Investment Manager Report
Dear Valued Investors,
Trade issues and Hong Kong politics continued to weigh on local stock markets in the past quarter. At least, there were signs of rapprochement between Hong Kong Chief Executive Carrie Lam and the protesters—a willingness to talk was a key part of the denouement of the occupy movement in 2014. The stock market
wasn't able to celebrate for long because the protests continued and were
sometimes violent. In addition, the trade war lingers in the background. Indeed, a near-term resolution on the U.S.–China trade front is hard to assess. Yes, perhaps it is advantageous in the U.S. political cycle to achieve a deal. However, maybe being seen as taking on a foreign opponent plays well with the electorate, too? Who knows the political calculation? What is clear is that short-term political considerations seem to be dominant, as other countries around the world encourage both sides to put an end to the damaging dispute.
The political calculus, however, may be changing. For, based on recent data from the U.S. manufacturing sector and particularly export orders, the trade dispute may be tipping the U.S. closer to recession. It seems now that consumer confidence is the only thing keeping U.S. GDP growth above water. Were that to falter, GDP growth could easily turn negative, as it has already in parts of Europe. So attention has turned to global growth and the possibility of a synchronized downturn. My expectation is that any recession would be likely much milder than the crisis of 2008; much more like the recession of the early 1990s or the early 2000s. And such a synchronized global slowdown is likely to hurt global stock market performance. Much of this seems to be starting to get factored into stock prices—the next thing we need to look at is how governments might be able to prop up domestic demand.
In the U.S., there is less room to use fiscal policy, after the large corporate tax cuts enacted in the past years. They have proved to be a mild short-term stimulus but one that seems to have failed to spur any investment cycle. The U.S. Federal Reserve does have room to further cut rates. However, with a falling stock market and potentially a weakening housing market, two important transmission mechanisms from monetary policy to consumer spending may be losing steam. In the eurozone, there is even less room to stimulate. Traditional interest-rate policy and the lack of fiscal coordination makes fiscal policy politically intractable. Asia looks a lot better-placed regarding stimulus. For a start, real interest rates—far from hovering around zero like in many of the G7 nations—are in healthy territory: this suggests that Asia economies ex Japan are much more susceptible to traditional stimulus measures. High current account surpluses, low inflation and in some cases fiscal surpluses suggest plenty of room to act with both fiscal and interest-rate policies. Indeed, the moderate stimulus enacted by China dealt with trade war headwinds far more easily than appears to have been the case in the U.S.
We have already seen signs of loosening interest-rate policy across the region. However, it is perhaps surprising that India came to the fore recently by using fiscal stimulus in the form of tax cuts. Surprising because India, with a structurally higher rate of inflation and a current account deficit, may be one of the Asian countries least well-placed to embark on fiscal stimulus. India's policymakers may point out that, though this may be true in a regional context, relative to its own history it has put itself in a more solid position to use traditional tools of macroeconomic management. In my mind, most countries in Asia should be able to mimic whatever India can do at this point. And where traditional tools are not available, Japan is one of the few countries to show the requisite courage in implementing unconventional policy. Indeed, we are starting to see Asia's regional leading indicator appear to reach a trough and start to turn upward, even as the rest of the world is weakening. This is not to say that I believe in “decoupling” but it suggests a degree of cushioning for domestic demand in Asia that is controlled by local authorities.
And it is in domestic demand that we continue to focus our portfolios. We would much rather tap into the long-term growth in living standards and the development of national champions than try to time global growth cycles. But as we maintain the positioning in our portfolios, we are encouraged that Asia, in the face of a global slowdown, seems more in control of its destiny than other parts of the world. Perhaps because of the greater traction in China's domestic economy to the mild stimulus that policymakers put in place, A-shares have been one of the best-performing markets year to date. We continue to see A-shares as an exciting opportunity for the long term, but this does not blind us to equally exciting opportunities elsewhere in Asia, where policymakers are yet to act. It is frustrating to see geopolitical forces play such a significant role in the short-term performance of the region's stock markets. However, we have to keep our focus on the longer-term horizon—companies, management and secular growth trends. In an environment where everyone seems fearful to look beyond the next few weeks or months, it is in the long-term thinking that we are most likely to find an advantage.
Robert Horrocks, PhD
Chief Investment Officer