Month: June 2018

Donald Trump’s “America First” ideology is one of many manifestations of a break in the process of globalization. The incremental increase in open markets for trade, capital and labor which for decades was promoted by the U.S. now faces opposition from domestic interest groups that have been left behind. Politicians are exploiting the built-up resentment of “silent majorities” which feel that they have been exploited by a darwinian system that combines market fundamentalism with meritocracy to promote the interests of a self-serving elite. At the same time, this new global elite, a “noisy minority”  with highly progressive views on social issues, has clashed with a “silent majority” which identifies with traditional conservative social values. Trump has masterfully played upon this resentment, by espousing anti-globalization positions on trade, immigration and climate change, and by touting “politically incorrect” views on foreigners, immigrants and minority groups.

The resentment is not only a U.S. phenomenon, but also obvious in Brexit, Italian and German political instability, the rise of strongmen in Turkey, Poland and the Philippines, etc… The consolidation of Xi’s power in China also is rooted in the same soil, as the Communist Party recognized that the enormous rise in wealth concentration in China would inevitably cause political chaos without the re-imposition of order by strong reins. The process continues around the world with or without the democratic process; Erdogan’s supremacy was confirmed in Turkey last Sunday, and both Mexico and Brazil are headed for controversial elections which are likely to mean decisive breaks with the past.

These powerful domestic political forces can play out in unexpected ways. In France, disruption has produced Macron and a shift to the right. Something similar may happen in Brazil, where the current leader in the polls, Jair Bolsonaro, promises a sharp turn to the right.  Brazil has been a reluctant participant in trade liberalization, choosing to pursue long-standing protectionist policies. On the other hand, for decades it has fully embraced financial liberalization and a highly orthodox (i.e. U.S. determined) monetary framework. The result has been an over-sized financial sector, a rapid process of premature de-industrialization, wealth concentration and economic stagnation. Several generations of the best students from Brazilian universities have flocked to banks (Brazil’s leading bank, Itau, prides itself on its engineering culture.) Into this mess has stepped Bolsonaro, with a message of “Law and Order” and support for traditional “family values” which appeals to a “silent majority” heavily influenced by evangelical churches. Ironically, in highly bureaucratized, statist, leftist Brazil, change means a move to entrepreneurial freedom, and Bolsonaro, so far, has espoused a very pro-business, economic-freedom agenda.

The new resistance to globalization has several important consequences.

First, over the short-term it may favor the U.S.. This is certainly Trump’s political calculus. As the largest economy in the world, the U.S. relies less on trade than almost any other country, and it can move to self-sufficiency more quickly than others can. As the largest consumer market in the world and the prominent importer, it can largely impose its own terms on those seeking access  to its market.

The opposite goes for small countries with export-oriented economies. The big losers are countries like Taiwan, Korea, Thailand and Mexico, all of which are key players in global value chains. For example, those most hurt by Trump’s proposed tariffs against Chinese imports, aside from the American consumer, will be the Taiwanese and Korean producers of electronic parts. Ironically, as more countries favor nationalistic approaches over global connectivity, large protectionist economies such as Brazil and India may now gain a significant edge in attracting investment.

Second, Trump’s policies are inflationary. They will push wages up, which will benefit Trump politically. The Federal Reserve is likely to be compliant and allow inflation to rise, as it is in the interest of the U.S. to see nominal GDP higher than nominal interest rates.  However, higher nominal rates and a rising dollar will be a heavy burden on EM countries that have borrowed heavily in U.S. dollars and on those that need foreign funds to finance current account and fiscal deficits.

Third, higher wages will accelerate the trend towards robotization in developed countries. This is already happening in an accelerated fashion in Japan with its declining work-force, and it will spread quickly to the U.S. Trump’s “America First” protectionism is happening exactly at a time when automation technology is making it increasingly practical to “reshore” supply chains and final-stage manufacturing back to the U.S. Interestingly, this week Foxconn, the world’s largest electronics contract manufacturer, broke ground on a $10 billion investment to manufacture flat-screen liquid crystal display panels in Wisconsin, its first investment outside of Asia.

The disruption in supply chains  will be extremely disruptive to those EM countries that actively participated in them. Once again, the small export-led economies will suffer the most. However, large EM economies with big domestic markets like Brazil and India have the least to lose. China will combine automation with a rapid move up manufacturing value chains in order to increase the in-sourcing of intermediate goods, creating more pressure on small export-led economies.

Fourth, as the U.S. increasingly flaunts the rules of global trade to promote ”America First,” it will seek to impose bilateral deals on exporters wanting to access the its market. Other large economies will do the same, reluctant to export consumer demand. Regional blocks will increase in importance, with China determined to dominate an Asian trading block. If the U.S. pursues its popular “cold war” against Chinese technology companies it will force Beijing to double-down on its efforts to dominate frontier technologies. The result may be a strange new tech world which revolves around two separate ecosystems, one dominated by Silicon Valley, the other by Beijing. The current structure of the technology venture capital system which now invests with equal eagerness in both countries may be completely disrupted. We may see the same happening in the auto sector, with the industry revolving around the two largest markets China and the U.S., with separate supply chains.

Fifth, as regional trading blocks gain traction, U.S. dollar supremacy is likely to decline. In particular, the Chinese yuan will gradually gain space as China becomes the key player in Asian trade. China has already replaced the U.S. has the largest importer of hydrocarbons and will increasingly insist on having contracts priced in yuan. The U.S.’s heavy handed implementation of trade and financial sanctions, such as those on Iran, Russia and North Korea, also will accelerate the acceptance of yuan-based contracts.

