1997 and its Aftermath, Today

Writing in Hong Kong at the beginning of July, I am bound to comment on recent events in the city. The violent attack on the Legislative Council building last week has shocked many observers, and although the extradition treaty has been shelved, there is growing concern among my Hong Kong friends and business contacts about the future; whether in fact the “One Country Two Systems” model agreed between the Britain and China in 1997, will be maintained at least until the 50 year term is up, in 2047.

The fact that the Hong Kong’s GDP was 20% of China’s in 1997 and is now less than 3% (and in fact is smaller than Shenzhen) is a telling indication of how much less importance China might attach to Hong Kong today compared to 20 years ago. Nevertheless, the attractions of its international financial centre, British legal system and independent judiciary, free press, free movement of people, and goods are still important, as well as the low tax rate of 16.5%. The Hong Kong dollar/US dollar peg is as sound as ever; despite many brilliant hedge fund managers attacking it, it has stood the test of time since 1983, and we do not expect it to change.  Having said that, it is probable that some individuals, and businesses, will migrate to other centres such as Singapore.  We continue to believe that Hong Kong has some of the best run companies in the Asia Pacific region, and it remains a very valuable gateway into China for trade, property, banking and insurance.  Two of our most favoured companies, are AIA, based in Hong Kong, and Ping An (in China) both in the rapidly growing insurance sector.

Despite the probability that the Federal Reserve will cut rates rather than increase them in the second half of 2019, there is growing concern that we may be approaching the end of a very long economic expansion, and that we could have a recession in 2020. There are many signs of this economic slowdown in retail, in tourism, and in trade.  For example, we have seen the number of Chinese tourists fall off sharply to certain destinations such as Thailand, where Indian tourists are taking the slack and becoming a new growth sector.  Also Chinese capital outflows have sharply slowed and their purchases of Australian and Canadian properties have ground to a halt.

The uncertainty about the trade talks between President Trump and President Xi Jinping, continues to overhang the market and we can no longer make any confident predictions about the outcome. We have shifted our attention over the last year to Southeast Asia, notably to Vietnam and Indonesia, as well as Thailand and Singapore, which have been the major recipients of foreign direct investment and transfer of assembly plants, in electronics as well as textiles and shoes, away from Southern China into these new low cost destinations.

Despite a potential slowdown in China’s GDP growth to perhaps 5 or 5.5%, we still see domestic consumption and tourism growing at nearly 10%. In June, Chinese consumers’ purchases of domestic brands have outstripped foreign brands for the first time – one consequence of Trump’s trade war.  Luxury cars, cosmetics, and LVMH type purchases continue to do well despite a fall in the overall automobile sector.  We are now researching more deeply into the most successful consumer brands such as the hotpot chain, Haidilao.  Also, BiliBili and Weimob, are two of the fastest growing online apps which are very popular with the millennial generation (aged 15 to 24) in China (numbering some 300 million young consumers).

We expect the Reserve Bank of India will continue to cut rates after its 0.25% cut in June. The 10-Year India Government bond yield has also fallen below 7% as inflation has eased.  The Indian budget was announced on 5 July by the new Finance Minister, Mrs Nirmala Sitharaman, and although taxes on the wealthy have increased, there is more support for the rural poor and small business.  In the second half of this year, we expect the economy to pick up with the low oil price, stronger capital spending and lower interest rates.  It has been however a shock to see that the US terminated India’s trade classification as a developing nation under the GSP (Generalised System of Preferences) trade program. This does not have a broad impact because of India’s relatively limited exports, mainly generic drugs and software programs.  We do not believe therefore that the Indian market will suffer, but it is a negative development.  We have hitherto seen India as a protected market from the US-China trade tensions.

South East Asia continues to grow at an average of 5%, led by Vietnam and Indonesia, both having more progressive pro-business governments, focused on improving infrastructure, as well as middle class consumers. The growing impact of foreign direct investment from China, as well as the rest of the world, is favouring such companies as Siam Cement, Ayala Land, Hoa Phat (factory construction in Vietnam) and Ace Hardware in Indonesia. Over the next decade, our belief is that ASEAN could be the most rewarding (and hitherto underrated) region for investors, so we are progressively increasing our SE Asia weightings in our regional funds.  This includes Singapore, where we are making a program of research visits this week, in technology, real estate, finance and telecom.

 

 

Robert Lloyd George
10 July 2019
Hong Kong

The Elephant Can Catch Up with the Dragon

For many years now, we have been following China and India as the 2 leading emerging markets in Asia and the world, as well as South East Asia. China has often gone rapidly ahead, in economic growth; but in terms of investment returns, India has made up, over a 10-year period, a better overall performance to the patient investor.

In our comments below, we highlight recent events in China – the Trade War, the crisis in the pork industry, as well as our detailed comment on the recent elections in India.

CHINA

It is difficult for those of us who have followed China closely for over 30 years, since Deng Xiaoping first opened the country to market forces and foreign trade (with the result that income per capita has multiplied 30 times since 1980), to recognize the new global situation today.

The US and China are in an economic “Cold War”: a temporary trade truce will not change this reality, nor will it completely alter China’s rapid ascent to prosperity.  Domestic consumption will keep growing Chinese brands like Anta, Midea, Haidilao, Geely, Alipay, and Wechat.  There is an investment opportunity here for contrarians to buy China’s leading brands.

At the same time, there is a growing, and largely unreported, crisis in China’s rural hinterland with a pig population of 440 million. China accounts for over 45% of the world’s pork production in 2018; and the sudden advent of African swine fever is devastating the 36 million small farms in rural counties, employing about 40 million people.  Between 40% and 50% of these pigs will have to be slaughtered (some of the virus is due to sloppy farming practices of feeding waste to the pigs), and with an estimated 100% rise in meat prices in the 2H19, large increases in imports of meat and grain from the US, Brazil, and other nations, and rising inflation for Chinese consumers.  (Chinese people consume nearly 60 million tons of pork annually, almost 3 times more than chicken, and 10 times more than beef or lamb.)

The impact of the Trade War is more difficult to evaluate; but it has certainly depressed the “animal spirits” of Chinese businessmen and investors. Hence, our constant anticipation of a strong market rally in July if a truce is reached between Donald Trump and Xi Jinping at the G-20 Summit.

