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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FAST FORWARD BIOTECH

Although recombinant DNA was first patented in 1976, it is perhaps only in 2020, with “messenger RNA” pioneering Covid vaccines from Pfizer and Moderna, that the promise of biotechnology has finally reached millions of grateful patients.  Just as Sir Alexander Fleming discovered penicillin in his London laboratory in 1928, it was only in 1943 that the miracle antibiotic was finally mass produced and became available to Allied Troops by D-Day.

We have compared the Covid 19 pandemic to a war; and just as in war time, technology and medicine are speeded up by the pressure of events, so this last year has accelerated (thanks largely to operation “Warp Speed”) the application of biotech and RNA/DNA products for general medical use.  As investors, we expect Biotech to be the key sector of the next decade, bringing a host of new products to market.

China is trying to achieve scientific leadership and technological self-sufficiency by 2030.  Under lifetime President Xi Jinping, the priorities of China’s next 5-year plan, announced at the recent National People’s Congress, are no longer just economic growth (target was 6%, now dropped), addressing income inequality (rural vs. urban) or “common prosperity,” strong manufacturing (maintained at 25% of GDP vs 11% in USA), but also tougher regulations on internet companies, such as Alibaba and Tencent.  China will become a more tightly managed economy, with a stronger SOE or state-owned sector.

The recent US-China meeting in Alaska has highlighted the gulf in diplomatic relations, which has worsened under President Biden.  China presents a challenge to Western democracies in its treatment of Uighur minorities in Xinjiang, its draconian crackdown in Hong Kong freedoms, and its continuing threat to Taiwan.  It is difficult to see how trade relations can improve against this tense background of sanctions and tariffs.

Nevertheless, China’s economy continues to recover; and the consumer sector (70% of the economy) presents us with numerous opportunities, not only in on-line businesses, such as Bilibili, and pharmaceutical leaders, such as Wuxi Biologics, but increasingly in old line value names in retail, finance, and travel.  The dramatic shift from growth and technology, to value, has mirrored a similar shift in the US market; but China’s stock market has had a more violent correction (30% to 40% in some technology names).  Could this be a harbinger of things to come?

We believe that it is a healthy correction (Central Bank crackdown on high margin financing) in an on-going bull market.  The opening up of some economies, both in Asia and in the West, may be slowed down by a “Third Wave,” or possible variants of the virus; but the rapid rollout of vaccines in the US, the UK and Israel, is promising.  Science will finally conquer the virulent disease emanating from Wuhan.

South East Asia looks like a promising area for value investors, as the recovery of energy and commodity prices improves terms of trade for Indonesia and Malaysia.  For Thailand, a recovery in tourism will be needed; and we expect that, by autumn.  India’s stock market continues to do well, and we have raised our exposure in regional portfolios to 15%.  The Budget promises more infrastructure spending, more vaccine production, and easing of taxes and regulations.

There are 5 technologies potentially changing the world in the next 10/20 years:  1) Genomics or Biotechnology, 2) Artificial Intelligence, 3) Robotics, 4) DNA processing, and 5) Blockchain.  But in the immediate future, semiconductors remain the essential ingredient for everything from automobiles to military equipment.  Taiwan Semiconductor Manufacturing Company retains a large lead over all its competitors, and China also depends on their supply.  This is, to some extent, an insurance against an invasion or military conflict, since Taiwan’s semiconductor fabs may be destroyed, and skilled engineers would emigrate.  Also, Japan and other nations would apply sanctions.

I have been very impressed by the investment insights of John Authers, formerly of the Financial Times, and now with Bloomberg.  He commented recently on the prospects for rising inflation, based on his historical analysis of monetary values, of demographics, and the labour force.  He says, “Inflation was a rare phenomenon until the 20th century, when it suddenly became the norm.  The establishment of the Fed and the First World War came immediately before the great explosion…”

Demographic trends are also important; world population grew by about 20% a century until 1900, jumped 60% in 1900-1950, and then exploded to 140% in 1950-2000 (us Baby Boomers), but will fall back to 60% in 2000-2050 and stagnate thereafter.  There is quite a close correlation between population growth and inflation; however, increased longevity can prolong consumption (at least in wealthier countries) until 80 or 90. 

“The entry of China into the global workforce was … possibly the greatest deflationary shock in history…”  A remarkable assertion.  But as we wrote last month in covering The Great Demographic Reversal, this trend has now come to an end after 30 years.

“The elephant in the room, for inflation in the 20th century, is the abandonment of currencies based on precious metals.  The temptation for a great inflation reset is a political choice; and this will probably be the route many countries choose to reduce their debt burdens …

“The Post Pandemic” period is like a post-war period.  We can study the 1921 depression, or the 1947 inflation, to imagine what 2022 will look like. 

In his remarkable history of Manias, Panics, and Crashes, Charles Kindleberger states that financial crises frequently occur in the aftermath of a war; and 1920/21 (which coincided with the Spanish flu) was a classic example, resulting in a stock market crash and 6 months’ depression (which, as Jim Grant remarked, “cured itself” without official intervention because the market cleared).

Our own experience of 2020/21 Covid, closely resembles a war, with battles won and lost, and enormous state expenditures to combat the enemy and the economic distress resulting from lockdowns.   One of the immediate results has been a financial mania, which has driven up the S&P 500 from its low, on the 23rd of March 2020, by 68% in the last year.

This week, China announced new rules for land sales.  Since 1997 and before, China’s municipalities followed Hong Kong’s Model of keeping taxes low and funding their expenditures by regular land auctions to developers.  This has inevitably caused debt to soar, and a property bubble to develop.

Now the government is trying to cool down the property market, and land prices will likely start to fall, as higher cash deposits are required from developers.  Construction and real estate are an important part of China’s economy (17% of GDP) and the major form of investment for Chinese savers(though mainly cash, not mortgages).  This could, therefore, have a broader impact on consumer confidence and wealth.  Xi Jinping famously remarked that “a house is for living in, not for speculation.”  But will there be growing political pressure on the Party if housing prices fall 50%?  They have, after all, risen 4 times in the past decade in China’s major cities.

