Changing world orders and investment opportunities
We all know the famous saying – “two things in life are certain, death and taxes.” I’d like to add one more, and that is volatility. While investors and advisers alike look to deploy client capital in times of market calm, the reality is that volatility is always here. As we face the next bout of volatility wherever it may come from, we must consider it within the context of the changing world order.
To start, let’s consider the last 500 years of history. There have been four major changes in the world order. This started with the Dutch empire, and no-one will forget the power of their naval supremacy during their reign.
Then came the British with their reign ending at the end of World War II overtaken by the United States.
There are a few similarities that can be drawn between each empire and the rationale of their reign. The first of these similarities is that at the height of their might; they controlled the lion’s share of global trade. Given this trade was mainly settled in the reigning empires currency, it became the reserve currency of the world. This is the ultimate characteristic of the success being atop of the world order.
Conversely, their downfalls also have shared characteristics; with the main one being a heightened level of external conflict overtime in order to protect their position in the world order leading them to ultimately spend more than they earned. In order to keep the party going, the only way to deal with this issue is ultimately to print money. Sound familiar?
Now this brings us to today’s conundrum. What most people are not aware of is over the course of the last 100 years the US has defaulted twice (yes, they ran out of money!) on their sovereign bonds. The first instance was under President Roosevelt in 1931 with the second time being in 1971 under President Nixon. So why does this story matter for the future of investing?
Because today, the US is looking down the barrel of having to stay atop the world order while managing increasing discontent within its own borders. This requires an incredible amount of money printing which over the long term will drive a greater divergence between the rich and the poor. It will also lead it to currency devaluation as other world powers push for the next changing of the guard.
While each change of the world order isn’t identical, they do rhyme.
Without a doubt, the collective power of the Asian region, spearheaded by China, has grown substantially over the last few decades. At the end of the day, the world is limited by its resources, and as the next global power’s standard of living of its populous grows, others must make way and potentially cede their standard of living.
We have long seen companies from Western economies invest significant resources into getting a piece of the ‘China Dream’ knowing that as the global tides of economic might change, so does the power of the consumer.
This is not a new story, but what has changed over the last half decade or so is very relevant for positioning investments to take advantage of the next set of tailwinds of the Chinese consumer. Traditional Western brands are now being superseded by local brands.
Strong patriotism by the Chinese people to their nation has brought about this change in consumer patterns. Partially spurred upon by President Trump’s negative sentiment towards China, and coupled with the quality of
Chinese brands, both added further fuel to this fire. Johnny Walker Black has been replaced by Moutai; Nike by Li Ning and Samsung by Huawei. This transition hasn’t happened overnight, but it has happened.
If one continues to invest in the notion of the ‘safe route’ by investing in Western stockmarkets to gain access to China, it will simply be an ever-increasingly diluted exposure to China, mixed in with the declines of traditional markets. Same can be said by investing in an emerging market (EM) strategy given that around 80% of EM is Asia, with the remaining 20% simply noise which will generate more volatility without material value added.
Going back to the risk of ‘living in excess’ or spending more than you earn, is a characteristic of the start of the downfall of an empire. We saw that with the Dutch, followed by the British and now the US. China has seen how history has played out for these countries and is now seeking a longer-term solution to de-risk its population.
Say hello to the goal of common prosperity. We have coined the term recently calling it “adjusted capitalism”. Let’s be clear here; this is not communism making a comeback, but at its base roots, improving the Gini Co-efficient (the measure of wealth distribution) to a level which will not allow the roots of populism as seen in many Western democracies fester.
There has been plenty of media commentary over the last nine months coining the actions of China’s government ‘authoritarian’ and ‘heavy handed’. But if you consider each of the policies they have enacted, no-one disagrees with their fundamental form. Here are the key ones:
Reining in the affordability pressure of property ownership in China, clearly stating that property is for living, not for speculating;
Reducing monopolistic behaviour of mega cap companies to ensure innovation can still challenge the incumbents, which leads to higher productivity and competitiveness; and
Reducing the burden on the cost of living for families who want to give their children equal opportunity in achieving their best in their education endeavours.
The only difference between Western democracies enacting policies and the Chinese central government is due to their style of government, they simply GSD (Get Stuff Done) without having to obtain everyone’s buy in. It’s the way the Chinese government has succeeded on the world stage since its opening up in the 1990s. It is what is known as the utilitarian model - achieving the greatest good for the greatest number of people.
One final piece of evidence which is suggesting a change in the world order is reflected in changing sentiments in trade settlements. At the time of writing, China and Saudi Arabia announced a potential new partnership in which China will buy Saudi oil and settle in Chinese Yuan. Currently, 80% of all oil trade is settled in US dollars, so what can we look forward to in the future as this develops further?
The key change will have to come from countries increasing their allocation of foreign reserves to Chinese Yuan. Currently as reported by the IMF, only 2.48% of reserves are held in Chinese Yuan compared to 55% in US
Dollars so there is clearly a long runway to go for global acceptance. What is the long-term implication of this?
Oil producers receiving Chinese Yuan would then in turn spend it on Chinese debt and imports which further strengthens the Chinese economy. This in turn will then pave the way for further trade to be settled in Yuan, be it base metals or other soft commodities. This in time we believe will secure the Chinese Yuan as the next major reserve currency of the world.
If we then relate all these concepts back to investing, where does one see itself as an asset allocator in the current market cycle? On a relative and absolute basis, can you allocate at an attractive price? The answer is yes if you have a three to five year investment horizon in mind:
Right now, Asia has endured a correction over the last 12 months but is now positioned with numerous tailwinds. These are summarised in Chart 2.
By contrast, the US is facing a huge amount of headwind as it unwinds the last decade’s worth of easy monetary policy, and lives with the reality of tightening conditions in order to bring inflation back under control.
Furthermore, valuations are at extreme levels with a relatively low margin of safety if severe corrections were to eventuate.
Are you and your clients now positioned to take advantage of the next changing of the world order and the investment returns linked to it?
Jonathan Wu is chief investment specialist at Premium Asia Funds Management.
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