It is worth also considering the other Asian nations that have large trade surpluses with the USA. The new 25% tariff will cost each US household about US$830 a year.  The real winners are China’s competitors in South Korea, Taiwan, and – more importantly – South East Asia (Vietnam, Thailand, Malaysia, Indonesia, Singapore).

We continue to believe that Vietnam and Indonesia will be the immediate beneficiaries of a rapid shift in manufacturing from Southern China to these cheaper locations. In the longer run – more than 5 years – both India and Bangladesh can become significant manufacturing exporters given their large cheap labour force. Against this, we have to estimate the impact of automation, 3D printing, etc.

Moreover, China’s working population peaked at 1 billion in 2013; and by 2035, it will have 80 million fewer working-age citizens, resulting in lower economic growth and lower savings rates. Coupled with a rapidly shrinking surplus on current account (and trade account), this could result in a weaker Renminbi.

INDIA

The election result in India has exceeded all expectations, with Mr. Modi’s BJP increasing his majority from 282 to 303 seats out of 543.   This will enable Mr. Modi to complete and accelerate his economic reform programme in the next 5 years to 2024, with positive implications for infrastructure, consumption (tax cuts coming), and the Indian share market, plus the Rupee (lower oil prices, less uncertainty) and lower interest rates, as inflation subsides.

We are very bullish on India, the best emerging market in the world, with the highest economic growth and strongest corporate profits, and (thanks to its democratic system) a degree of political stability and predictability. Mr. Modi’s personal probity is a key factor in his electoral success, and in our ongoing optimism about India’s economic and political directions.

While the US-China trade situation continues to be unpredictable and acrimonious with negative effects on the technology sector, India, on the other hand, looks the most promising market over the next 5 years. To quote Mr. Modi today, “India wins yet again. Together we grow, together we prosper, together we will build a strong and inclusive India.”  During the next 5-year term, to May 2024, we expect that India will see less disruptions to growth, such as demonetization and GST, and more fulfillment of India’s growth potential, with the same major policy agenda in place.  Meaning that:

  • Tightening GST compliance by introducing invoice matching, will boost GST collections by 20% in the next 2 years
  • Farmers’ incomes could double
  • Affordable housing and a broader property market, by allowing banks to fund land acquisitions and giving tax incentives for rental income
  • Keeping inflation low and reducing the high cost of capital for Indian developers and corporates. We expect a 75 bp policy rate cut at a minimum, and perhaps more than 1%
  • Infrastructure will be the major push for the New Delhi administration, focusing on roads, railways, airports, and subway systems
  • Consolidation of public sector banks, with some resolution of the nonbank financial (NBFC) situation
  • Mr. Modi started with financial inclusion (300 million new bank accounts since 2014). Now he will continue with medical insurance for all
  • A focus on tourism and job creation in this sector
  • Faster dispute resolution by improving the legal system. This has been India’s Achilles heel for a long time, and would be extremely beneficial, in our experience, for foreign investors
  • Finally, “Make in India” will continue to be a core policy, and will include defense equipment

We expect India to continue to outperform Asia ex-Japan because it is selling at 18 times PE, but has higher (15% – 20%) earnings growth, compared to 6% in the rest of Asia; and foreign funds are still very underweight India because of the political uncertainty in the last few months. We expect that that the current goods and service tax, at 28%, could be cut to 18% for sectors like cement in order to boost affordable housing or 2-wheeler.  Our local investors in India are greatly encouraged by Mr. Modi’s win and the stable political outlook which results; and we expect the underperforming midcap sector to recover strongly in the second half.

Conclusion

On balance, we counsel our clients and investors to maintain an equally balanced portfolio between China, India, and South East Asia. With the possibility of a US market setback, and some currency volatility, we have been focusing, especially, on low risk and low volatility selections, such as Singapore REITS and other high yield, but growth, businesses in South East Asia.

 

 

Robert Lloyd George
1 June 2019
Hong Kong

                           

Asia Today, and the Long Term

As we get into the summer months, there are some headwinds, in the short-term, to our positive view of Asian markets. Most notably, the oil price has risen to US$75 a barrel which will weigh on the current account and trade balances of China, India, Japan, and the major Asian economies. Also, we do not yet have a definitive trade agreement between the US and China, and the uncertainty has been exacerbated by the US pressure to remove waivers from the Iran oil sanctions (both China and India import a lot of oil from Iran). World trade growth has slowed over the last 12 months from 4.5% to 3%, and this is particularly affecting exporters in Europe.

Nevertheless, the first quarter has seen stronger-than-expected earnings, and economic growth in the Asia Pacific region has held up well. China is still the key driver of the global cycle. Although the Chinese economy accounts for around 19% of world output, the contribution of Chinese economic growth is now approximately 30%, according to the IMF. Last year, moves by the Chinese government to deleverage slowed down growth, but since January, we have seen a move to introduce new stimulus through tax cuts as well as infrastructure spending. This makes us a good deal more confident about the outlook for China and the region, and the 32% jump in the Chinese index in the first 4 months indicates a return of domestic investor confidence. In our view, this is the beginning of a longer-term recovery and opening up of the Chinese A Share market, which will see a rise of China’s market capitalization from 50% of GDP to something more like the 150% we see in the USA and Europe.

As we have observed before, there are parallels with Japan in the late 1980s after the Plaza Accord with the US, which led to strong capital inflows with a strong yen and high savings rate. In this regard, we have analyzed carefully the debt position in China, and we remain confident that, although corporate debt has risen and recently US dollar denominated borrowing has grown, the high savings rate (over 50% of GDP) and foreign exchange reserves of US$3 trillion are more than sufficient to offset these concerns. Having recently started reading The Hundred Year Marathon, about China’s strategy to replace the US as the global super power, I remain convinced that it will be very difficult to keep China down, particularly with regard to technology, where they are still moving ahead rapidly with artificial intelligence, robotics, 5G, telecom and, perhaps most interestingly, biotechnology and other innovations in the medical sphere. We expect that, with the concerted commitment of the Xi Jinping national team, growth will be maintained at 6%, and we would not be concerned if it fell to 5%.

Meanwhile, India is holding the world’s largest democratic election, with 900 million voters over a 6-week period. There is some nervousness about whether Mr. Modi and his BJP party can maintain an absolute majority. Our expectation is that his economic reform program will be maintained even if he returns to power with the support of a coalition. Democratic systems are much harder to handicap for investors because of unexpected outcomes like Brexit, Mr. Trump’s 2016 surprise election, or even recently, the Ukraine electing a comedian as their president.

