Full episode: Market Call for Monday, May 13, 2019
Tyler Mordy, president and CIO at Forstrong Global Asset Management
Trade wars: Another China buying opportunity
What to make of renewed trade tensions? We doubt recent conflict marks a fundamental shift in the global macro environment. Donald Trump’s latest maneuver is not altogether surprising, given his proclivity for eleventh-hour pressure tactics. By now, investors should view these policy shifts as a central feature of this administration’s dynamic.
The negative impact on China would still be manageable if there’s a total breakdown in negotiations. Total sales to the U.S. only account for 3.8 per cent of Chinese GDP and China would swiftly move to support economic activity with large fiscal and monetary support. Domestic policy matters more than trade wars in China. With or without a trade resolution, policy is already set to drive the country’s cyclical recovery. Renewed trade tensions simply sustain a heightened sense of risk, ensuring loose policy.
Most importantly, Trump continues to take a wrecking ball to the U.S.-led post-war world order and America’s longstanding alliances. Slapping tariffs on their closest allies will practically chase them into China’s arms. But there is a longer and more critical strategic reorientation at play: By withdrawing as the world’s leading country, the U.S. effectively allows for the emergence and even acceleration of new powers.
Meanwhile investors will continue to panic over China, citing a history of volatility, rising debt and a clumsily managed economy. China comes with risks, but leaning on historical precedents when powerful secular changes are underway rarely serves investors well. The most important facts about China are a shift away from exports and capital spending to consumer-led growth, improving margins and financial liberalization. These developments take time.
Looking out further, the ascent of China as an independent economic center of gravity is a boon for investors. With diverging economic trajectories and monetary policies, macro trends in China are highly diversifying. Chinese assets reflect this, showing low correlation to rest-of-world stocks and bonds.
In recent years, however, there’s been limited urgency to diversify geographically, especially for those overweight U.S. assets (almost everyone). But as China’s market opens and becomes more accessible (in part facilitated by the development of China-focused ETFs), these diversification benefits become even more important. Investors should stay long the Chinese stock market. We’re only in the foothills of a long journey.
XTRACKERS HARVEST CSI 300 CHINA A-SHARES ETF (ASHR)
With China at the epicenter of U.S. trade tensions, the country’s onshore “A share” equities have been pummeled into a bear market. The question now is, with Chinese equities oversold and trading at attractive valuations, are there reasons to maintain a longer-term constructive outlook?
We think so for a number of reasons. Firstly, the Chinese government and the People’s Bank have already started loosening fiscal and monetary policy to help combat the impact of trade tariffs. The economic benefits of such stimuli tend to show up with a lag. Furthermore, the recent devaluation of the Chinese yuan will help cushion the blow and leave China’s non-US exports more competitive.
Lastly, A shares were included in MSCI’s bellwether emerging markets index last June. However, the inclusion was more of a symbolic victory than a game changing one, as A shares represented less than a 1 per cent weight in the index by August 2018. For comparison, full inclusion would represent approximately 17 per cent of the index. MSCI still wants to see progress on numerous fronts, including internationally traded index futures, a reduction in trading suspensions and increased (or removal of) trading quotas for foreign investors. Thus, MSCI’s gradual inclusion approach can be viewed favourably, as it provides a win for China’s market reform efforts, will spur new (albeit modest) inflows, continue to incentivize financial market liberalization and better regulation, and provide upside as A shares move towards full inclusion.
ISHARES MSCI SOUTH KOREA ETF (EWY)
Korean equities are dominated by technology, autos and financial stocks, which together account for more than half the market. Samsung and its subsidiaries alone represent a quarter of the market. A trifecta of earnings headwinds has coincided in recent months to batter all three market segments. All three drivers of negative absolute and relative earnings performance are cyclical in nature and the starting position is extremely depressed by historical standards. Global PMIs are stabilizing and showing tentative signs of revival, which suggest the semiconductor sales cycle will be turning around soon (assuming the stabilization is not derailed by an all-out U.S.-China trade war). Chinese auto sales are bottoming out and Korean auto makers have recently launched a range of competitive new energy vehicles in global markets. While there are no signs of a decisive rebound in auto demand, 2019 is likely to be a better year than 2018, which was abysmal. Korea has suffered significant collateral damage from these trade tensions. A truce will allow economic momentum to recover further, especially in the export sector which is so tightly integrated with logistics chains associated with Chinese manufacturers.
VANECK VECTORS VIETNAM ETF (VNM)
PAST PICKS: FEBRUARY 25, 2019
KRANESHARES CSI CHINA INTERNET ETF (KWEB)
Total return: -6%
BMO JUNIOR OIL ETF (ZJO)
Total return: -4%
HORIZONS GLOBAL MACRO OPPORTUNITIES ETF (HGM)
Total return: -3%
Total return average: -4%
Horizons Managed Global Opportunities ETF (HGM.TO)
Performance as of: April 30, 2019
1 month: 1.5% fund, 2.6% index
1 year: 0.3% fund, 9.5% index
3 years: 7.5% fund, 10.2% index
INDEX: 60% S&P Global 1200 Index, 40% ICE BofAML Global Broad Market Index.
Returns are based on reinvested dividends, net of fees and annualized