In conclusion, we see many crosscurrents in the world, and in Asian markets, at the present time.   For example, the US dollar has made an unexpected recovery against the Euro (because of Europe’s vaccine problems).  This will help emerging markets.  Inflation is a concern as we look ahead 12 months or more.  The technology bubble is deflating somewhat (will Bitcoin follow?)   But, on balance, we believe a balanced portfolio of growth and value in 25 high quality Asian securities, is likely to outperform in the next few years.  The tremendous economic improvements in quality of life and communications, in both China and India, are the biggest factors in the world today.

Hong Kong

April 2021

The Silver Standard

It is sometimes forgotten that the defeat of the Kuomintang (KMT) Nationalist Government of China, under Chiang Kai-shek in 1949, by the Communists under Mao, was due as much to the hyperinflation and corruption of KMT officials, as to the military success of the Maoists.  The origins of China’s hyperinflation can be traced to the US Silver Purchase Act of 1934, which led directly to China going off the silver standard in 1935, as the price of silver rose from US$0.24 to US$1.29.

The new Communist government had learned a lesson from the previous decade of battling the Japanese, and then the Civil War, that you cannot finance a war with paper money and unsold debt issues.  One of their first priorities then, was to restore stability to the currency – now the Renminbi or Yuan — which they achieved by 1951. 

The last 70 years of Communist Party administration has been partly dominated by this historic fear of hyperinflation among the Chinese people, which was shared by the German people after the 1923 Weimar hyperinflation.  Moreover, there was austerity in the PRC government and Army ranks which contrasted with the previous KMT corruption.

In recent decades, a sudden flare up in inflation in China — notably in 1989 when it jumped 28% — has always alarmed the Chinese authorities because of this abiding memory.  It was, therefore, interesting to note that in 2020, when the US government increased its money supply by 26% in a matter of months — the fastest ever — China did the opposite.  There were few bailouts or transfer payments to the population.  The PBOC, or Central Bank, held the line.  Interest rates remained at 3% (on 10-year bonds), not zero.  And the RMB strengthened against the Dollar. 

So, back to the present day:  China remains conservative in its monetary policy and cautious in its foreign policy, though it is true to say that Xi Jinping, who has been behind the famous “One Belt One Road” policy (and has also taken a harder line on Taiwan), is also, like Vladimir Putin, effectively president for life, so the possibility of grandiose strategic errors is higher than in a “term limits” presidency.

The only 3 economies that experienced positive economic growth in 2020 were Taiwan, China and Vietnam.  Taiwan had the highest growth of 3%, with an excellent record on Covid (only 919 cases and 9 deaths) and a strong export record on semiconductors, where they have become, de facto, global leaders.

The Indian Budget was presented on February 1st and has further stimulated the share market with a focus on privatization, a higher fiscal deficit (9% of GDP) and more spending on infrastructure.  Nominal GDP growth will be over 14% in the coming year — the highest in the world, certainly for a major economy.  India is also increasing its spending on healthcare (manufacturing vaccines, especially), which is still only 1.5% of GDP.  We believe Pharma, as well as private banks and property companies, will benefit.  The apparent overvaluation of the Bombay Sensex may be undercounting the corporate profits surge, which we anticipate in 2021-22 to be over 40% year-on-year.  India may also open its bond market further to foreign investors and emulate China’s success in attracting foreign capital.  It is fair to say that nearly all major international investors are underweight India, which still has the best growth prospects in Asia in the decade ahead. 

Climate Change

In his new book, How to Avoid a Climate Disaster, Bill Gates explains that we have until 2050 (just about 28 years) to reach “net zero” carbon emissions — a difficult target.  He also mentions, in passing, that China achieved its goal of lifting most of its people out of poverty in the past 30 years by building many coal-fired plants very cheaply (75% less), which they are now exporting to Pakistan, Indonesia, Vietnam, and many African nations.  “If these countries opt for coal plants, as China did, it will be a disaster for the climate,” Gates comments. 

In fact, a direct correlation can be traced since 1980, between the industrialization of China (70% powered by coal), and the warming of the global climate, due to more CO2 emissions.  Europe and the USA have been flat in their emissions for decades:  the incremental change in pollution has been entirely due to China, and now to India and other developing nations.

To be fair, China is now making a huge effort in solar, wind, hydro, nuclear, and electric vehicles.  Some of our best investment opportunities have been found in these alternative energy sectors, with China’s competitive efficiency driving down prices in solar panels by 90%, and also in wind turbines, so much so that it is challenging to find players with profit growth.

Outlook for 2021

According to JP Morgan, we are about to have one of the strongest economic rebounds ever recorded, except for post-war periods.  The world economy will grow over 7% this year, led by India (14%), China (9%), and USA (6.5%).  The massive increase in liquidity, engineered by Western Central Banks, will lead to strong equity markets, especially in Asia and Emerging Markets. 

Stanley Druckenmiller, in a recent interview, said the difference between the USA and China, indeed Asia, is that “they haven’t borrowed from their future,” and therefore have a healthier, less indebted macro-economic and stock market outlook.

However, there is one interesting difference — the UK, Israel and the USA are leading the world in vaccinations today.  While Asia has, broadly speaking, very few Covid cases, they have been slow on vaccinations.  This may mean that places, like Hong Kong and Singapore may take a few months longer to open up their economies.

In summary, we expect that the US Dollar will remain weak, and commodities will enter a “super cycle” of strength in metals, energy, and food.  The stock market will remain in an uptrend, at least until we hit 5% inflation at the end of 2021 or early 2022, which will be a testing year for the global financial system.  Asian currencies should remain strong against the Dollar.  We must, perhaps, ask the question whether Bitcoin, and the rise of cryptocurrencies, is signaling a new world order in which the USA, and the Dollar will play a less important role.

Hong Kong

2 March 2021

RECOVERY AND REFLATION

As the Chinese New Year approaches on February 12th, we are trying to discern the trends in the year to come.  President Biden has set out important new policies in his first 2 weeks, including a US$1.9 trillion reflation package, and a continued tough line on China, both on trade and human rights.  Xi Jinping has responded at the Virtual Davos by proclaiming his belief in free trade and openness, while, at the same time, putting military pressure both on India and on Taiwan.  Meanwhile, markets continue to discount a rapid economic recovery from the Covid pandemic.  In Asia and Australasia, ironically, the travel and lockdown restrictions are far tighter than in the USA and Europe, although there have been, for example, only one case in Singapore and only one case in New Zealand in the past 6 months.  Southeast Asia will continue to lag behind the economic recovery of China as long as travel restrictions are in place. 

