The global economy is growing but that growth is very uneven. It is the story of east versus west, developed markets versus developing markets.
Asia’s growing importance in the world of global investment was aptly demonstrated last month, with over 30 of BlackRock’s leading investment managers convening in Hong Kong to discuss opportunities in the region. China was the center of attention, with participants believing uneven global growth and the country’s commitment to sustainable economic growth will favor Chinese markets.
According to Dennis Stattman, CFA, Managing Director & Senior Portfolio Manager, BlackRock Global Funds – Global Allocation Fund, today’s global economy is skewed towards Asia.
“The way we see the world today is that the global economy is growing but that growth is very uneven. It’s the story of east versus west, developed markets versus the developing markets,” he said. Stattman said developed markets will continue to struggle, partly due to an accumulation of financial constraints. He pointed out the fundamental difference between, for example, US consumers and Chinese consumers. Chinese wages are growing strongly in real terms because Chinese labor is very competitive. US wages, on the other hand, are weak; US labor is uncompetitive. In addition, US consumers have borrowed heavily, while Chinese consumers have been savers.
“This combination of strong fundamentals from China, weak fundamentals of US labor and a great deal of financial flexibility to spin on the part of Chinese consumer … and little to no flexibility on the part of the US consumer, provides long-term foundation for change and in fact underlies much of our multi-year view to the markets,” he said.
According to Rick Rieder, Managing Director and Chief Investment Officer, BlackRock Fundamental Fixed Income, growth over the next couple of years must be structurally slower than it has been in recent history,despite better economic data coming from Europe recently. “We believe that growth over the medium- to longer-term has to be influenced by austerity, continued deleveraging influences.”
Rieder pointed to job data from the US. “Prior to the current employment contraction, the modern US economy produced, on average, 140,000 jobs per month and 300,000 to 500,000 jobs in expansionary periods. August’s figure – 67,000+ jobs – appears anemic in comparison. In fact, the breakeven unemployment number is probably closer to 150,000 per month,” he said.
“Temporary labor is growing and we think that it’s a substitution for full-time hires. Companies are hiring people on a parttime basis because the cost of full-times, such as pension and healthcare costs, is so expensive these days. Breaking down the figures we see net full- time job loss but part-time hire uptake has grown. This is a strategic change, where real personal consumption and real personal income excluding current transfer receipts show no impetus for growth. ”
From a fixed income perspective, this generates a paradox. “Leverage has been falling, borrowing is falling, and there is simply not enough debt in the system for investors to buy because of this dynamic,” said Rieder.
“The developments of Asia’s fixed income, credit assets are very different than what’s happening in the US. The first is, which is no secret, that the growth around the world is slowing, but when you look at Asia versus the rest of the world, the growth is still dramatically higher than the rest of the world.”
Furthermore, Asia has gone through ten years of deleveraging alongside its growth to the point today deposit ratios and leverage are much lower than they are in the US and Europe.
This points to a very exciting fixed-income market in Asia, with plenty of potential or growth. According to Rieder, the US$ 4.6 trillion market in Asia could increase by two or three times by 2015.
“What makes it such an attractive fixed-income environment and credit investing environment is you’re going to get more products across Asian regions,” said Rieder. “We’re seeing inflows into funds to invest in Asia. It’s growing precipitously. People want to invest here; it is still an attractive environment.”
From an equity perspective, the attractive debt situation in Asia offers another advantage – policy flexibility.
According to Stattman, the US federal government has very little annual financial flexibility with part of this caused by what he calls a “tidal wave of entitlements expenditure”.
“Government spending may come down between now and 2015, if the economy recovers, but as that reciprocal decrease in government spending occurs, it will be replaced by a secular increase as social security,” he said. “There is no government program whatsoever to try and constrain this portion of spending. We believe that this is going to be tangible because the US does not have the financial capability so there’s going to be a great deal of pressure on the federal government eventually to cut back on its support for the consumer.”
Meanwhile, in other countries, particularly Asia, governments will have significant flexibility due to their strong reserves. “The US actually is number six in the world in terms of financial reserves, only US$ 372 billion in foreign currency and gold, and this is less than one seventh where China is. Again, on the issue of financial inflexibility, we think it is quite clear. It allows much faster growth in Asia and developing countries compared to what we will see in the US.”
