews Asia portfolios outperforming their benchmarks and even in positive territory for the year. The portfolio managers and analysts have been able to keep in close contact with holdings as well as keep up the steady flow of new ideas to which we are accustomed during more normal times.

However, it is undeniably strange to me that markets should have reacted this strongly. Clearly investors believe that governments have done enough to battle the virus and to support the economies for the moment. They also appear to believe that governments stand prepared and able to deliver the necessary economic medicine for a long-term recovery. I can understand this kind of optimism when it comes to the Chinese market—where China's authorities have the will to close down the economy and its citizens will cooperate with a strict enforcement. The mildness of the second wave also gives some hope; earnings reports and economic data suggest China is functioning quite like normal.
In the U.S., I am less sure of the response to the virus—the second wave seems more acute. And I am troubled by some of the Trump administration's moves on trade and visas. Although one can concoct short-term arguments for protectionism at times like this, my suspicion is the moves are meant to be for the foreseeable future. However, the Federal Reserve has shown itself capable and willing to do what is necessary not only for the U.S. economy but also for the global financial system. In that sense they are worthy of the market's optimism. Europe, on the other hand, may be most at odds with the market's optimism about recovery and the authorities' willingness and ability to stimulate economies and support business. For the initial European stimulus has been small relative to other parts of the world and the European Central Bank (ECB) has not been as successful as other central banks in creating accelerated growth in monetary aggregates.

Should we worry too much about Europe? In one sense, no. Our portfolios are built around the growth in Asia's domestic demand and other emerging economies. On the other hand, Europe is a significant part of the world economy, and how successful it is in reflating will have an impact on the world and the attractiveness of various markets. My main concern is that if the U.S. is able to successfully support its own economy while Europe continues to be weak, this may raise U.S. yields relative to Europe. The U.S. long bond would re-emerge as an attractive investment for Europeans trying to shelter from domestic weakness. In so doing, they are likely to prevent the dollar from weakening and may even push it higher—something that is likely to be a headwind for Asia stock markets and particularly for the non-Asia parts of the emerging market asset class. In such an atmosphere, it is likely to be the economies of North Asia, with their significant current account surpluses that are best placed to perform. However, there is one aspect where Europe does seem increasingly better placed than the U.S.: Europe still seems (for the moment) to be reaching out to Asia, both central and eastern Asia, in terms of building trade routes. This is all part of China's One Belt One Road initiative, of course, which will have the added benefit of some potential infrastructure and stimulus spending in Europe. In this sense, Europe seems committed to the ideas of global economic cooperation that the U.S. finds so troubling.

It is in this relationship that I see the best prospects for the continued growth in world trade. It would be a realignment of diplomatic influence away from the U.S. and towards China. A world split between two poles. In this scenario, China's attempts to build trust in its capital markets, and its bond markets in particular, start to play a very significant role. Are we moving to a stage where China enjoys perpetual current account deficits financed by foreign purchases of its government bonds and the increased internationalization of its currency? That seems an increasingly likely scenario and one that is likely to raise the profile of Chinese assets in the minds of international asset allocators. Just as China increases its significance in the global economy and global politics, so, too it is increasing its significance in global benchmarks. But there is one caveat—the Chinese have made some missteps. The new security law in Hong Kong raises questions about their ability to manage an international financial center and creates mistrust between China and Europe and may yet get in the way of improved economic relations. Certainly, there have been increased signs of nervousness towards China in parts of core Europe.

At Matthews Asia, we stand in the middle of this, trying to monitor the developments that seem to be occurring on a daily basis. Yet, we remain mindful of the longer-term trends and committed to helping our clients protect and grow their investments in countries that seemed destined to still have the fastest-growing economies and growing domestic markets that will be the breeding ground for their own corporate champions. Ultimately, it is those businesses that we try to identify and to hold for many years.

Robert Horrocks, PhD
Chief Investment Officer