Fund Manager of the Nedgroup Investments Global Emerging Markets Equity Fund recently spent some time in Hong Kong and China amidst the trade wars and protests that are happening there. He had some very interesting insights to share with us:
No turnaround expected soon
Headline moves in indices over the last few weeks look modest but below the surface there are huge moves going on! Recent developments in markets and some interesting macro and micro themes from my recent visits to Hong Kong and China make it an interesting time to share observations - but please excuse some opacity as we are implementing strategies whilst markets are in a state of flux.
The last few weeks saw markets struggle - first with Trump playing hardball with Xi Jinping (or is it Jerome Powell?), and then the sharp reversal in momentum trades. Since our long-held view of economic slowdown became consensus, the moves in bond markets and our favoured quality growth names had got more extreme and overbought. Despite taking profits and reducing exposure to many of our favoured positions this was always going to be a tough moment. Our analysis is clear that we see no significant economic turnaround soon, the recovery in money supply is still too modest as yet.
However, momentum and quality has reached extreme levels and there is ample room for further gains in value - but this is always a dangerous trade as there lurk ‘low quality’, structurally challenged companies here. So, we need to discern where the opportunities have presented themselves - in both quality growth names that have finally pulled back and those better cyclical names that are turning after long periods of underperformance.
Meanwhile, tech continues to do well - but I doubt this has all that much to do with the latest iPhone launch. We suspect the strength here is telling us about new sources of demand for high speed data, 5G and so on. Despite the alleged new breakthrough by Google in Quantum Computing reported in the Financial Times recently, AI and machine learning will power much of this demand for a while to come. Elsewhere in cyclicals it will require more policy action I think - though India has started.
The power of tech – surveillance and drones
As we are all aware, technology is changing the world at an accelerating pace. It affects productivity and demand patterns as discussed above, and it is our day job to focus on this. But it also affects the geo-political balance of power and the long-term risk premium which I was reminded of in my travels as the debates intensified.
Digitalisation, miniaturisation and massive increases in computing power are causing huge change in our world. On my trip I saw even basic appliance makers in Hangzhou, the high-tech Silicon Valley-like hub of China, incorporating this technology into their products and, their manufacturing plants.
Most of them told me they are seeing better trading conditions. Hangzhou, of course, is at the forefront of surveillance being the HQ of both Alibaba and Hikvision, the surveillance camera champion. Everywhere you go, you seem to be watched by their cameras. The enormous volume of data being collected on us by Silicon Valley as well as the champions of Hangzhou and their masters in Beijing may well impact on personal liberty - but it is undeniably an accelerating trend, bringing increased security and, arguably, lower risk premiums in the long run as the centre increases in power.
Then, all of a sudden, we witnessed the opposite: the ‘centre’ doesn’t have it all its own way and the trends of miniaturisation and digitalisation give power to the weak and those on the periphery.
Drone and "cruise" missile strikes on Saudi oilfields sent Brent and WTI soaring +10% at the end of day one as 5.7m barrels of crude per day were taken out of production. This is c5% of supply - the worst impact on oil since August 1990 following Saddam Hussein’s invasion of Kuwait. Like the internet and social media, this technology has empowered the weaker and the periphery. The disorganized.
Forming an outlook
It is obviously easier to calculate medium term investment probabilities using first and second order impacts on stocks and sectors! Here, the economic slowdown is focusing minds. India and Indonesia are both pushing ahead with long overdue reforms, Central Banks are easing (finally) and India is cutting taxes, showing that the authorities are not content with a slowing economy. Our tentative view of a recovery sometime later in 2020 is looking more likely.
Meanwhile, the trade war continues to ratchet up verbally and I am hearing more observers mention what was once a fringe, near conspiracy theory: that Trump is using the Trade dispute to force The Fed into cutting rates. He is a property guy after all! While the Trade War is rightly discussed at length by talking heads on TV, I am wary of thinking I can add much value in the short space afforded here. What I have seen first-hand, however, is that the people on the ground, who are paid to deal with such things, have been busy. Unsurprisingly some of the best companies in the front line of the trade war have seen this coming from a long way off. Production capacity has been shifted, and some can supply all their US customers from outside China already and Vietnam (in the portfolio, naturally) has benefitted already. These are successful, pragmatic business people. Trump has been tweeting about his trade position for many years now, and some senators and congressmen from even earlier. Simpler supply chains have had time to adjust.
This is not to say tariffs are ok. A tariff is, of course, a tax on your own consumers so it is a negative fiscal shock that also reduces efficiency. I should state that I have some optimism rooted in the fact that Trump’s book was called ‘the Art of the Deal’ and he has an election looming. Having said that, there is a valid argument that Trump and Xi Jinping have backed themselves into a corner. Both, however, need economic growth. The American system can withstand economic shocks very well - though Trump would lose an election, Xi Jinping has the opposite problem. He can withstand short term shocks relatively easily - but the system probably has inherent long-term vulnerabilities under stress. We still think some kind of deal is probable but there will be long term issues like defence and compliance that will linger. With concerns about the availability of key technological components for import as well as export markets China is racing to reduce its exposure to both. This is happening at approximately the right time for its development journey so is eminently achievable in a year, if not months, in our view.
There is always plenty to worry about. Hong Kong unrest, Trade Wars, inverted yield curves, the Middle East. But in a series of recent meetings with companies from Taiwan to Thailand, Mumbai to Hangzhou we saw senior management and entrepreneurs cautiously excited by opportunities they see. While we expect economic momentum to bottom in Q3 the recovery at the moment looks weak through Q1 - but policy changes are afoot and trends are changing. We are excited too!