By contrast, India has had a strong recovery, with an 85% decline in Covid new cases and fatalities.  A massive rollout of the vaccine is underway in the 1.4 billion population of India, which has a median age of 28.  We see a strong recovery in the property market in India, and we have recently added Godrej Properties to our Indian Ocean Fund portfolio.  Interest rates are low, in real terms, in India; and the need for new housing is pressing.  This will also benefit the private sector banks, which we have long maintained as core positions – HDFC, ICICI Bank, Kotak Mahindra, as well as State Bank of India, which we have added in the past few months.  Indian housing affordability is at the lowest level for nearly 20 years.  We also see potential for recovery in both Singapore and Hong Kong property sectors, although these will also depend on a reopening to trade and travel. 

In China, the striking fact is that the technology sector has increased from 17%, a decade ago, to 66% of the MSCI China Composition today. 

This is an even more extreme ratio than in the USA, where the famous FAANGs are now about 15%, and technology is 28%, of the S&P 500.  The question is really, how long will it take for vaccines to be rolled out, whether they will be successful against the new variants of Covid, and whether life will return to normal by this summer.  If so, then the on-line businesses may suffer a slowdown as old line cyclicals – retail, hotels, restaurants, airlines, and trading businesses – recover their growth and profitability.  Our best guess is that the technology sector continues to outperform on profitability.  As Howard Marks has recently outlined in his interesting paper on growth and value investing, these are businesses with few capital costs, or tangible assets, but a high return on equity.  We have, therefore, not touched our core positions in Bilibili, Shenzen Innovance, and Wuxi Biologics, which constitute 22% of our portfolio.  In addition, we are increasing our exposure to semiconductors, or DRAMs, both through Taiwan and South Korea, where, in addition to Samsung Electronics, we are investing in SK Hynix, the second largest semiconductor manufacturer. 

The outlook, moreover, for emerging markets, relative to the US market, remains very promising, both in terms of valuations, and of earnings growth. 

Source: Goldman Sachs

The discount to US equities has now reached the lowest point since 1999, at 47%.  As we have often commented, over 70% of emerging markets are accounted for by China, South Korea, and Taiwan today, with a heavy technology component.  This year, we’ll see the rollout of 5G in China and in the USA, with 100 times the speed of 4G, which was introduced in 2010.  Many smaller technology companies will benefit, in both major markets, from this development, which is likely to last for the next 5 to 10 years, and involve US$17 trillion of investment in many areas, such as self-driving cars, the internet of things, Artificial Intelligence, and remote telehealth. 

While the opportunities for earnings growth in China and India remain very attractive, the risks in the broader US market, are also worth considering, since they will impact global markets.  There is a very high level of speculative activity, which is typified by Bitcoin, Tesla, and small cap stock activity.  The real risk is that there may be a sudden reappearance of inflation.  The new president has swiftly moved to raise the Federal minimum wage to $15.00 an hour.  Commodity prices are rising fast, particularly natural gas, and also palm oil prices in Southeast Asia.  The Baltic Dry Index has surged 63% in the past 2 months.  There may be many supply shortages after the pandemic ends, and pent-up demand for many consumer sectors and products.  We, therefore, are of the camp that believes inflation can surprise by rising to 3% or 4%, instead of the Federal Reserve’s preferred rate of 2%.  Interest rates would have to rise, by the end of this year, to respond to this development.  The other risk is a deterioration of US-China relations, particularly with regard to the Taiwan question, which has become more pressing – and Biden has followed Trump’s lead in maintaining close relations with Taipei.  

All of these are rather theoretical, and remote, risks at the present moment; but as the New Year of the Ox begins, we are conscious of the fine balance of risk and reward.  This is one of the reasons why we are focusing on a conservative fund structure, such as the Pacific Income Fund, which will comprise 50% of Japan and 50% the rest of Asia, focusing on high-yield, low price to book names, such as Mitsubishi, Sumitomo (of which Warren Buffett has bought 5%), and also CK Hutchison, Jardine Matheson, and some high-yield names in Korea, China, and Southeast Asia.  The two-tier market, between technology and the old cyclicals, will likely change this year, with a return to value and dividend yield. 

After a record return in 2020, we are cautious about how long this rate of return can last.  As one commentator put it, “Who would have predicted a US equity market return of 18% in 2020, in the face of nearly 25 million Covid infections, and over 420,000 deaths, an estimated GDP decline of 3.5%, earnings decline of 17%, and unemployment of about 11 million?”  This year, the risk may be that, once we return to normal, the market itself will correct on the arrival of good news. 

Predictions that China will overtake the USA by 2026/2030 are, perhaps, premature, given the demographics and productivity trends, which show a decline in China’s Total Future Productivity from 2.8% to 0.7% in the past decade.

Nevertheless, we are bullish in Chinese technology and healthcare companies, which have powered our performance for 2 years.

In conclusion, we remain positive about the outlook for the Asian economies and markets, and wish our investors and readers a Happy Chinese New Year. 

Hong Kong

1 February 2021

THE GREAT DEMOGRAPHIC REVERSAL* AND PREDICTIONS FOR 2021

“The rise of China and demography created a ‘sweet spot’ that has dictated the path of inflation, interest rates, and inequality over the last three decades.  But the future will be nothing like the past – and we are at a point of inflexion.  As the sweet spot turns sour, the multi-decade trends that demography brought about are set for a dramatic reversal … for a significant rise in inflation and wages, or a rise in nominal interest rates.”

China saw an increase of over 240 million in working age population between 1990 and 2017; and Eastern Europe added another 200 million, compared to only 60 million in USA and Western Europe.

China’s share of world manufacturing output grew from 8.7% in 2004 to 26.6% in 2017 (extraordinarily rapid).  No wonder deflationary forces have been so strong for the past 30 years, and there has been a very rapid rise in income and wealth inequality, especially in the USA, UK and Europe, leading to Brexit, Trump, and other populist manifestations.

In the next 30 years, beginning now, there will be a sharp reduction in the growth of the labour force globally, and an increase in the aged, dependent, or retired population.  

