STRATEGIC AMBIGUITY

China’s Communist Party is celebrating its Centenary on July 1st, with nationalist and ideological fervor, and renewed emphasis on loyalty to “Xi Jin Ping” thought.  Will the lifetime President feel it is incumbent upon him to demonstrate China’s newly assertive military and naval prowess?  The U.S. maintains, under President Biden, its “strategic ambiguity” with regard to Taiwan, a policy in place since Nixon’s visit to China in 1971.

A crisis in the South China Sea is, perhaps, the one exogenous factor that could seriously upset the global bull market in equities, particularly as it relates closely to the all-important semiconductor supply chain.  We maintain a core position in TSMC, which is, in our view, the global leader in miniaturizing (to 5 nanometers or less) semiconductor circuits.  Samsung Electronics is also a key player.

Meanwhile, the economic outlook for the second half of 2021, and 2022, remains robust, with India growing at 11% (earnings growth now estimated at 42%), China at 9%, and the USA at about 7% — the fastest for decades.  Even India’s renewed wave of Covid 19 cases has not damaged optimism about economic recovery, with only a few local lockdowns.  We now expect Asian travel to be opened up in the second half of this year, which will especially benefit Hong Kong, Singapore, and Thailand.

Meanwhile, the threat of a resurgence in inflation seems to have receded.  Almost all market commentators and economists agree that it was inevitable, given the extraordinary growth in U.S. money supply.  Professor Lacy Hunt, of Hoisington, was a lone voice against this consensus, arguing that demographics (ageing population), productivity (automation), a decline in the velocity of money, and other factors, argued for continued deflation or disinflation.  If this is, indeed, the case (and the jury is still out), the bubble in U.S. equities, and also in real estate, globally, may continue for some time.  (In Europe, for example, property buyers can borrow Euros for close to zero.)

So far, isolated financial scandals, such as Greensill and Archegos,have not dented market optimism.  The case of Huarong, in China, may be larger, and has resulted in some outflow of institutional capital from Chinese bonds.  The expectation is that China’s PBOC, and monetary authorities, will stand behind Huarong (and, virtually, all China’s banks remain under State control).

Where is deep value to be found?  We have been impressed by Warren Buffett’s astute analysis of Japanese trading companies (Mitsui, Mitsubishi, Sumitomo, etc.), selling on price/book ratios of 0.5 times, with dividend yields of 5%.  We find the same characteristics (large volume of traded goods and commodities) in Korean Chaebol (Samsung, Hyundai, etc.); and the old “Hongs,” such as Jardine Matheson, Swire Pacific, and CK Hutchison, which we have added to our regional portfolio in the last 3 months. 

There has been a definite shift from high growth, high PE, Chinese internet shares (Alibaba, Tencent, Bilibili, etc.) to “deep value” shares in shipping, trading, banking, and real estate.  Also interesting are Hang Seng Bank and Wharf; and, even HSBC, which has gone ‘back to its roots’ in Hong Kong and Southern China, while disposing of its US consumer lending business. 

Then there is the interesting sector of real estate.  The surprising thing is that global property values have not fallen during the pandemic.  Indeed, there is a boom in many locations (Florida being an example).  Despite all the negative news about Hong Kong, residential property is still in demand with interest rates so low.  We have also analyzed Sun Hung Kai Properties, Hong Kong’s largest developer, with high margins and strong balance sheets.  As long as rates stay low, or near zero, the boom in global property is likely to continue.  But there is a clear divergence between China and the USA – in monetary policy, as well as in their real estate sectors.   China is definitely tightening, whereas the US is on a massive spending binge, which will increase the US debt burden.

All of this raises questions about the US dollar’s fragile hegemony.  China already has a larger volume of trade than the USA, but most of its trade continues to be denominated in US dollars (oil, for instance).  What will happen if China loosens up its exchange rate and eventually allows free convertibility of the RMB?  We do not expect this imminently, and we also note that it took more than 20 years for the world to shift from a sterling- to a dollar-based system.  The euro will continue to play an important role.

The depressing news about India’s dramatic increase in Covid cases in recent weeks, underlies the case that this pandemic will likely continue for some time (2 or 3 years possibly) in many developing countries – Brazil, India, and Africa, among them.  The stark divergence with the “vaccinated” countries – Israel, the UK, and the USA being the leaders, and the rest – will surely be apparent in travel patterns this summer.  The good news is that we see vaccinations ramping up quickly in Hong Kong, Singapore, and most Asian countries.  We remain sanguine about the economic outlook for the region.

Robert Lloyd George

Hong Kong

May 1, 2021

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