India moves slowly, but steadily, towards greater prosperity and the inclusion of hundreds of millions of their citizens in the new digital economy. The expectation is that middle class consumption will rise from US$1.3 trillion today to about US$3 trillion within the next decade. This is the investment opportunity in India – in the field of consumer brands, travel and tourism, housing and savings products. India now has a US$2 trillion market cap, and the domestic fund management industry, focused on Bombay, is growing at a rapid pace. India’s economy is growing at nearly 8%, and it would not surprise us if wealth creation in India surpasses that of China over the next 50 years, given that it is a much freer system.

Meanwhile in Indonesia, we have had a decisive win by President Joko Widodo with over 65% of the votes, in another large democracy of 260 million. This will also remove uncertainty and bring more foreign direct investment to Java and the Indonesian islands. We see both the banking industry and the consumer sector as being the key drivers of growth in Indonesia, although infrastructure will be a very important area as well. Singapore, at the center of this dynamic region, has very good prospects to attract more capital, with almost $1 trillion of high net worth individual wealth domiciled in Singapore, over 80% from international investors, notably Indonesia, Malaysia and Brunei. We favour the banking, real estate and oil service sectors in Singapore, and we continue to screen the high-yield and REIT sectors for interesting long-term investment opportunities in Singapore dollars.

Overall, there is a great deal more stability and predictability about the long-term picture in Asia than in Europe or the USA today. We do not expect any sudden or dramatic political changes, and the region is, in our view, in a very long-term cycle of catching up to its previous position, before 1800, in the world economy.

As I outlined in the East-West Pendulum, from AD1 to 1820, the 2 largest economies in the world were always China and India. Although, historically, this growth has been centered on China and India, there have also been very wealthy and successful kingdoms in Indochina and the East Indies, which we see as being precursors of today’s dynamic Asian economies.

In addition to the quantitative factors, we should highlight the fundamental and qualitative changes that are taking place in the emerging markets, especially in Asia. In contrast to the backlash against capitalism in the US and Europe, there is a move in Asia and the emerging markets, towards much better corporate governance and a healthy and positive attitude to capitalism and entrepreneurship among the millennial generation, which dominates these countries.

Chinese ‘millennials’ alone (350 million) outnumber the entire US population. The other millennial countries, with young populations, are India, Indonesia, Pakistan, Bangladesh, Philippines, and Vietnam.  In these nations, there is also a rapid improvement in financial technology – for instance, China’s mobile payments market is now 50 times bigger than America’s.  Alibaba and Tencent handle 20 times more payments in 1 month than PayPal or other US companies.  This transformation has been led by the millennial generation.

With 60% of the world’s population in Asia, there is no doubt that the growth of middle class spending (defined as having daily income and spending up to US$100 per capita), in that region, is a key indicator for all multinational companies. With growth at 5% or more, China, India, and Indonesia double their per capita income every 14 years; and, within the next 30 years, this large human population in the east will quadruple its annual spending.  The “late mover advantage” will mean that solar power, mobile phones, and digital on-line business will rapidly transform the economies of Asia (and, indeed, Africa).  It is surprising, therefore, that the emerging markets are selling at a 25% discount to the S&P 500 with this compelling growth story, and improvement of corporate governance, and treatment of shareholders being a major positive change.

Robert Lloyd George
3 May 2019
Hong Kong

The Real Costs of Populism

Writing in the first week of April, we are still not certain about the outcome of Brexit, or of the US-China trade deal. Our assumption is that Britain will, indeed, go out of the European Union, (perhaps with a long delay) but, hopefully, with an agreement rather than without, but that there will be economic costs and damages to the nation.  In fact, there already are such costs apparent, in the closure of 3 large automobile plants, the departure of many high-level city jobs to other European centers, and the general economic malaise and lack of decision-making, which has led to a fall both in Sterling and in the value of London property.  All of this could become very much worse if Jeremy Corbyn becomes Prime Minister in the next year.

Likewise with the US-China trade deal, much of the damage has already been done, even if there is, at the end of April, a triumphant announcement by President Trump, that he has now agreed terms with China, and there will not be any further tariffs on trade, that the Chinese market for many sectors, such as finance and autos, will be opened up, and that China will attempt to redress its large trade surplus by making major purchases of US energy, food, and other products. The costs of populism, in both cases, are now coming home to roost; and the ordinary voter and citizen can begin to appreciate what folly it is to upset the benefits of globalization and free trade, which have given us all such prosperity over the past 30 years.

Nowhere is this more true than in Asia, where there is much less opposition to globalization because nearly all voters and citizens have benefited from the spread of trade and hundreds of millions have been raised out of poverty in China, in Indonesia, and in India. In both India and Indonesia, elections are being held in the next two months which will almost certainly result in the re-election of the existing governments, precisely because they have generally delivered the economic goods, as well as attempted to clean up corruption and enable more foreign investment and trade.

Although China does not have elections as such, the Beijing government is both sensitive and responsive to popular demands. It is therefore determined to maintain 6% GDP growth, and to continue to boost infrastructure development, providing US$650 billion of new credit to the financial system in January.  This has resulted in a 30% jump in the Shanghai Index in the first three months of the year.  (Our Bamboo Asia strategy is 50% weighted in China and Hong Kong, and has outperformed strongly year-to-date.)

The Chinese Yuan has remained steady, if not strong, against the US dollar. In fact, we liken the US-China trade deal today to the US-Japan Plaza Accord of 1985, which led to a revaluation of the Japanese Yen, and to a 5-year boom in Japanese stocks and property.  With over US$3 trillion of reserves trapped in China, and private savings in China exceeding that figure by more than 2 times (50% of GDP), we expect that China A-shares will continue to surprise global investors with strong earnings, improving corporate governance, and a catch-up of market cap to GDP from its current level of 50%, to 100% within 2 years.  In sum, we expect China will be one of the best performing markets in the world between now and the end of 2020.

Asia’s Switzerland

We are interested in Southeast Asia because we see the consequence of the US-China trade war as being of great benefit to Vietnam, Indonesia, Philippines, Thailand, and, eventually, Singapore. We highlight Singapore because it is at the center of this increasingly wealthy ASEAN region, and has the unique characteristic of a strong and clean government and currency; and it has become, in effect, the banking centre of Southeast Asia, or its “Switzerland.”

