Far East & Emerging Markets

30 Oct 2019

It would be difficult to begin any coverage of this area of the world without mentioning the phrase “tariff war”.  All eyes have been on the rhetoric used by President Trump, the type and scale of response from the authorities in Beijing and the movement of the Chinese exchange rate.

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Starting with the latter, some weakness in the renminbi is a perfectly rational market response to trade frictions and the breaching of the 7.0 level versus the US dollar prompted a furious reaction in Washington labelling China a currency manipulator.  The Central Bank in Beijing has however for several years endeavoured to manage its exchange rate around a trade-weighted index value, which can differ markedly from the rate against the dollar.
 
Since China moved away from the formal dollar peg in 2015, the greenback has been one of the world’s strongest currencies, so some weakening against it is quite understandable.  In an ironic way, Mr Powell’s actions at the Fed in lifting US rates throughout 2017 and 2018 triggered much of that dollar strength so his recent change of path will be coming to Beijing’s assistance.
 
China’s economy continues to cool, with August’s industrial production rising by a mere 4.4% annualised, well below economists’ forecasts, and representing the weakest yearly growth for more than 15yrs.  Retail sales grew at 7.5% in August, more closely in line with expectations, but still the second slowest annual rate since the financial crisis.  The response by the authorities to this recent cooling has been to make a number of reductions to the Reserve Requirement Ratio but they are also mindful of the problems in the shadow banking system from earlier years, hence their stimulus being regarded as tepid in some quarters.
Clearly China will be well aware of the timing of US elections and may conclude that time is on their side from the perspective of seeing “who blinks first” in their desire to reach an accord.
Some encouragement amongst the gloom is offered by the chart above, which illustrates that money supply in Europe has resumed its uptrend after the dip in Q2 and has now surpassed the peak of spring 2018.  Should international tensions dissipate and domestic demand continue to be solid, then the current bleak path for PMIs could reverse. 
 
In that regard European equities, rather like the UK but for entirely different reasons, have been neglected by global investors and look cheaply rated.  Though analysts have reduced profit forecasts for Continental equities as the months have passed since the spring, their expectation is still for 4% growth in calendar 2019 and 8% next year.  The dividend yield of c3.5% is very appealing compared with the potential returns from bonds.  In the latest quarter, shares recorded very modest gains, with Italy and France in the vanguard.
Chinese stimulus as % of China's nominal GDP
Chinese stimulus as % of China's nominal GDP

Source: Stifel September 2019

The chart above indicates a distinct seasonal pattern to the injections of stimulus by the Chinese authorities and suggests they might be in no hurry to accelerate support for the economy in the remaining part of this year.  Uncertainty about the likely course (and timing) of action is magnified by the current political disturbances in Hong Kong and by the on/off conversations between Beijing and Washington (which are expected to resume in October). 
 
Clearly China will be well aware of the timing of US elections and may conclude that time is on their side from the perspective of seeing “who blinks first” in their desire to reach an accord.   Nevertheless recent official comments do indicate that more policy stimulus is coming.
 
India surprised markets during the quarter by cutting its effective corporation tax rate from 35% to around 25%.  This measure has come on top of cuts by the Central Bank in domestic interest rates, justified by both lower inflation (the annual rate of core CPI is almost 2% lower than it was a year ago) and by the weakening sense of momentum within the economy. 
 
For most of the past five years, Indian GDP has grown consistently in a range of 6% to 9%, but the recent announcement that growth in the second quarter sank to a low of 5%, missing consensus forecasts of 5.7% by a very wide margin.  While cuts in the cost of money will be welcome, the speed of response in the economy to such stimulus is not rapid, as we highlighted earlier in this Review.  Capital spending is both a long term necessity for the unlocking of the country’s potential but also more likely to be implemented in the short term because of the tax reduction.
 
Overall emerging market equities struggled against the twin headwinds of trade uncertainties and slowing global growth momentum and the resilience of the dollar made it additionally difficult for investors to forsake that currency exposure for higher risk ones.  Investor confidence was also not aided by the events in Argentina, where the dollar equivalent of its stock market index dropped 48% during the quarter, though that country forms but a small part of the global emerging index benchmark.  

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