The world will increasingly shift from a deflationary bias to one in which there is a major inflationary bias.  China’s greatest contribution to global growth and globalization is behind us.  It peaked in 2012.  China’s falling savings rate, and a rapidly ageing population, will lead eventually to a current account deficit and an end to the global savings glut which produced such extraordinarily low interest rates in the US and Europe in the past 15 years.

The two big demographic growth opportunities in the world, of the next 20 years, are Africa and India; but Africa has 54 nations and poor infrastructure.  India is a single, connected market (in an area the tenth of the size of Africa), of 1.4 billion, mostly young consumers.  India will beat China in global growth over the next 2 decades.  It is the one major emerging market where most Western investors remain underweight, and low interest rates have been the prevailing tendency since 1981.  The 40-year bull market in bonds is over; but what happens to stocks?  There will be a premium for growth, and that growth will be highest in Asia, then the USA, then EU.  Valuations today are lowest in Asia, about half of US valuations relative to economic output or earnings.  “The 40-year trend in disinflation is ending.”

Predictions for 2021

  1. The US Dollar continues to weaken, especially against the Swiss Franc, gold, the Yen, and other Asian currencies – the Chinese Renminbi, even the Indian Rupee.  
  2. The Flow of Capital from West to East accelerates, and China’s bond and stock markets, after taking in $650 Billion in 2020, exceed $1 Trillion inflow.  The RMB breaks 6 RMB to the dollar.
  3. The price of oil recovers — after a strong economic rebound globally, and tensions in the Middle East — to US$60/barrel or higher.
  4. Vaccination in most Western economies will be complete by 2Q, leading to a strong economic recovery and rising prices.
  5. Post Covid economic recovery exceeds all expectations by summer 2021, with pent-up demand, consumer spending, travel, trade, and investments up.  USA +5/6%, China +8%, India +12% vs. Europe.
  6. Corporate earnings exceed 30% growth in Asia and in certain sectors — technology, healthcare –but also cyclicals — airlines, hotels, autos, shipping.
  7. By 2H21, inflation returns +5% in Western countries, higher in emerging nations.
  8. Biden will lead European Allies to take a stronger line against China on trade, technology, and human rights.
  9. Technology sector peaks out (temporarily):  surprise winners by mid-2021 include banks and oils.
  10. The pandemic has accelerated change in working habits, education, and society.  Globalization may not regain its momentum:  nationalism is on the rise.
  11. Focus on biological medicine is here to stay.  Vaccines were created in 8 months, through RNA.
  12. A new investment paradigm.  New winners, which will outperform, include Fintech; and inflation beneficiaries (energy, real estate, gold, bitcoin, cyclical shares).  Reflationary assets, commodities, and mining.
  13. The size of the National Debt:  US$27 Trillion!  What happens if interest rates go up?  Bonds will collapse.  10-year Treasury will be at 2% by end of 2021.

Our immediate view in Asia is positive with a particular focus on Japan, which offers high yields, and low price to book valuations (something which Warren Buffet also identified, when he made his $6 Bn. investment into Japanese trading companies).  Both dividend payouts and share buybacks are rising.  We see this trend in other Asian markets, too, and have structured a “Pacific Income” vehicle with 4% dividend yield, 2% share buyback gains, and 9% dividend growth, equaling an expected 15% annual compound growth.

China will continue to power global and Asian growth.  South East Asia, led by Singapore, Vietnam, Indonesia, and Philippines, will have a strong rebound.  India will stage a strong economic recovery, led by the banks.  The major shift in asset allocation, by global institutional investors, will be back into emerging markets, for the first time in 10 years, and that will mainly benefit Asia.

We wish all our readers and clients a Happy and Healthy Christmas and a Prosperous New Year (of the Ox).  

*A new book by Charles Goodhart and Manoj Pradhan

Hong Kong

1 January 2021

“Hedge Biden with Chinese Tech”

As US Election Day approaches, investors are anxious about increased capital gains tax, more regulations, and a weaker dollar. Looking round the world today, it is clear that economic growth is strongest in China, and its neighbors, South Korea and Taiwan. We have 72% of our funds invested in these 3 markets, mainly in the technology sector. The winners from the US/China trade war are Taiwan, South Korea, and (to a lesser extent) Vietnam, which is benefiting from a transfer of manufacturing, but is difficult to invest in and still has some high foreign premiums.

Taiwan Semiconductor and Samsung Electronics are the two big winners: and there are a dozen smaller names supplying cloud services, electric vehicle batteries, semiconductor equipment, and other key areas of on-line services and products (MediaTek, UMC, Delta Electronics in Taiwan, SK Hynix, Samsung SDI, and Samsung SDS in South Korea). Our assumption must be that the Covid 19 Pandemic will continue to paralyze world trade and tourism for up to another 12 months – and South East Asia, in particular, will suffer from this cessation of activity, although there are some promising signs this week of a more immediate “opening up” in Southeast Asia and Australia. China and India are both large domestic consumer economies, which will continue to exhibit robust consumer spending and corporate earnings growth.

President Xi Jinping made a visit 2 weeks ago to Shenzhen, echoing the famous “Southern Tour” of Deng Xiao Ping in January 1992 (the month our company, Lloyd George Management, was founded in Hong Kong) when he said “To Get Rich is Glorious!” and fired the starting gun for capitalism in China. This time, Xi was urging young Hong Kong entrepreneurs to consider Shenzhen (no political problems), which is, indeed, a technology hub (Tencent, HuaWei, etc.) with nearly 20 million inhabitants and low taxes. In addition, there is strong government support for the “Greater Bay” Area of Hong Kong, Shenzhen, Guangzhou, and Macau around the Pearl River, with its excellent infrastructure, and nearly 100 million middle-class population.

This is not, in our view, the end of Hong Kong which has, this year, seen 20 I.P.O.s totaling US $15 billion (and, in China, more than $47.5 billion); and ANT Financial will follow On November 4th, with an estimated US$34.5 billion (the largest ever I.P.O. anywhere). The Hong Kong / Shanghai and Shenzhen “connect” means that the Hong Kong Stock Exchange still performs a vital role for China in raising international capital, while maintaining a closed capital account.