In the chart below, we show the comparison between banking deposits in Switzerland and Singapore, and their growth rate. Singapore has always benefited from the inflow of capital flight from Indonesia and Malaysia and, further afield, from China and India.  It offers permanent residency to wealthy Indians and Chinese, and attracts their families by offering a clean, healthy lifestyle, low taxes, and a good legal system.  Now that Hong Kong is becoming increasingly absorbed into, and dominated by, China, Singapore does indeed have a unique raison d’être in attracting capital as well as talent from all over Asia.

We have had elections in Thailand, which have produced a continuation of the status quo, namely military (or semi-military) government, despite the protestations of Mr. Thaksin. This will be followed in May by the coronation of the new king.  Likewise in Japan, we will enter a new era, “Reiwa,” from the beginning of April with the accession of the new emperor.  We expect this will be symbolized by the Tokyo Olympics of Summer 2020 when Japan will also, (as it did in 1964), present itself as a new, modern and open-minded nation which will counter the demographic effects of aging and diminishing population by being much more open to immigration, especially from China, Korea, and Southeast Asia.  Japan can, in fact, present itself as a democratic alternative to China’s totalitarian system.  Japan already offers capital investment in South Asia and Southeast Asia to counter the enormous gravitational pull of the “One Belt One Road” program of China, which is now encountering some resistance in Pakistan, Sri Lanka, Malaysia, and even Thailand.  Nevertheless, Xi Jinping recently made a successful visit to Rome where Italy has now signed up as another participant in the “One Belt One Road” scheme.  It is clear that the US and China (like the US and the Soviet Union in past decades) will compete and come into conflict over the allegiance of many countries, not only in Asia but now increasingly within Europe.  The case of the Huawei 5G is already a cause célèbre in which Germany and Britain, for example, have to choose between security risks and economic benefits.

Our investment conclusion remains clear-sighted, long-term, and steady in its analysis that China, India and Southeast Asia, in an appropriately weighted portfolio (around 30% in each region) will provide investors with the best long-term total returns, including dividend income. This is one reason why we have emphasized Singapore and Southeast Asia, because of the stability and high yields on offer.  We remain positive on the outlook for Asia this year, especially in our call for the re-election of Mr. Modi to a further 5-year term of office in May, which will boost returns from Indian shares and strengthen the Rupee.  Our equally positive assumption, that free trade will prevail over nationalism and ideology, is another reason why we think Asia, with its high economic growth and productivity, will prove to be a rewarding region for investors over the next 5 years.

 

 

Robert Lloyd George
8 April 2019
Hong Kong
 

 

The ASEAN Opportunity

Asian markets have started the year in a bullish mood with nearly all markets up 5 to 10%, in particular China, which rose 12% in the first 6 weeks. We look for further gains this year especially in the neglected and under researched A Share market, in which we are pioneers.  The recent discussions between US and China trade negotiators have also focused on the Renminbi remaining stable against the US Dollar (currently 6.70).

China is undergoing an important transition from being the low-cost manufacturer of the world to an economy focused more on serving domestic consumer demand, and doing more business with its Asian neighbors – hence, our renewed emphasis on ASEAN, with a target weighting of over 30% in Singapore, Malaysia, Thailand, Indonesia, Philippines, Vietnam.

In January, we saw new credit issued to Chinese borrowers surge 51% year-on-year to 4.6 trillion Renminbi, or US$687 billion. Despite the 6% fall in passenger auto sales in the past year, and an 8% decline in new residential completions, we expect easing financial conditions in China to power a cyclical uplift in the first 6 months, with key beneficiaries being energy, utilities, and infrastructure.

We remain concerned in the medium term about the property and construction sector in China with an estimated 50 million empty apartments. Meanwhile, demographics is having an impact (as it has in Japan in the past 30 years) with China’s working population between 15 and 64 declining at an annual compound rate of 0.3% from a peak of 996 million people in 2014, falling by about 30 million over a decade.  Property in China has an outsized impact on the economy, both in terms of construction and bank lending.  (According to some estimates, the value of real estate held by private households is nearly 5 times GDP, compared to a US peak of 2 times GDP in 2005.)  The current meeting in Beijing of the Communist Party leaders, has confirmed a GDP slowdown to 6%, but has announced tax cuts, and other stimulus measures, including support for the A Share market.

One of the important developments in China this year is the rollout of 5G by the major telecom groups, such as China Mobile and China Unicom. We also see opportunities in the China Tower Corporation Limited, which has 1.9 million operating towers across China.

Has there really been a Trade War? Like Brexit, the mere threat of such a spectre has chilled capital spending and expansion plans.  Companies prepare for the worst.   Donald Trump, while on the one hand reducing taxes and regulations on domestic US businesses, has ramped up his “America First” campaign, and threatened not only China, but also Europe and even Canada and Mexico, with tariffs.  The reality is that the US wants to do more business, but on their terms – and the real threat was China’s “Made in China 2025” target of dominating AI, robotics, 5G, electric vehicles, and other key strategic industries of the future (many defense related).  However, ambition is one thing.  The reality is that China today imports US$250 billion worth of semiconductors (more than oil imports) and is not yet ready to compete in so many areas.  It will, nevertheless, be hard for the US to keep China down, and it is right to insist on intellectual property protection.  This is now fully accepted and supported by President Xi Jinping’s administration.

The only exception to the upward trend has been India, which is down marginally year-to-date on investors’ apprehension about the May elections, and rising tensions with Pakistan. Although the stock market has been weak (especially, the midcap stocks, which are down 16% in the last year), the actual corporate results remain strong with revenue growth of 22.7% in the past quarter.  This indicates the strong GDP and consumer growth across India.  However, the margins have been pressured by a volatile oil price and Rupee, as well as high real interest rates.  Earnings, measured by EBITDA, grew 16% YoY (excluding oil marketing companies).  The exceptions to this slow profit growth have been IT and private banks, as well as retail, all of which we are overweight.  The energy, telecom, and auto sectors have been the worst performers.

Overall, we remain sanguine about the outlook for Indian equities over the medium term.

Meanwhile in Southeast Asia, we remain focused on the consumer opportunities in Indonesia and the Philippines, represented by fast food outlets, hardware stores, telecom and banking. The value proposition in Southeast Asia is also mirrored in the relatively high dividend yields of 4 to 5% on some major companies, especially in Singapore, Malaysia, and Thailand.  With the increased flow of Chinese trade and investment into this area, we expect strong sales and earnings reports to come through in the next 2 years.

