Positioning Portfolios For Political Shifts And A Changing China

|
Includes: CHN, CN, CNY, CXSE, CYB, FCA, FXCH, FXI, FXP, GCH, GXC, JFC, MCHI, PGJ, TDF, XPP, YANG, YAO, YINN, YXI
by: Neil Dwane

Summary

Reasons for optimism: Post-Trump reflation, rising yields and a higher oil price. Causes for concern: Dull global growth, rising debt, political risks and NIRP.

China is on the path to becoming its own asset class, disruption is more than a tech trend, and populism and protectionism are powering the new politics.

We continue to urge our clients to take risk to earn returns. Much-needed yield potential can be found in US and Asia high-yields, EM debt and European equities.

Originally published January 23, 2017

Our first Investment Forum of 2017 was held in the vibrant city of Hong Kong - a fitting location for an event with China as the lead agenda topic. Politics and disruption were the other big topics of the day, and all three themes converged in our recurring discussions about Donald Trump's ability to disrupt the political status quo - particularly US-China relations.

The state of the global economy

Although global economic growth has remained somewhat dull, it accelerated slightly in the second half of 2016 - and the markets responded. Reflation hopes soared after Trump's victory, despite uncertainty about his priorities. If Trump successfully lowers taxes, reduces regulations and increases infrastructure spending, the US should be able to extend its late-cycle growth.

Globally, rising bond yields and a higher oil price are also cause for optimism. Of course, there are also legitimate reasons to be cautious. As the memory of the Great Financial Crisis recedes, global debt levels are rising. Moreover, euro-zone banks continue to appear risky, and we expect the central banks of both Europe and Japan to row back on their negative-interest-rate policy errors.

China: An asset class in its own right

Although not without its issues, China is making the necessary changes to succeed in the long term. Consider how China battled deflation and a commodities collapse: Their aggressive monetary-policy changes successfully restored profits, inflation and the profitability of state-owned enterprises. Moreover, China is at least confronting key structural issues by "rebalancing", and while high debt and slower growth are problematic, China acknowledges the need to reform and has the will to do so - unlike Europe. Still, Trump presents a wild card: His policies could hurt trade relations, China's "One Belt, One Road" policy and China's longer-term regional ambitions.

In the end, however, China's overall trajectory is clear: It boasts the second-largest economy in the world and has more listed companies than the US does, giving the country 18 per cent of total global equity-market capitalization. Yet China currently makes up a mere fraction of the world's leading market indices, which don't include China's onshore markets. As China's rebalancing and reforms continue, this should change. In turn, more investors will join us in considering China to be its own asset class.

Disruption is more than a tech trend

Artificial intelligence has been an enticing tech story since 2012, when machine learning, new algorithms and processor advances aligned with deep storage capacity. Although AI is in the early adoption stages, it is contributing to faster automation of previously manual work. This disruption could lead to efficiency gains, but it could also exacerbate income inequality, prompting governments and regulators to step in.

Companies that thrive off disruption could also shift the investment trend away from indexing: With the top 20 per cent of companies accounting for all of the US market's gain in 2016, actively picking stocks looks like a much more attractive proposition. For our part, our research team is adapting to this theme by implementing new "disruption ratings" on the companies we cover. We may find that future success in any industry requires embracing a new mindset: You will be disrupted, so get busy disrupting!

Populism and protectionism power new politics

As part of the changing political trend that is moving away from globalization and free trade toward populism and protectionism, European politics will take centre stage in 2017: Brexit negotiations should begin in earnest and a "super election cycle" will roll through the Netherlands, France, Germany and possibly Italy. Regardless of Brexit's ultimate shape, the European Union may be keen to help the UK make its exit before the EU's Parliamentary elections in May 2019.

Another factor pressuring the region is that many feel the EU has too many members and therefore must "shrink to grow". So while it is possible for Europe to muddle through 2017, the EU needs to build a vision and roadmap that is sustainable - and the clock is ticking. In the US, politics could play a major role in the future course of monetary policy: Trump may have an opportunity to appoint six out of seven members of the Fed's Board of Governors.

Key considerations for investors

Here are five of the more significant opportunities and risks for investors to consider:

  • As China assumes a larger role in major global indices, it should play a larger role in investors' portfolios.
  • Europe may remain mired in a depressing political cycle, and European financials appear risky.
  • Although still expensive, US equities may have room to run if Trump's fiscal stimulus and tax cuts come to pass.
  • As the "hunt for income" goes global, much-needed yield potential can be found in high-yield bonds in the US and Asia, as well as in emerging-market debt and European equities.
  • Overall, we continue to urge our clients to take risk to earn returns - a stance that has been validated time and again by the market's results.

About this article:

Expand
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here