Chinese assets are reaching an inflection point (part 1)
(This is the first part of our Sunday blotter. We will publish the final part tomorrow)
I often make the distinction between the owners and renters of assets. Owners are, as you can deduce, investors in assets for the long haul. Multi-year time frames. They acquire fixed income securities and hold them to maturity. Equities are not liquidated because of the whims of a quarterly earnings report. They are not distracted by the gyrations of daily, weekly or even monthly volatility, price swings that are just inherent to financial markets. If prices fall, they tend to add to exposures because their investment horizon covers years, not the blink of an eye. Renters on the other hand, have a much shorter investment horizon. These more speculative types acquire assets for rather scant periods, effectively renting the returns on these financial instruments in order to generate profit. They tend to liquidate into weakness as it is often viewed as the discrediting of a short-term thesis. Momentum is often an important precondition and when it reverses, they cut their losses and move onto the next idea. In the emerging world, the last few weeks have been a good time for renters and a period of reflection for owners.
Speculators have ruled the day. The prevailing narrative has been one of USD strength, higher US interest rates and the dire consequences that this will have for emerging market economies and financial assets. Comparisons are being made between Turkey’s woes and Thailand’s financial crisis of 1997 that spread across Asia and led to the eventual Russian default and blow up of Long Term Capital Management, which in turn was the true catalyst for the Federal Reserve slashing rates in September 1998. Price action and heightened volatility across emerging markets have vindicated this negativity and contagion seekers scour the globe for the next Turkey. Any country with a current account deficit, dysfunctional government, out of control fiscal position and political instability are being challenged by asset renters looking for the next selling opportunity. While the United States exhibits all these traits, US bonds and stocks remain the ultimate safe haven during these times of stress.
The View from the Peak thematic model portfolio is part owner of assets, part renter. We have to engage with clients with multiple time frames, from speculators to the holders of assets with a multi-year horizon. This is why we look at the world simultaneously through the prism of tactical (0-6 month time frame) and structural (6 months and beyond). It is always important to make the distinction between these, because defining one’s time frame is vital when determining a thesis. Renters of assets believe that my thesis that emerging market assets are currently providing a multi-year buying opportunity is moronic, because it is incredibly difficult to get a speculator to buy weakness when momentum against emerging market assets, both outright and relative to the developed world, is so strong. That said, in a world where there remains a shortage of longer term, high quality yields, close to 8% returns on 5-year notes in India and Indonesia are starting to look attractive to investors prepared to own assets through noise.
The bearish narrative for emerging markets, is partly based on fact, partly based on misconceptions and partly based on fearmongering. The outlook for the emerging world is nowhere near as bad as the perma-bears would have you believe, but it would be naïve to think that a) that there isn’t a strong degree of truth in their message about declining global liquidity, and b) that price action isn’t telling you something nasty is going on. Turkey clearly has problems and will head to both the IMF and an ugly recession at some stage in the next few quarters, but the contagion effects to other markets is the fundamental issue that is still well and truly up for debate. I continue to believe that the institutions that oversee many of the world’s emerging economies remain in solid shape and that the vulnerabilities that saw en masse EM contagion in 1997-98 are simply not that severe. More importantly, global liquidity remains ample, oil prices are healthy, and long-term bond yields have not risen significantly. Yes, spreads have widened as the funding costs for emerging market sovereigns and the underperformance of EM equities, especially in China, are portraying a negative message, but does it truly reflect the facts on the ground? I say it doesn’t.
It’s a quiet week for data. The annual Jackson Hole Symposium will be watched closely, especially Chairman Powell’s speech on Friday. Despite my view that EM selling is overdone, those of you expecting the Fed to announce a pause in tightening due to market volatility will be disappointed. The RBA releases minutes on Tuesday. On Wednesday Japanese Industry Activity and the Fed releases their minutes. On Thursday, Japanese, German, EU, and US Manufacturing PMIs, Singaporean CPI, and US Home Sales. Friday, Singaporean Industrial Activity and US Durable Goods Orders.