In recent weeks, China has made a number of unusual policy announcements. They have banned all of the 88 million members of the Communist Party from playing golf! They have also announced for the first time since 1979 an easing of the one child policy which has had such a profound effect on Chinese society over the last generation. Finally and perhaps most significantly they have ended the financial repression by starting to free up interest rates, both deposit and lending, in the banking system. The long period of artificially low real interest rates in China has led to massive misallocation of capital, and this is surely a positive change.
Since this summer, the world has been watching every day to see what China does next, especially the American press. Now the US anxiety seems to have moved on from the possibility of an economic crash or a large devaluation by China, to the military risks associated with China’s building artificial islands on coral reefs in the South China Sea. Actually we believe that the risks are not too high and that China and her neighbours will be careful to avoid conflict.
President Xi Jinping, who is the strongest leader since Deng Xiaoping, clearly intends to make China a great power, and does not want to have a collision with the United States. We do not believe that China’s rise is necessarily to the detriment of the United States and the mutual sabre rattling with China’s neighbours is as much an economic tool as a matter of national ego. He has recently made a State visit to Britain, where he had dinner with the Queen; to Vietnam, in order to improve relations with China’s important neighbour, and finally to Singapore where he met Ma Ying-jeou, the Taiwanese President, the first time that the Communist and Nationalist leaders have had a formal meeting since Chiang Kai-shek met Mao Zedong in 1945.
The indications are that Xi Jinping and all the Senior Chinese leadership want to have peaceful relations with all their Asian neighbours. The Anti-corruption policy, now in its 4th year, has been remarkably determined and successful, although there is obviously some risk from the opposition groups (and vested interests): for private sector businesses however, it is a welcome improvement.
America’s so called ‘Pivot to Asia’ has so far had little impact on the region except for the Trans Pacific Partnership, which could potentially redirect US$100 billion of trade away from China (which is not part of TPP), to Vietnam and other countries. The likelihood, however, is that South Korea, Indonesia and eventually China would all join the TPP, and that like the WTO a decade ago, it will encourage China to restructure economically. (Most commentators agree that the US Congress will pass the deal).
Everyone is waiting to see in the next two weeks whether the IMF will announce the accession of the Renminbi to the SDR (special drawing rights) as one of the five global reserve currencies. Although this does not in itself have great financial consequences, it is a very important symbolic move, which will also make China’s capital account more open and its capital markets more accessible. Hong Kong should be a major beneficiary. The real question is whether the Renminbi will subsequently devalue, as it becomes more easily tradable. We have taken the view that this is not likely or desirable for Beijing, although over time, with a large capital outflow from China, the currency may have to become more competitive. Yesterday China entered a bull market, up 20% since Aug 26 and the mood is very positive. The USA has almost US$20 trillion of national debt and China may own up to 10% of that debt along with other major creditors such as Japan and the OPEC nations.
Now it appears that Europe is following Japan into the deflationary ‘ice age’ as no less than twelve European countries now have negative interest rates, and that, like Japan, they have very low growth and frequently declining populations. This seems to be an unsustainable situation, but most experts have been wrong footed by the continuation of low rates, and even if the Federal Reserve raises its rates by 25 basis points by December, we are not expecting a sudden increase of inflation or a return to 4% to 5% bond yields.
We do however, believe that investors will pay a premium for high growth in countries such as China, India and South East Asia where there is real GDP growth of more than 6% and real rates remain high. If, as some economists opine, we are in the final stage of the ‘Kondratieff Winter’ with commodities falling to generational lows and deflation affecting more and more areas of the economy in the west, then Asia will surely be the winner from this global slowdown as it was in the 2008/2009 financial crisis. Asian countries have little or no debt or welfare spending. They have financial strength and competitiveness in manufacturing and increasingly in services. Meanwhile, consumers are starting to assert themselves. McKinsey says that Chinese healthcare spending will increase from US$357 billion in 2011 to US$1 trillion in 2020. We have been studying this theme and along with domestic healthcare sector beneficiaries, we are closely following regional businesses such as Raffles Medical, Kao and the Thai hospitals.
We remain confident about our positions in companies such as IMAX China and in Asian wealth management businesses such as Noah and Value Partners. This month, we added Techtronic to our portfolio. They are a growing power-tool manufacturer based in Hong Kong with focus on brands and quality.
The Bamboo Fund is up 11.2% since Sept 30 and is now 98% invested including recently added names such as Alibaba, Baidu, Ctrip, Naver (Korea), Nanosonics (Australia) and MakeMyTrip (India). We now have about 25% invested in “Tactical” small cap high growth Asian names to produce alpha, balanced by over 70% in safe, dividend-paying consumer staples, financials, and telecoms.
Despite IMF and OECD forecasts of slower global growth in 2016, and the near certainty now of US interest rates rising, we remain confident that investors in Asia, after a bumpy ride in 2015, will enjoy a rising wave in 2016. Earnings reports remain robust, the Asian consumer is confident (as today’s “Singles Day” in China attests) and markets are reasonably valued.
Robert Lloyd George
11 November, 2015