The Victory of Light

Reflecting on the situation in Asia at the beginning of November, we can look forward to the winter solstice, when the time of darkness is past, and the shortest day passes into greater sunlight. In the political sphere, we can see the return of mutual understanding, after estrangement and confrontation. This is becoming visible in the truce between the US and China on trade firstly; secondly, and hopefully in the final stage of the agonising Brexit process in Britain, with some hope of reconciliation with Europe in 2020. Thirdly, and lastly, from our Hong Kong office, the hope is that the worst is over after the last four or five months of political demonstrations and violence. Now, new leadership is needed to address the deep seated problem of inequality and the lack of opportunity for the younger generation (most of the Hong Kong demonstrators are teenagers). This is a global theme, although inequality is more extreme in Hong Kong where the median property price is 21x median income (compared to 8.8x in San Francisco, 12.6x in Vancouver and the US average of 3.9x.)

One political forecast we may anticipate is a swing to the left in 2020 perhaps in Europe as well as in the USA, with political leaders trying to address this inequality, through higher taxes and wealth redistribution. President Trump’s impeachment process may impact global markets in the first quarter, and the US dollar may weaken against Asian and global currencies. There is also a risk that inflation might reappear (notably in China where CPI has now reached 3%, owing to the doubling of pork prices this year). This would imply an end to the extraordinary period, through which we have passed, of negative real and actual bond yields, across the developed world, and probably will result in a recession by 2021.

Against this background, we are nevertheless confident that the Asia ex Japan region will outperform, especially Southeast Asia and India owing to their favourable demographics, political stability and underlying growth of consumers’ spending.

In India, for example, we have seen the beginning of an end of a severe monetary squeeze in the past six months, now resulting in an improving earnings picture and the bottoming out of economic growth, which has fallen from 8% in 2018, to about 5% in the last quarter of 2019. Our expectation is that Mr Modi’s second term, which will run till 2024, will result in more pro-business policies. We have seen the corporate tax rate cut, from 30% to 25%, and to 17% on new business, which makes India with its large low cost labour force, competitive with Hong Kong, Singapore and other low tax East Asian export economies. India’s government, under the BJP, has realised that power to harness the national energy towards wealth creation, depends on a smaller role for government, and a reduced tax burden.

Another positive development is the bottoming out of technology cycle, with a renewed emphasis in our investment strategy on Taiwan and South Korea. The introduction of 5G in China and other countries will engender a new cycle of demand for hardware, especially servers. One reflection of this cycle may be that Japanese machine tool orders may have bottomed out, after a very steep fall of 35% yoy, for the past two years. Another interesting development is that China’s government has recently embraced the Blockchain technology (perhaps to avoid the US dollar payment system) which has prompted a rally in blockchain related shares in China. We are monitoring the implications of this step carefully.

We believe that it is, medium term, rather bearish for bank share prices, and we have, for example, seen this week HSBC declaring disappointing profits, and a reduction in their manpower, and the sale of notable subsidiaries like France (over 90% of their profits are coming from Asia, notably Hong Kong and Southern China).

China’s oil production

China wants to be more independent in its trade and current account payments, and also in its energy needs (currently 70% imported from Middle East and Africa). We have selected a private Chinese fracking energy equipment provider which will benefit from this drive for energy independence.

The Hong Kong economy will almost certainly have had a recession in 2019, after two quarters of slowing growth. The severe impact of the political unrest and violent demonstrations on the tourism and retail industry, have affected hotels, restaurants and shops all over the territory. Property transactions have surprisingly held up, because of the recent decision by the Hong Kong government to allow 90% mortgages for properties up to HK$8 million (US$1 million). Nevertheless, we would be cautious about the outlook for Hong Kong property, given the high valuation level today. We are looking carefully for buying opportunities in Hong Kong shares, at this very depressed level, after such a difficult year. Our experience of the last 40 years of Hong Kong, suggests that the economy and the people of Hong Kong have great resilience, and buying opportunities occur during times of unrest and uncertainty like 1966, 1983, 1998 and 2003 during the SARS outbreak. At the same time, there has been undoubtedly some shift of wealth and corporate activity, from Hong Kong to Singapore, and we continue to look positively on the Singapore market as a centre for wealth management, banking, insurance and trade finance for Southeast Asia.

There are positive political developments in Indonesia, and large infrastructure projects. Our team of research analysts continues to scour the Southeast Asia markets for good stock picks, especially in the area of Renewable Energy. We recognise the importance of including climate change as a factor in future investment returns: although, truthfully, coal will likely represent 75% of electricity production in SE Asia until 2040 – as it has done in both China and India – we are researching opportunities to invest in hydro, solar, and wind power: and in the development of electric vehicles in Asia.

In general, we have become more cautious about Asian Frontier markets, and have now excluded Pakistan, Bangladesh and Sri Lanka from our Indian Ocean Fund because of the extreme lack of liquidity, and tradability of shares. The only Frontier market which we continue to favour, is Vietnam, which has adopted a positive policy towards foreign investors.

Robert Lloyd George
4 November 2019
Hong Kong