As Stattman pointed out, monetary policies across the world are far different. The US, Europe and Japan feature very accommodative monetary policies that deal with the weaknesses Stattman already outlined above. “But in the more rapidly growing parts of the world, we have the opposite sorts of policies, policies that increasingly will have to deal with the risk of inflation,” he said.
“Inflation comes from higher labor costs and higher resource prices. Having said all of that, markets reacts and prices change. If I were spoken to you half a dozen years ago, many of the strengths that we see in a developing economy were not priced-in to the stock markets but increasingly they are.”
With bargains to be found in the US, Stattman has ramped up equity participation in that market. “We can find a very large number of high-quality global US companies that trade for 8, 9, 10, 11, 12 times growth earnings. We think these represent excellent long-term entry points – now, that doesn’ttell you whether it will go up or down in thenext calendar quarter or two, but we areconvinced this is a good entry point for anumber of global companies.”
As a result, Stattman’s portfolio is slightly overweight equity market; and underweight sovereign bonds which are not paying their holders against the long term risks of inflation or volatility.
“Not long ago, we had two days in which the US 30-year bond lost. In those two days, more than a year’s worth of income in price, so we believe that the better value for investors today lies in the equity markets,” he said.
“So our basic message is that, as you look around the world that you differentiate economic outlooks and market prices– and increasingly, market prices are compensating you for taking every risk and being involv
Jeff Shen, Managing Director, Head of Asian and Emerging Market Equity within BlackRock’s Scientific Equity Portfolio Management Group, brought the discussion back to Asia, speaking of some of the challenges and opportunities surrounding China’s economic growth in the near term. “China is historically driven most by export, second by fixed asset investment, and I think that both, going forward, are going to be quite difficult,” said Shen.
“China is going to be increasingly more inward focused than outward focused,” he said. “I had a conversation with government officials in Beijing… China is essentially thinking its global responsibility is to take care of their population. So they are inward looking, looking after 1.3 billion people in China as part of their effort for global responsibility. The profile would be very inward focused and as we look at China in a very inward looking view. Now it’s about balance and making sure that the overall economy of China can achieve a sustainable growth.”
According to Shen, China’s long-term strategy is shifting its whole focus westwards.
“In the context of balance, the government is gliding the whole focus gradually into central and western parts of China. I don’t think that is a short-term fix, I think it will be long-term strategy as China is gradually growing into its profile away from a concentration from the coast, into inward provinces in the country. I think there are great amount of opportunities, potential and that’s going to change the growth picture of China moving forward,” he said.
Within China’s increasingly domestic-focused economy, Shen sees great opportunities in energy.
“We’re looking at a very clear beautiful day in Hong Kong and those types of days are harder to come by in Shanghai and Beijing,” he said. “So I think energy and the nature of energy will certainly become a very important component of how we can deliver sustainable growth in China.”
According to Shen, the problem of sustainable growth will be solved by alternative energy, something particularly suited to China’s unique situation. “If you think about the nature of the alternative energy investment, this is a large-scale problem: this is a problem that cannot be solved in a very ad-hoc fashion. You need government support, you need tremendous amounts of credit, and you need a huge amount of commitment and long-term pricing. These points are almost tailormade for the Chinese government, [based on its experience] in looking through the infrastructure and investment,” he said.
But while China’s focus may remain inward, Shen sees great opportunities for exports of its alternative energy expertise. “China’s going to be at full throttle of developing alternative energy and that’s going to have global implications on how we look at energy going forward,” he said. “So again, coming back to this, the nature of growth will be very inward looking, but at the same time, exports are still a very important component.”
China’s influence in developing markets in Asia and beyond is also a major driver and theme for investors. In particular, China’s thirst for commodities is driving trade forward.”
“It’s pretty clear the commodity producing countries, Brazil, South Africa, Russia, Australia, Canada, are all very important for the linkage with China. I do think that the economic linkage is going to be strong and the economic linkage is going to continue to be there and China is going to use the trade component to look at potentially the internationalization of our needs,” said Shen.
One idea is that Hong Kong would become the center for China’s offshore RMB market. “So there’s actually potential of Hong Kong becoming a London-equivalent offshore euro dollar market. So clearly, it will be an important strategy for China as it taps outside the mass market and international and regional markets,” he said. BM