Indonesia holds a general election in April; and, unlike in India, there is no question that President Jokowi will be returned with a good majority to extend his reform and infrastructure plans, which are positive for Indonesia’s economy and market. Thailand also holds an election in late March, but we do not see any significant change for the economy.

The general impression of South East Asia is of a high degree of stability with growth rates of 5 to 7%. Consumers are, just as in China, conservative with high savings rates of over 30%, but per capita income in Singapore is US$53,000 – higher than Japan.  In Vietnam, Philippines, and Indonesia (with over 450 million people in these 3 large nations), the incomes average about US$3,000, but the middle class is now 15 to 20%, comprising a group of 70-90 million consumers, with US$10,000 to US$15,000.  Education is rapidly improving with large numbers of students at universities and people traveling overseas.  Many of the trends in China – infrastructure, tourism, healthcare, education, housing, e-commerce, and apps – are quickly mirrored (within less than 5 years) in ASEAN.  Alibaba has engineered a rapid expansion through Lazada in Singapore, Tokopedia in Indonesia, Bigbasket in India and many more in the region.

In conclusion, we believe a balanced portfolio of China, India and Southeast Asia will produce the best returns in the next 5 years with less volatility, and exposure to the best companies in the fastest growing regions in the world.

Robert Lloyd George
6 March 2019
Hong Kong

A Prosperous Year of the Pig!

History is a useful Guide for Investors, especially when the crowd is issuing warnings of doom and collapse. Throughout my 37 years in Asia, we have had periodic panics and stock market collapses, such as 1987, 1998, 2000, and the financial crisis of 2008/9, since which we have enjoyed a 10-year bull market.

Political crises, such as 1983/4 Hong Kong, 1989 Tiananmen Square, 9/11, and the Iraq War 2003, have also deeply impacted markets. One lesson we have learned is that life gradually returns to normal, daily business goes on, and it is well worth being a long-term contrarian investor.

My long-term faith in Asia, and in her hard working people, has never faltered.

Through my work with the Lloyd George Asia Foundation, I have also witnessed the thirst for education and self-improvement in some of the poorest neighborhoods of Calcutta, Manila, Bangkok, and the remote Karen Hilltribes Trust of Northern Thailand, which I recently visited. The first thing these children need is a reliable water supply – then dormitories; but the strong desire for literacy, for knowledge, for learning languages, and skills such as nursing and engineering is present everywhere.

In our investment strategy, we have increasingly focused on finding driven and committed entrepreneurs and founders of new businesses, whose energy and vision benefits all their shareholders. I have had the great good fortune of meeting Li Ka Shing of Cheung Kong, Robert Kwok of Shangri-La, TK Wen of Selangor Properties, Narayana Murthy of Infosys in Bangalore, among many others.  More recently we have visited young entrepreneurs in Vietnam, and other new frontier markets.  The ethical principles, and high standards of corporate governance, which have governed large companies such as Tencent since its founding, have led to them being ‘multi-baggers’ for investors over the last 20 years.

China today, as the world’s second largest economy, represents 15.2% of global output, but is only 3.2% of the MSCI All World Index of markets. The same figures for INDIA are 3% of the global economy and 1% of MSCI.

More importantly, by 2030, it is likely that China and India in 2040 may become the world’s two largest economies as their vast populations rapidly increase their incomes and standards of living. Surely for investors, it is appropriate to look forward rather than backwards.  Although, if we look back to 1800, India and China (in that order) were the two richest nations.  The wheel of history turns around, slowly but inexorably.

There is a parallel between Japan 1960-1990, and China 1990-2020. The earlier two decades, in each case, were periods of rapid economic growth, but poor stock market performance that were succeeded by the last decade of slower economic growth, and a stronger share market, as the accumulated capital from industry and exports was redirected into property and shares.  China is a special case, being a centrally directed economy, and the Shanghai market is a ‘policy-driven’ market.  In 2019 we see the opening up of China’s financial sector and inclusion of more A Shares in MSCI indices, which will lead to government support measures for the market.

In India, we definitely see scope for an interest rate cut of at least 50 basis points in February, given that inflation has fallen to almost 2%, and the RBI rate is 6.5%. Much will depend on the evolution of the oil price (we expect US$60 a barrel) and the Rupee holding steady at 70/71 to the Dollar.

This week’s Indian budget has been focused, for political reasons, on support for farmers and the rural poor, with talk of a Universal Basic Income. Further stimulus can be expected before the May election, which should favour automobiles, property, and other rate sensitive sectors (private sector banks/mortgage lending). Bank credit growth has accelerated to nearly 15%, though industrial production has slowed.  In India, as elsewhere in Asia, the real story is the consumer.

It is also noticeable that domestic Indian institutions have increased capital flows into the Bombay market while foreign portfolio investors are cautious. The ‘Nifty 50’ is on 16x PE (below its historic average) with earnings expected to 18% to 20% in the next year.  Though small caps have underperformed in the past 12 months, we anticipate a recovery after the general election.  Long term, India remains our favourite destination to allocate patient capital.

There are many unforeseen consequences to the Trade War (also true for Brexit). One is the geography of technology assembly plants.  Apple has intensified a search for ways to diversify its supply chain, and that hunt has now honed in on India and Vietnam.  To quote one manufacturer:  “American workers won’t work around the clock.  China is not just cheap, it’s a place where, because it’s an authoritarian government, you can marshal 100,000 people to work all night for you (at US$2 an hour).”

This year has elections in India, Indonesia, the EU, and several other key countries. In addition, the coronation of the New King of Thailand on May 4th closely follows a return to “democracy” there in March 24 elections.  On April 1st, the new Emperor of Japan will designate a name for the “Gengo,” or New Era, symbolizing his reign.  Japan will host the 2020 Olympics and become more open to immigration and foreign investment and influence.  The yen could be one of the stronger currencies of 2019/2020.

 

 

Robert Lloyd George
8 February 2019
Hong Kong

Predictions for 2019

As 2019 opens, we see cause for optimism with the following trends or events relevant to the Asia Pacific markets.