It is worth highlighting that Taiwan, of all the free democracies, has not only performed best against Covid 19 (only 540 cases, 7 deaths) but also has the best performing stock market. Export growth has also begun to recover last month (9.4%). Forecasts for the tech sector in Taiwan are for nearly 30% average earnings growth, on a PE of 17 times. That is why we include Taiwan’s tech names in our call to “Hedge Biden” by investing in Chinese technology.

There is also the threat of “Trust Busting” against Facebook, Amazon, Google, and Apple. This does not apply to Alibaba, Tencent, Baidu and the Chinese tech sector. We expect these names will outperform in the coming year (revenues and profits up over 30%).

Also in India, we have been pleasantly surprised by the strong sales and earnings growth announced by Tata Consultancy Services and Infosys, the 2 leading Indian software groups (almost 20% gain in EPS) as well as HCL and smaller names. India, despite its large number of virus cases, is coming back strong. The death rate for Covid is less than half of what it has been in the UK and the USA. 95% of cases recover quickly.

The other reason to hedge a Democratic sweep in the November election is an easing of US / China trade tensions, which would, in our view, bring a strong rally in Chinese A Shares.

China’s economy registered 4.9% growth in the 3rd quarter, so the year 2020 may turn out positive at around 3% annual growth — the only major economy to have grown this year. The Yuan, or Renminbi, should be 10% higher against the US dollar, seen against these figures (but is held down by the PBOC).

There has been a remarkable growth in international capital flows into China’s capital markets, both bonds ($370 Bn.) and stocks ($230 Bn.), as China has eased restrictions on foreign ownership of brokers, fund managers, insurance companies, and banks. Most major US and European financial groups are now represented in Shanghai.

Normally, all this would lead to a much stronger Renminbi, now at 6.68 to the US dollar, compared to 7.18 a year ago. We believe the RMB is 10% undervalued and may see a further rise in 2021.
In an historical perspective, it may not matter too greatly who wins the election, since the economic and demographic future is reasonably predictable. The Covid 19 Pandemic has accelerated existing trends – the shift of economic gravity from the US to China, for example – but also the policy response of governments, especially in the US and Europe, to print massive reflationary packages of financial relief, which will mark the end of the 40-year deflationary trend, since Volcker in 1980. We, therefore, expect a dollar and debt crisis, within 2 years (whoever is in power in Washington), which will impact the current US bull market. Nevertheless, we maintain our view that in 2021, Asia — and especially the favoured technology stocks — will outperform.

Robert Lloyd George

Hong Kong

1 November 2020

A New Map of Global Energy*

Just before Covid 19 hit the USA in February 2020, US oil production hit an all-time high of 13 million barrels a day, more than Saudi Arabia or Russia, and triple the level of 2008.  This single statistic illustrates how global geopolitics has been upended by a dramatic and rapid shift in the oil industry, and reduced the importance of the Middle East.  In his new book, Daniel Yergin brilliantly analyzes the impact of the new global energy “map” on the USA, Russia, China, and the Middle East, with additional chapters on climate change and electric cars.  It is clear that the outcome of the US Presidential Election, on November 3rd, will be particularly important for the oil and gas industry, since Biden has embraced the “Green New Deal” program of the more radical Democrats. 

China is, of course, our special focus in these monthly letters, given its economic and market importance.  China also represents, today, almost 25% of world energy consumption, including coal, which is 60% of its total energy, compared to 11% in the USA.   China, today, is the biggest consumer for oil flowing out of the Persian Gulf, and through the South China Sea – hence, the importance to China of the “9 Dash Map,” and their historic claims to the Spratly and Paracel Islands, which (illustrated with Map overleaf) they have now militarized – a claim that is rejected by the US, Vietnam, Philippines, Malaysia (and the World Court in the Hague).

Source: The New Map: energy, climate and the clash of nations.  David Yergin

In Chart 2, showing emissions by country, it is clear that China, with nearly 30% of global CO2 emissions, is, by far, the worst pollutant on the planet, double the USA, almost 3 times the EU, and 4 times India.  The “Green New Deal” in the USA, and Ursula von der Leyen’s plan for “zero carbon” Europe by 2050, will make very little difference, unless China does something radical.   (At the UN on September 22, Xi JinPing said China would try to achieve “zero carbon” by 2060.)

Source: The New Map: energy, climate and the clash of nations.  David Yergin

About half the electric vehicles sold worldwide are in China; but, in Chart 3 one can see that cars only represent 11% of emissions, compared with electricity and heat at 42%; and electric vehicles increase the demand for (often coal-generated) electricity.  Electric cars are not the end of the oil era.   China is also aiming at 250 airports by 2030, and already has over 25,000 km. of railways, and 130,000 km. of highways.  Through the “One Belt One Road” strategy, China is exporting massive energy-intensive projects to countries like Pakistan.  Electricity demand is growing 8% p.a. in China (it is flat in US and EU), and air pollution is still a massive problem.

Source: The New Map: energy, climate and the clash of nations.  David Yergin

In relative Terms, China has had a good pandemic, which has accelerated the shift in the economic balance away from the west and towards Asia.  China’s economy will be the only major one to record +3% growth in 2020, whereas, for instance, Spain (-20%) and India (-15%) have contracted sharply.  China has, moreover, not employed massive government money printing, or direct subsidies to the unemployed, as Europe and the US have done.  China’s export share has grown, with a strong balance of payments, and a strengthening Renminbi.  Since Trump was elected in 2016, China’s trade surplus with the USA has grown 25%.

This means that China’s economy will reach almost $12 Trillion this year, or 70% of the USA, and is likely to reach parity by 2028.  But this optimistic scenario may depend on how successfully China navigates a world trade slowdown, a large domestic debt rescheduling, and an increased dependence on the Chinese consumer.

The major theme of 2020 has been the “Return of the Stock Picker,” instead of ETFs and index funds, which have prevailed since 2009.  With a month to go until the US Presidential Election, investors are busy hedging their bets.  The US dollar remains weak, with corresponding strength in precious metals.  Asian markets are out-performing.  Their economies are in healthier condition than Europe or the USA.  Led by China, they are coming out of the virus lockdown, and resuming normal business.  In our regional Asian strategy, which has gained 22% year-to-date, we have our major overweight in China, Taiwan, and Korea (72% of the Fund) with a focus on technology and healthcare.

