I wanted to jot down a few thoughts regarding my appearance this Monday with Real Vision TV on the outlook for Asia for 2018. Broadly, I think there are going to be four factors that will drive the region.
1) Can long term USD funding remain stable? If so, the risk premia for all assets, especially emerging market assets, will continue to fall. Putting it simply, in a world that has no yield (only $1.8tn of investment grade securities that yield over 4%) and a lack of volatility in long duration sovereign assets, especially in the US, the demand for all yielding assets will remain incredibly robust. This will be determined more by the inflation outlook, than by Fed policy, as the flattening of the US curve has indicated. While there is a sizable swing in the supply demand dynamics for quality fixed income with Fed selling, wider US deficits and the likelihood that the ECB will wind back its pace of purchases, the global demand for yield will continue and emerging markets will remain the primary beneficiary of this. This is especially the case for those countries with positive real yields such as India, Brazil, Indonesia and Russia.
2) Chinese Financial Stability will not threaten the region and will only add to the re-rating pressure for Asian assets. Please refer back to my report on China, several weeks ago “Lesson 2 for 2018, The drivers of a 20% correction remain higher rates and China”. In it, I drive home the point that for all the rhetoric, President Xi Jinping isn’t a reformer and as such, will be determined to maintain growth rates at current levels to achieve goals such as doubling GDP this decade. The consequence of this is that fears of deleveraging and a clamp down on credit are overblown and I would encourage you all to listen to my discussion on Chinese P2P lending with Martin Chorzempa of the Peterson Institute .
3) A deterioration in US / China trade relations remains an almost binary event. For all the rhetoric, we have really seen nothing and until we see something dramatic, outside of the small scale responses via quirky and rarely used rules, then asset markets will be interested and nothing more. My recent discussion with Chad Bown from the Peterson Institute was a real eye opener. The key question is how far is the US prepared to push China when North Korea is the elephant in the room and they need Beijing to help diffuse the situation or even bring them to the negotiating table? Politically, in the Administration it comes down to who is the President most likely to seek advice from? Is it the National Security Council (NSC) or is it the trade people? Thus far, it seems to be the NSC that has had more influence on him on trade issues. However, that could change if the domestic political landscape shifts and they need to be seen as accomplishing something.
So far, President Trump has done absolutely nothing on trade and with the exception of taxes, very little else. If his supporter base gets frustrated with the progress, or lack thereof, the Administration may turn to trade because that is an area where he can respond. His closest trade advisors, including Ambassador Lighthizer are very focused and concerned about the China problem and the existential threat of that country to America’s economic system. They view China as undermining the WTO and the global trade system, however, their approach has not been to gather support from the global community or multi-lateral institutions, but rather, to go at it alone. As an aside, there is a meeting of the OECD this week on steel overcapacity. This could be viewed as a progress regarding China’s overcapacity problem, so we will see if the US contributes in a meaningful way. Ultimately, the real concern is that if the President gets frustrated going into the political season next year, and if trade policy hawks get their way, there could be an escalation of US anti-trade rhetoric and action.
4) I alluded to this via the discussion on trade, but North Korea remains the overwhelming threat to the region for 2018. It is un-hedgable because the timing of any escalation is unknowable. If you are concerned, keep your leverage low, but if conflict can be avoided, Asia’s re-rating will continue.
These are the main thematic considerations for investing in Asia equity and credit markets in 2018. A level of calm, and risk premia will continue to fall leading to 20% gains across emerging Asia. China should lead the way, especially the banks. Japan will lag but the corporate reform story remains very compelling.
Founder, View from the Peak
IND-X Advisors Limited