  1. The US dollar peaks out and the increase in interest rates by the Federal Reserve will be slowed down.
  2. The oil price stays near to US$50 a barrel and this is a huge tax cut and economic boost, especially to the Asian importers.
  3. There is a comprehensive trade deal between the US and China by March or, perhaps by extension, in the summer.  This will comprise a significant increase in China’s purchases of US products, including energy and food; an enhanced agreement to open up China’s markets, especially the financial sector, the auto sector, and other major industrial product sectors; a respect for intellectual property, which can be monitored; and an agreement not to impose new tariffs on each side.
  4. This will lead to a strong rally in the most depressed stock market in the world, the China Benchmark CSI 300 Index, which finished the year 2018 down 25%, being the worst performing market last year.  We expect it to be among the best performing in 2019.
  5. We expect that the Indian election in May 2019 will result in a successful re-election of Mr Narendra Modi and the BJP, which will boost the performance of the Bombay stock market in the coming 2 years.

Most observers agree that Emerging Markets are now undervalued. It is interesting to analyse the growing weight and influence of China on the Emerging Markets universe.

Therefore what happens in China’s economy is increasingly important to the whole world. We expect that China’s growth rate will settle down to about 4% by 2020 and that debt levels managed by the PBoC.  The Renminbi, however, would devalue by 10 to 15%.

The Chinese government has reversed policy, from one of deleveraging to stimulation. The PBoC cut the RRR another 100 basis points at the beginning of the year. Fixed-asset investment has been picking up for 3 straight months from a bottom in August 2018, and the government has announced that investment in railways will jump by 40% in 2019.

If previous rounds of stimulus relied largely on investment, this time Beijing is looking to the consumer, by introducing the first personal income tax deductions for key spending areas like healthcare, education and housing beginning this year, which is expected to contribute up to 1% GDP growth.

It is clear that the government is more concerned about the state of the economy and is under more pressure to stabilize the situation at hand. Combined with the possibility of a trade deal, we think the point of maximum bearishness could be behind us.

The New Year opens with brighter prospects of US-China trade tensions easing, and if the 90 day period is extended, some accord will be reached before summer. Meanwhile China is determined both to support its economy, currency and technology sector, and also to provide its 1.4 billion consumers with more choices.  We see strong growth in tourism, in cosmetics, in food and beverage sales, in sportswear and even in mutual fund sales.

The opening of China’s savings and investment sector is undoubtedly one of the biggest opportunities of the next decade. China has a savings rate of almost 50% of national income, which is equivalent to US$5.4 trillion in 2017.

Last month we made a research visit to the Philippines, with 105 million population of whom over 11% work overseas, is a medium sized Asian economy of over US$330 billion GDP (about US$3,100 per capita). The growing middle class economy is reflected in the success of companies such as Jollibee, which is the only competitor to McDonald’s, worldwide, which has won over 50% market share in its home market.  Another significant trend which we observe all around South East Asia is the growing importance of China, as a source of investment, trade and tourism (Chinese tourist numbers are growing 40% p.a. in the Philippines), which will impact infrastructure and telecoms particularly.  Foreign Direct Investment flows have reached 3.2% of GDP, second only to Vietnam in the emerging ASEAN markets.

Tourism in Asia

Our focus in South East Asia remains on the consumer sector, where we see the strongest companies with sustainable growth – Ace Hardware in Indonesia, D&L Industries in Philippines. Infrastructure is covered by Hoa Phat in Vietnam, Siam Cement in Thailand, and Ayala Corp in Philippines.  On balance, this year we see ASEAN as an outperformer.

India will benefit from an easing monetary policy (with inflation at 3% and rates at nearly 8%, India has the highest real borrowing costs in the world) in the approach to the May general election. The clean-up of the banking sector continues under the new governor, Mr. Shaktikanta Das and is expected to add more liquidity into the system. India is expected to remain fastest growing economy and corporate India’s profit is estimated to grow at 18% CAGR over the next two years.

2019 Forecasts for Asia

Source: LGM estimates

The fall in the oil price also benefits nearly all Asian economies especially China, Japan, India and Indonesia. Economic growth is expected to accelerate in India, Indonesia and Philippines.

There are still uncertainties and ‘unknowns’ in the 2019 market prospects, especially as they relate to the unpredictable nature of politics, and of US leadership in the world, a certain ‘vacuum’ of power has developed in both the Middle East, as well as Asia, which opens the door to dangerous players such as Iran.

On the other hand, North Korea appears much less threating than it did a year ago. China’s role in Asia has strengthened despite the apparent concessions it is making to the U.S. in Trade.  President Xi Jinping’s recent speech highlighted his intransigence, when it comes to national priorities such as Taiwan.  Nonetheless, we do not see China’s economic momentum being seriously constrained in the next few years.  There are still great opportunities in the world’s 2nd largest economy which is driven 80% by its domestic consumers.

 

 

Robert Lloyd George
10 January 2019
Hong Kong

China and Australia

The first week of December has seen a spike in volatility, after the Huawei news, nervousness about Brexit, and uncertainty on Fed actions. Headline news can be misleading – the true story is one of progress and reconciliation between the US and China, (and possibly between the UK and the EU, if a second referendum is called).  We remain positive on the Asian markets in 2019.

November saw a notable recovery in Asian markets, especially in India where we achieved an 8.5% gain (in US Dollars), and in our Bamboo Fund up 5.5% or twice the Asia Pacific benchmark. Much of this recovery has been due to a fall in the US dollar, and recovery of Asian currencies, and also the news coming last weekend of a ‘truce’ between President Trump and President Xi Jinping in the ‘Trade War’.  With the oil price also strengthening somewhat after the G-20 meeting, this will result in a much better tone in Emerging Markets in the next few months.  We expect that this rally will last well through Christmas and Chinese New Year and hope to see some resolution of the trade issue before the end of the three month period on February 28, 2019.

The reaction in China has certainly been positive and one consequence is that the government is easing its tight austerity measures, including deleveraging, in favor of a more stimulative program, as well as opening up the Chinese markets for imports by lowering tariffs on automobiles and other sectors, including the important financial sector where American banks and fund management companies can now have wholly owned subsidiaries. In November, growth in the services sector grew at its fastest pace in 5 months, and the PMI rose to 53.8, which confirms a policy shift.  We believe the impact will be favourable for the A-Share market, that the Renminbi will be held stable, (or not break the RMB7.00/US dollar line) and that business confidence, which has been quite depressed in China this year, will recover in the next few months.