This month, we must focus on Japan, in which Prime Minister Abe stepped down after nearly a decade in the job, to be succeeded by Mr. Suga.  The challenge for Japan’s leaders remains the same — a declining population, and a rising China.  Japan’s population is shrinking rapidly, from 127 million in 2014, to less than 100 million by 2050 (or 25% in 30 years).  Deflation has gripped the Japanese economy since 1990, though the Bank of Japan has cut rates below zero, and purchased most of the JGBs (Japanese Government Bonds), or $760 bn. p.a., so that Bank of Japan now owns nearly 50% of the country’s outstanding debt.  The Central Bank has also bought a large amount of Japanese shares, so that its balance sheet is now larger than Japan’s GDP.  Is this the future of Western economies?  Could the Bank of Japan, or Government of Japan, simply cancel half their outstanding debt and, thus, recover the stimulus of economic growth from under a mountain of debt (250% of GDP).  In the meantime, it is not only Warren Buffett who has spotted “value” in Japan’s old established “Zaibatsu” or trading companies, such as Mitsui, Mitsubishi, and Sumitomo.  Japan’s dividend payouts are rising, as are share buy backs:  there is a real bargain for investors in this forgotten market, and, indeed, in the Yen.

In 2021, the world will benefit far less than in 2009 from China’s recovery, as the country turns inward for the first time since the 1970s.  Another familiar echo of that decade may be the return of inflation.  Despite the dramatic pivot by Jerome Powell at Jackson Hole in August, towards lower rates for longer (and 2.5% inflation), the market may look further than the Central Bank (The bank of England is now openly contemplating negative interest rates on gilts).  Volatility will become more pronounced in all asset classes in the face of this uncertainty about the dollar, and about interest rates.

The Supreme Court has suddenly been thrust into this highly charged election, with the death of the much respected Ruth Bader Ginsburg.  At this stage, it is impossible to predict, first, whether the Republicans can force through a new Superior Court Justice in the next 2 months, or what effect this will have on what is expected to be a close, and perhaps, contested US Presidential election.

Source: IMF World Economic Outlook, June 2020 Update

We remain positive on the outlook for Asia in 2021, when we see a strong recovery from the virus-dominated economy of 2020.

*(Review of David Yergin’s new book, The New Map)

Hong Kong

1 October 2020

The Gold Renminbi

When we wrote last month about the decline in the US dollar, the obvious question was: What is the alternative: Euro, Yen, Swiss Franc, Pound? As China is now the second largest economy, and the No. 1 global trading power, it is worth considering if an alternative exists in the Yuan, or “Renminbi” (people’s money). The Chinese authorities clearly see the risk of continuing to depend on the US dollar to pay for all their imports, especially oil: also, as a medium of exchange, or store of value, for their massive reserves of US$3 Trillion (the largest in the world). It is estimated that currently 60% is held in US dollars and nearly 4% in gold, with the balance in Euros, Yen, etc.

China has been actively buying gold since 2015, building their gold reserves from as low as 1% to around 3.4% today of total forex reserves today. This is much lower than developed countries like the US at over 8,133 tonnes, 80% of its reserves, and even Germany at 3,363 tonnes, 75% of its reserves. China currently holds 1950 tonnes in gold reserves officially, an increase of over 90% since 2015. Unofficially, analysts have estimated that China holds closer to 5,000 tonnes.

The top 10 countries hold close to 50% of global official gold reserves, while the IMF itself holds 2,814 tonnes as well. But China has already begun, 2 or 3 years ago, to offer Saudi Arabia and other major oil producers (Russia, Iran, etc.), payment for its oil shipments, in “Petro Yuan” or Renminbi backed by gold, with an implicit guarantee against devaluation, instead of US dollars. Given the centuries-old preference among both Arab traders and Chinese businessmen for the precious metal, instead of “Fiat” paper money, this makes sense for both sides. In addition, the attraction for Arab investors and other international institutions to buy Chinese RMB bonds at 2.9% on 10-year paper, instead of 0.6% in US dollar 10-year Treasuries, is evident. (It is also interesting to note the historical perspective, that while the Western world effectively abandoned its gold standard in 1931, the Chinese continued on its silver standard for some years longer.)

With the real risk that the Trump Administration, or perhaps its Democrat successor, could further “weaponize the dollar” by imposing more severe sanctions (as they have already done on top Hong Kong and Chinese officials), and effectively shutting China out of the US dollar financing system, it makes sense for China to explore alternatives – a gold-backed RMB, or even a digital RMB, which (backed by China’s massive reserve) could overtake Bitcoin (if supply was similarly limited).

But readers may question why we are so interested in gold, and its role in the global monetary system. Given that Asia – headed by China and Japan, but including South Korea and Taiwan – runs a large trade and current account surplus with the West (and, indeed, with emerging nations), the question of whether the US Dollar continues to dominate the global financial system becomes even more pressing. If China can succeed in making the RMB internationally acceptable by having a link to gold, it would dominate the Asian financial system (and Hong Kong may become the leading forex centre).

The long cycle of disinflation, which has been in place since 1982, has seen interest rates fall from 15% to nearly zero. This has now finished. The bond bull market is over. The “Ice Age” of deflation is giving way to “The Great Melt” of massive monetary stimulus, and frenzied fiscal pump-priming, in an attempt to paper over the current pandemic-induced slump. Inflation of 4% by the end of 2021 is now anticipated by many experts.

With that monetary background, we may be in for extreme volatility in currencies and markets. If the gold renminbi comes to pass (or, indeed a gold ruble), then the demand for gold will soar (and, in fact, both Russia and China have been steadily purchasing gold for their central bank reserves now for several years); and demand for the dollar will slump. The era of US dollar domination of the world’s financial system may end by 2025/2030.

In addition, it is worth noting that China has become the first major country to launch a “Digital Yuan” or Chinese cryptocurrency, backed by The Peoples’ Bank of China, and likely to replace much of the existing digital on-line payment systems of WeChat (Tencent) and AliPay (Alibaba), which account for RMB 2 Trillion (US$300 Billion) in payments currently.