Fed Watch:

• Don’t blame Trump for the decline of globalization (SCMP)
• The rising USD and EM (WSJ)

India Watch:

• India’s national strategy for artificial intelligence (NITI.Gov)
• A look at the value factor in the Indian stock market (Indexology)

China Watch:

• A look at Chinese ETFs (ETF.com)
• Xi tells CEOs he will strike back at the U.S. (WSJ)
• Beijing’s big idea for southern China (SCMP)
• How China secured a port in Sri Lanka (NYtimes)
• JPMorgan on MSCI A share inclusion (SCMP)

China Technology Watch

• China extends lead in most powerful computers (NYtimes)
• Google invests in JD.com (CNBC)
• U.S. faces unprecedented threat from China tech (bloomberg)
• CATL, the rise of China’s new EV battery champion (Technology Review)
• Competition in energy storage markets (McKinsey)
• The disruption of battery storage technology (McKinsey)

EM Investor Watch

• The Erdogan Supremacy (NYtimes)
• Erdogan’s   bet pays off  (Brookings)
• India’s shaky reforms (FT)
• Now Erdogan faces his economic mess (NYtimes)
• The roots of Argentina’s surprise crisis (Project Syndicate)
• The rise of strongmen in global politics (Time)

Tech Watch

Seven reasons why the internal combustion engine is dead (Tomraftery)

 

 

 

 

 

The emerging markets asset class is said to provide better opportunities for skilled investors because stocks are supposed to be priced more inefficiently than those in developed markets like the United States. However, important markets such as Brazil and Mexico have come to be dominated by highly sophisticated local and foreign institutional investors and are now probably nearly as efficiently priced as developed markets. Nevertheless, there are still significant pockets of inefficiency in markets where short-term traders and retail investors have a dominant presence and in large markets with many smaller stocks which are not on the radars of institutional investors. The Chinese A-share market and India are arguably the two markets which perhaps best display these characteristics and therefore offer the best opportunities for skilled investors to profit.

The SPIVA Scorecard, which is compiled bi-annually by S&P Dow Jones Indices, provides regular comparative data on the relative performance of actively and passively managed portfolios in different markets around the world. As previously discussed (active-vs-passive-in-emerging-markets), the data shows that emerging markets in general are somewhat less efficient than developed markets and provide some opportunities for skilled asset managers to outperform indices. This is particularly true for the larger asset managers, presumably because they have more and better resources to conduct fundamental research. SPIVA also provides detailed analysis on specific countries which provides an interesting view on which markets may provide the best opportunities for skilled managers to harvest alpha (i.e. outperformance relative to the market).

The table below shows the percentage of managers able to outperform indices over five and ten year periods in representative U.S. and emerging markets for the period ending at year-end 2017. The figures refer to managers in each country investing in their own domestic markets (i.e. Brazilian managers investing in Brazilian equities.) SPIVA uses its own indices for each market, and these are constructed to represent a market universe of easy accessible to the standard international investor. Domestic managers in each country may be measuring their performance in comparison to other benchmarks, which may be significantly different than the index used by SPIVA.

The first thing to note is that, by and large, markets are efficient.  U.S. large caps are exceptionally efficient, with only 10% of funds able to outperform over the long-term (10 years). Though smaller companies with less market capitalization are much less followed by Wall Street research firms and are deemed to be less efficiently priced, the evidence from SPIVA shows that only 4% of managers can beat the small-cap index over the long-term. The same is true in Europe where less than 15% of managers beat the index over the long-term.

Outside of the U.S., however, there appears to be large differences in the degree of market efficiency. Latin American markets, which are increasingly institutionalized and have a large participation of foreign institutional investors, appear highly efficient. SPIVA provides results net of fees, so in Latin America where fees can be exceptionally onerous, the numbers may be partially explained by high expenses. South Africa is another market highly dominated by institutional investors, which helps to explain why the market appears very efficient.

In addition to the high participation of institutional investors, the opportunity-set of investable stocks is another factor that determines market efficiency. Mexico, Chile and South Africa are very shallow markets dominated by very few stocks, so these are very well followed by investors. Brazil’s equity market has more depth, but still the very large and competent institutional investor base focuses mainly on a few dozen securities.

In the SPIVA data-base, India stands out as a particularly good environment for active investors. Well over half of managers outperform the index over five year periods, and almost half over ten years, despite relatively high fee structures. This high level of inefficiency points to a market where institutions still have a weak presence. This is particularly true in small and mid-caps, where foreigners are largely absent.

Though not yet covered by SPIVA, the other large and inefficient market is China. The China  A-share market (stocks listed in Shenzhen and Shanghai) is a very deep and growing market dominated by local traders and retail investors and with very little participation from institutional investors. Chinese A-shares were recently included for the first time  in both the FTSE and MSCI emerging markets indices followed by foreign investors and will become increasingly important in coming years.

In addition to having the highest -growth economies and the largest and most dynamic stock markets, China and India also provide the best opportunities for investors to outperform their competitors by engaging in thorough fundamental research.

Fed Watch:

• Don’t blame Trump for the decline of globalization (SCMP)
• The rising USD and EM (WSJ)

India Watch:

• India’s national strategy for artificial intelligence (NITI.Gov)
• A look at the value factor in the Indian stock market (Indexology)

China Watch:

• JPMorgan on MSCI A share inclusion (SCMP)

China Technology Watch

• CATL, the rise of China’s new EV battery champion (Technology Review)
• Competition in energy storage markets (McKinsey)
• The disruption of battery storage technology (McKinsey)

EM Investor Watch

• The roots of Argentina’s surprise crisis (Project Syndicate)
• The rise of strongmen in global politics (Time)