Another major impact will be the acceleration of the trend of transfer of manufacturing to Vietnam, Indonesia, Thailand, Malaysia and the Indian sub-continent. We see already more Chinese and multinational companies moving production to these areas not only because of US pressure but also because of lower costs.

Our portfolio strategy is gradually to move the ASEAN weighting up towards a third of the portfolio.

I spent two weeks last month in Australia, a wonderful, welcoming country with abundant natural resources and beauty (especially in the Northwest, around Broome). With a GDP of US$1.4 trillion, and an average income of A$73,500 (US$53,057), Australia is a wealthy country with only 24 million people, which has not had a recession for 27 years.  One of Australia’s most remarkable achievements has been building up US$2.7 trillion of “Superannuation” or retirement funds, which is equal to almost twice GDP, or over US$100,000, each.  (As Alan Greenspan’s new book, Capitalism in America, highlights, the greatest US challenge of the next few years is tackling the entitlement problem and the US$22 trillion national debt.)

China is now easily Australia’s largest trading partner, accounting for about 32% of exports (almost half of which is iron ore) and 25% of imports. We are working on the assumption that China’s economy may slow to 6%, but its infrastructure demand (including One Belt One Road) will maintain growth and momentum, supporting commodity prices.  (Interestingly, the fastest growth in Australia’s exports of 33% has been to India.)  Also, Australia has recently become the No. 1 world producer of lithium.

In addition, there are now over 200,000 Chinese students in Australia, and 1.3 million Chinese tourists spending over US$10 billion annually. (They also buy 25% of Australia’s excellent wines.)  The property market in Sydney, and other major cities, has been supported by Chinese purchases, but house prices are now expected to correct, with median prices at 7 times average disposable incomes.  Our investment focus in Australia has been mainly on resources (including gold mining), but also on the healthcare and services sector, also closely connected to China.

Thinking about China’s path over the next 3 years, it is worth keeping the long term perspective in mind. Since 1978, or 40 years since Deng Xiao Ping’s economic reforms began – life expectancy has been extended by 9 years, and average annual income has increased from 614 Yuan to 67,569 Yuan or about US$10,000, a nominal increase of 100 times, while the US average has grown 5 times.  The proportion of the Chinese population living in cities has grown from 18% to nearly 60%, or 840 million.

The Communist party’s legitimacy since 1989 has rested on its ability to deliver economic growth and better living standards, not Marxist ideology. The question today is whether this can be maintained, under increased pressure from the USA and under a lifetime presidency with no constitutional procedures for the succession.

On balance, we give the benefit of the doubt to Chinese economic planners, who have managed successfully a transition from a state directed economy to one today whose growth is driven nearly 80% by consumer spending. Our investment strategy remains focused on healthcare, education, travel and tourism, and e-commerce.

Robert Lloyd George
7 December 2018
Hong Kong

The Turn of the Tide

Our confident expectation is that President Donald Trump will reach a “truce” in the trade war when he meets President Xi Jinping in Buenos Aires on November 30. The elements of such an agreement are already in the works and China is very willing to make a deal which will appear favourable to the US electorate. In particular, they will increase their imports from the US substantially by boosting purchases of food stuffs, energy and capital goods (one of the most interesting areas may be LNG, which will meet China’s requirements for a cleaner environment).  Deng Pufang reminded the Beijing leadership in a recent speech that his father, Deng Xiaoping had established China’s foreign policy in the 1980s as “hide your edge and nurture your strength” meaning that China needs to behave humbly and not try to take the lead in world’s affairs.

The recent rapprochement between China and Japan during Prime Minister Abe’s visit to Beijing last week, is very interesting in this light, since six years ago the two countries came near to conflict over the Senkaku/Diaoyu islands. China is re-assessing its aggressive policy in both trade and territorial claims, again the indications are positive that they will be more accommodating with their foreign partners in the next few years.

Our view as outlined in last month’s investment outlook is that China’s Shanghai A-Share market is now extremely oversold and deserve long term investors’ attention, the PE ratio is 10.7x forward and the market is now cheaper than it was after the 2008 financial crisis. There has been a shift from the consumer and technology shares which led the market until recently into the defensive areas such as banks, utilities and telecoms.  We expect the recovery will encompass all these areas as well as the tech heavy ADRs such as Alibaba, TAL Education, Hauzhu and Tencent.  The e-commerce giants in China still represent the best long term businesses for us to purchase.  We are mindful of Warren Buffett’s advice to buy when others are fearful and to stay conscious of our neurotic partner “Mr Market” who offers prices way lower than value.  We are also trying to follow Keynes’ investment advice when he said that the right method of investment is to put large sums into enterprises which we know something about, and in management in which we believe, and not to spread our risk too widely in enterprises which we know little about.

Regarding China’s economic slowdown, we perceive the shift away from exports and infrastructure (or fixed asset) investment as a healthy change, bringing new opportunities in consumption, tourism, education, and healthcare. Next week, Xi Jinping is opening the “Shanghai Import Show”, which again highlights China’s propensity to consume foreign brands (in fact China ran a current account deficit in 2Q18 for the first time, and it is expected to grow, as China’s tourism expands).

For the first time, the Beijing government announced a series of income tax deductions for mortgage payments, rent, education and medical expenses. We expect that these will be further policy announcements to encourage consumers to spend, and some stimulus measures (expected to add 1% to GDP growth), and jobs, and counter the effects of the trade slowdown.

Our focus this month is very much on South East Asia and the opportunities which it now offers us as many multinationals and Chinese businesses shift production into Thailand, Malaysia, Vietnam, Indonesia and India.

Vietnam’s manufacturing and labour costs are about 31% of China’s and it is perhaps the economy which we see growing faster, with a foreign investor friendly government and a stable currency. For long term investors it is also noticeable that some of the South East Asian currencies, notably the Singapore dollar, have shown steady long term appreciation.

Singaporean dollar vs US dollar over 20 year

Finally, on India where there has also been panic selling in the last month after the default of IL&FS and the rise of interest rates from 6.0 to 6.5% together with a concerted attack on certain financial institutions such as Yes Bank. We believe that there are attractive opportunities to buy long term plays on the growth of the Indian middle class, in particular the growth in the housing market.


The Indian market and Rupee have been oversold, foreign investors sold almost US$4 billion out of Indian shares in October, as usual being matched by domestic investors and institutions. Major Indian corporates reported 25% year on year growth in revenues, but EBITDA only grew 15%: the weak rupee, and rising energy and commodity costs, have pressured margins.