Reviewing 2020 investment performance so far, it is striking that China is one of the few major markets showing a gain of 11% (in Shenzhen, it is 32%), which has helped our Bamboo Asia Fund, LP to an estimated 20% gain year-to-date. (For clarification, this is the fund managed by Robert Lloyd George and Lloyd George Management (HK) Limited; Management of Quaero Capital Funds (Lux) – Bamboo has been moved back, last month, to Quaero Capital LLP to manage.) Only the NASDAQ, with a 26% rise, powered by Apple, Microsoft, Facebook, Google, and Tesla, has outperformed. Both South Korea (+6%) and Taiwan (+5.4%) show positive trends, whereas South East Asia (Singapore -21%, Thailand -16%, Indonesia -16%) has lagged behind badly. To some extent, these numbers reflect the economic realities – that the ASEAN economies are still in lockdown, deprived of tourist income and business investment – but it is also true to say that China, South Korea, and Taiwan, as well as NASDAQ, reflect the weight of technology in their indices. It is hard to overemphasize the rapid acceleration of technological trends such as online purchases (and now cryptocurrency payment systems).

The commodity group has also seen some wide disparities. While oil has seen a 30% fall, due to wide cutbacks in commercial aviation, shipping and transport, gold is up 28% and silver an astonishing 50%. We would also highlight the recent strength of lumber (+100% this year), and, particularly, iron ore (+45%), whereas copper and aluminum are relatively flat. The economic prospects for 2021 are still very uncertain. And we do not believe it is helpful to make forecasts for the Asian economies since so much now depends on the course of the virus – will it continue for another 6 months, one year, or longer? Will we have a successful vaccine by the beginning of 2021? Who will prevail in the presidential election of November 3rd? Our hope is for a calming down of US/China trade tensions next year, and a return to normalcy after an unusual and feverish year in 2020.

One of the key messages we are getting out of China these days is “KEEP IT AT HOME” – the tourist dollars ($70 billion last year), the students studying in the US, UK, and Australia, and the manufacturing (especially technology). Xi Jin Ping calls this “Dual Circulation,” (it is not clear why); but it means China, in the next 3 years, becomes much more self-sufficient, and turns inward instead of looking out to the world. It also means a stronger RMB, (China’s money supply has grown much less than Europe or US in 2020), and perhaps a shift to a more convertible, global reserve currency.

Hong Kong

1 September 2020

The US Dollar Weakens

At the beginning of the virus pandemic, in March, we commented on “The Virtual World” in terms of on-line work, on-line study, even on-line dating. The last 5 months of the virus lockdown have (like a war) accelerated both economic and social trends. This is clearly mirrored in the outperformance of the “FANGS” (plus Tesla) in the US market, and of the “BATS” (Baidu, Alibaba, Tencent, plus others in healthcare) in the Chinese market.

There will be a lot of “creative destruction” in old line businesses – for instance the lamentable bankruptcy of Brooks Brothers in the retail space. In fact, physical retail has shrunk dramatically everywhere. Marks and Spencer, among other UK retail chains, has laid off 30% of their staff. In Hong Kong, demand for office space has sharply contracted.

So what does this mean for employment? Nearly 30 million Americans were made unemployed in March and April. Now it is estimated that 17 million are still unemployed (as at July 31st), especially workers in hotels and restaurants, airlines, etc., still on furlough; but many more around the world will lose their jobs. They will have to re-train, with new skills, in an on-line world.

What of the millions of students coming out of college in these next few years? The job opportunities have dramatically diminished. Robots will also increasingly perform the manufacturing work previously executed in Asia. The demand for labour contracts, but salaries should increase. The share of capital and labour in corporate profits will shift in favour of the employees.

It is especially the case in the 18 to 34-year-old bracket that layoffs have been very severe. This will affect consumer and investor behaviour for some time to come. Savings rates are climbing again.

What does all this mean for investors? The US dollar is weakening for several reasons: a growing perception that Trump will lose to Biden on November 4th, that the US has handled the virus badly, and that the government finances and deficit have rapidly weakened. The Euro is heading for 1.20 – there is a strong momentum for commodities. Gold has made a new all-time-high at $1930 an ounce, and silver is up 80% this year.

Gold’s new all-time high has a symbolic importance in that it reflects falling confidence in the US dollar and, hence all “fiat” currencies. It is calculated that, based on the expansion of the Fed’s balance sheet to $7 Trillion plus, gold is likely to exceed $5,000/ounce over the next 3 years.

China/US relations are getting worse, but they still need each other. It is actually quite difficult to transfer manufacturing currently done in China, “back home” – though Japan is paying their companies to do just that. We estimate that 80% of US and European companies will remain committed to China.

The Hong Kong situation also deserves some commentary. Whatever our view of political liberalism and human rights, the facts on the ground are these. The majority of Hong Kong people want to get back to work, and China is the source of much employment, through tourism and investment. With a small “second wave” appearing, the Hong Kong economy is still struggling to recover, with the border closed and strict quarantine in place.

The Hong Kong Exchange shares are, however, doing very well, with this week’s announcement of Ant Financial, the Alibaba payments subsidiary, coming to market: and an estimated $1 Trillion in market capitalization is available from Chinese companies relisting their shares in Hong Kong, from New York.

In Southeast Asia, the situation is like Hong Kong. Everyone’s waiting for China. And, unfortunately, until there is a successful vaccine (Oxford University promises in October), nobody is yet willing to travel. Our bet on a swift recovery in Singapore has not yet worked out. Large domestic economies, like Indonesia, are doing better.

India, despite a growing number of virus cases, has had a good month in the market. The $16 Bn. investment in Reliance JIO, by Facebook, Google, Silver Lake, and others, is powerful evidence that it is India, not China, which could be the Emerging Market of the Next Decade, with on-line services in the spotlight. The World Bank estimates online sales, as a percentage of total retail sales, were only 2% in India, versus over 40% for China, and around 14% globally.

Is China really growing at 3%? That is a leading question. With GNP estimates for 2020 coming in from the USA (-9.5% in 2Q), Europe (-10%), and Singapore (-10% in 2Q), it is hard to see how China’s economy (without a major fiscal stimulus), can grow rapidly with much foreign trade and investment. We focus on freight, electricity consumption and retail sales, which have not recovered strongly since the re-opening. There are also small “second wave” outbreaks of the virus in Xinjiang and Dalian. Thus, we have also focused on the healthcare and technology sectors, which continue to do well. TSMC was up 10% in a day, on an anticipated shortage of integrated circuits.

The disconnect between the real economy and the capital markets continues to surprise observers. But the estimated $10 Trillion of liquidity added in the past 3 months by Central Banks to the global financial system, and the growing spread of zero real interest rates, means that we continue to be positive on investing in Asia.

Hong Kong

3 August 2020

Will Inflation Return? And, The Second Wave

At present, in the midst of the Covid Pandemic, nobody expects rising prices despite the enormous stimulus programs and Central Bank money printing in the US, Europe, Japan, and China.  Yet we see pent-up demand, after the 3-month lockdown in retail sales, in auto sales and in housing sales.  Money is freely available at a very low cost.

As Walter Bagehot famously remarked in 1860, “John Bull can stand a great deal, but he cannot stand a 2 percent interest rate,” meaning that, when rates reached what was then a rock-bottom level for the UK, undue speculation revived in Turkish loans, Egyptian bonds, and other developing nations offering yields of 10% because of their poor quality credit history.

Today, speculation is reviving among day traders (the recent case of the bankrupt Hertz is one instance).  In Hong Kong, plenty of zombie companies are traded at ridiculous share prices.  Property, commodities, bitcoin, and unproven medical remedies for the virus, have all been punted.  As we highlighted last month, the divergent realities of the economy and the stock market have been striking.  Since the end of March, government money-printing is the main stimulus behind the market’s exuberance (though to be fair, the unexpected revival in employment and retail spending has somewhat vindicated the optimism of investors).

Russell Napier argues that the government guarantee, in Europe and the US, for bank loans will provide a trigger to finance consumption, and will produce 4% inflation by next year, though this is not yet implied by option or bond prices.  Chris Wood (“Greed and Fear”) also expects that the Fed’s move to buy more junk bonds, and to do “yield curve control” may raise the potential for inflation readings to surprise on the upside.  The Bank of England has implicitly underwritten the British government’s spending plans, undermining the Central Bank’s role to “lend, not spend.”  USM1 and M2 have risen 33.5% and 23.1% year-on-year, the fastest growth since data begun 60 years ago.

As for the second wave now occurring in Florida, Texas, Germany, and even Beijing (only about 300 new cases), there is an implicit commitment in the US and Europe not to shut down the economy again.  We will, therefore, see numbers climbing again (now it is nearly 11 million infections worldwide and over half a million deaths); but, hopefully, the global economy will gradually revive and get back to its previous growth trajectory by the 4th quarter.

China was the “First In, First Out” major economy, and signs of a strong recovery in retail, auto, and housing sales are emerging.  In particular, e-commerce is booming with the leaders, (Alibaba, JD.com, Suning, VIP shop), seeing sales grow between 20% and 50%.  China’s GDP will be in positive territory (+2% this year) after a sharp dip in the January-April quarter, though trade numbers may continue to be weak. 

We want to focus on 2 important economies — India, our favourite emerging market, and Vietnam, the top-performing frontier market.  It is worth emphasizing that Frontier Markets total AUM has shrunk in the 6 years since 2014 from $50 bn to $5 bn.  Emerging Markets have seen a $40 bn outflow this year alone.  So the asset class is completely out of favour after nearly 10 years of underperformance.

Total Return Comparison S&P 500 Index vs. MSCI Global Emerging Market Index

Source: Bloomberg

But India (which has seen a $3bn inflow in the last month) has the best fundamentals compared to China, Brazil, Russia, Indonesia, and South Africa.  It is a large domestic consumer economy, with a young population of approximately 1.35 bn.  It has a democratic and pro-capitalist government under Mr. Modi, dedicated to streamlining bureaucracy and cleaning up corruption.  It has a closer relationship today with the US and Europe, and Foreign Direct Investment is growing rapidly, doubling from USD 35bn in 2011 to USD 73bn in 2020.  Investment was strong in manufacturing, communication and financial services – the top three industry recipients.  Notable megadeals included the acquisition of Flipkart, by Walmart (United States) and more recently an investment of USD 5.7bn from Facebook into Reliance Jio platforms.  The Rupee is stable, and the fiscal and trade deficit are reasonably under control.  The Pharmaceutical industry (23 listed companies) is making rapid progress and partnering with US and European industry leaders, as many essential products will be “reshored” from China.  We see considerable potential in the growth of the e-commerce market in India, which is still only 3% of total sales (40% in China).  Reliance JIO is the leader in this sector.  The Indian financial sector continues to lead the market (30% of market cap) led by industry leaders such as HDFC and Kotak Mahindra.  Finally, our core conviction remains that the Indian consumer will boost spending as incomes grow – Hindustan Unilever, Nestle, Britannia, being among our core conviction positions.

Vietnam, meanwhile, has come out of the virus better than any other ASEAN nation — only 300 cases.  The economy will grow 5% in 2020 – almost the best in the world.  Foreign multinationals – Samsung, Apple, Nintendo, and Google – are all moving manufacturing to Vietnam.  Factory construction is booming.  A very young population of 100 million has a thirst for education, for self-improvement, for better opportunities.  The government is pro-business, and is fast tracking $10 bn worth of infrastructure investment including a North South Highway, 2 metro lines, and a new Ho Chi Min City (Saigon) airport.

Thailand is also coming out strongly from the virus, despite the sharp fall in tourism.  Medical tourism will benefit as evidence of the high quality of their hospitals is underlined.  Most of South East Asia (Indonesia, Philippines, Malaysia, Singapore, and Vietnam) also depends on tourism, which accounts for 10% of Global GDP, and millions of service sector jobs.  So this will depend on when tourists from Europe and China overcome their fears of infection to venture overseas again.

Meanwhile, the US dollar is showing definite signs of peaking, as the prospect of a Trump defeat in November, a second wave in the south, and a weakening geopolitical position, impact investor sentiment.  This could eventually result in 2 or 3 years in a more severe currency crisis – and a surge in the gold price – in the aftermath of the pandemic.

Meanwhile, our advice to investors is to focus on Asia, the best region in the world for economic growth and political stability, which will outpace all other regions of Emerging Markets in the coming recovery.

Hong Kong

6 July 2020