Liquidity remains a key consideration in our portfolio strategy: the experience of the last 2 years in frontier markets like Sri Lanka, and Indian small and midcaps, have deferred the manager from making new commitments in these areas. While we want to own the 25 best long term enterprises in Asia, we prefer to invest in liquid, tradable shares.

We are very much long term investors. Although we cannot with absolute confidence forecast market turns, we believe that for long term value investors, this is an excellent opportunity to consider a broadly diversified portfolio in China, India and South East Asia.

 

Robert Lloyd George
2 November 2018
Hong Kong

 

Asia: An Extraordinary Buying Opportunity

We have rarely seen such a bearish mood in Hong Kong and China. Asia Pacific is nearing 5-year lows in terms of price earnings.  In particular, China is close to its lowest multiples in 5 years; but its economic prospects (despite the comments of Larry Kudlow) are still good.  We expect China’s GDP to grow 6% in the next year – and this means an additional US$840 billion of output on a US$14 trillion economy.

5 Year MSCI Asia Pacific Price/Earnings Ratio

5 Year Shanghai Composite EPS and P/E

The emerging markets are also at a very depressed and oversold level and have fallen 20% in 2018. Within the emerging markets, Asia now represents 75% with EMEA at 15% and LATAM at 10%.

Emerging Markets in 1988 vs 2017

When we consider that the Turkish lira and the Argentine peso have collapsed by -38% and -52% year-to-date, together with their respective stock markets, we can appreciate the contagion effect that this has on otherwise healthy economies in Asia.

Asian Currencies vs LATAM Currencies 1 Year Performance

Russia, too, has been suffering from US sanctions, and the Russian ruble and the Russian market have both reached new lows with negative effects on other Eastern European economies. Brazil has been dragged down by political uncertainty and the effects of the Venezuelan economic implosion have affected Colombia and its other immediate neighbors.

Asia stands out for political stability, financial strength, strong savings rates, and good growth prospects. India is growing at 8.2% on its last quarterly GDP numbers.  The inflation rate is low at 3.7%, and real interest rates are high.  The current account deficit, that India is currently experiencing, is half what it was 5 years ago, when it was 5%; and today, it is 2.4%, even with oil rising to US$80, and we expect US$100 by year end.

Mr. Modi is likely to get re-elected in May, 2019; the Reform Program will be maintained; corporate earnings are growing at 20%; and the Reserve Bank of India is probably one of the most conservative banks in the emerging world. The Foreign Portfolio Investors (FPI) owned by non-resident India have now been given some relief from the SEBI rule regarding KYC of beneficial owner of the fund.  There has also been a concerted attack on corruption and bankruptcies in the corporate sector as well as the banking industry in India, which recently affected banking and financial stocks.   September has been a torrid month for our Indian Ocean Fund, which fell 9%, together with the weakness of the Rupee.  The Indian Rupee at 73 is now down by 14%, against the US dollar since the beginning of 2018.  In our view, none of these extreme market corrections are justified by the economic fundamentals.

The real political risk today, it could be argued, is in Washington where President Trump, having threatened trade wars successively with Europe, Mexico, Canada, South Korea, among others, has settled new “deals” with all of them. This argues that he will logically find a new “deal” with China in due course, which would have a dramatic effect on the depressed share markets of Shanghai, Shenzhen, Hong Kong, and the region.  The midterm elections on November 6 actually highlight the political risk facing the USA, since the possibility of the Democrats gaining the majority in the House, if not the Senate, will create paralysis and stagnation in the legislature, and possible impeachment proceedings against the president.   This will surely lead to a fall in the US dollar and probably in the S&P 500.

The key for us is the relative performance of the US market and the US dollar compared with the rest of the world, in particular, with the emerging market index.

10 Year Ratio of S&P 500 / MSCI Emerging Market Index

In the past 30 years, we have never seen such an extreme outperformance of the US compared to the rest of the world. The key will be a change in the Dollar’s trajectory.  As the US debt surpasses US$21 trillion, and interest rates rise towards 3% (and, as J.P. Morgan suggested, to 5% over the next 2 years), net interest payments annually will reach US$1 trillion, exceeding total defense or social security spending.  At this point, it is hard to imagine there will not be some sort of crunch, or crisis, in the value of the US dollar, and the way foreigners perceive the risk in the Treasury bond market.

It is interesting to compare China, with US$3 trillion official reserves and US$7 trillion or more of private savings, and other Asian countries – Hong Kong, Japan, Korea, Taiwan, India – because there is clearly an imbalance in the world. The global savings glut, which has held down interest rates for the past several years, may now be reaching a moment of truth.  Instead of 50% of Chinese savings being channeled into US funds, we may see soon a reversal by which the huge private savings in China and India are channeled instead into their own capital markets.

China’s contribution to global growth has risen from 12% in 2000 to 30% in 2017. China is also becoming creditor nation with external assets of US$6.2 trillion and is increasing its direct investment into Southeast Asia, both because of cost pressures and trade tariffs.

China is not only an investor but the leading trading partner of nearly all Southeast Asian countries, notably Indonesia, Philippines, Vietnam, the most populous ASEAN nations. In our model portfolio, we are now targeting 40% China, 30% India, and 30% ASEAN.  Within Southeast Asia, we are overweighting Vietnam and Indonesia because of their large, young consumer populations.  For instance, we have selected the Home Depot of Indonesia, Ace Hardware, as one of our core positions.

The health of the world economy depends on the Emerging Markets, which account for 59% of global gross domestic product – up from 37% in 1980. This enormous shift of the world’s economic balance in the past 30 years is principally due to China’s rise as a manufacturing and economic power, especially in the last 20 years.  Now, many observers think that India is the next China, with its young population of nearly 1.5 billion, exceeding China’s, its growth rate surpassing China’s, and its open and democratic system of government proving, in the long-term, more resilient.  No investor in North America or Europe can afford to ignore the potential of China and India as investment destinations in the next decade.  Even if the oil price reaches US$100 a barrel, we expect that, as in 2007, the Asian markets can rise against this background of rising commodity prices.  Inflation may be coming back as wages rise and labour shortages grow. But for the next 12 months, we see a coming shift of capital away from the overvalued US market into the value opportunity of Asia.

 

 

 

Robert Lloyd George
5 October 2018
Hong Kong