Category: Russia

What to Expect for the 2020s in Emerging Markets

A decade seems like a long time but in investing it should be considered a reasonable period for evaluating results. Ten years covers several economic/business cycles and allows both valuation anomalies and secular trends to play out. Moreover, it gives time for the fundamental investor to show skill. Though over the short-term – the months and quarters that the great majority of investors concern themselves with – the stock market is a “voting machine,” over the long-term the market becomes a “weighing machine” which rewards the patience and foresight of the astute investor.

When we look at the evolution of markets over a decade we can clearly see how these big long-term trends play out. The chart below shows the evolution of the top holdings in the MSCI Emerging Markets Index over the past three decades. We can appreciate how constant and dramatic change has been in the twenty years since 1999, and we should recognize that the next decade will be no different.

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The top holdings at the end of each decade reflect the stocks and countries that have been favored by investors and, presumably, bid up to high valuations.

At the end of 1999, countries in favor were Taiwan, Korea, Mexico and Greece, and the hot sectors were telecommunications and utilities.

By year-end 2009, the new craze was for anything commodity related, and Brazil was the new craze. Banks, which benefited from a global liquidity boom also came into favor.

By year-end 2019, telecom/utility stocks and commodities were all deeply out of favor.  The high-flying markets of the previous decade (eg. Brazil) suffered negative total stock market returns for the whole period. The past decade has been all about the rise of China and the internet-e.commerce platforms and the chips and storage (the cloud) required to make it all work.

What will the next ten years bring.  Only one thing is certain: the pace of change and disruption will accelerate. Whether this will benefit the current champions or create new ones is anyone’s guess.

One difference from ten years ago is that emerging markets are not expensive. Unlike in 1999, the market leaders don’t seem to be at unsustainable valuations. On the other hand, there a few markets that sport very low valuations. These are mainly either commodity producers (Colombia, Chile, Brazil, Russia) or markets that have been through tough economic/political cycles (Argentina, Turkey, India).

Good luck to all!

Promoting Business Initiative in Emerging Markets

 

The World Bank has conducted its “Doing Business” survey since 2006, ranking countries according to the ease of conducting business. The rankings provide a useful comparison between countries, and the survey has enough history to show which countries are implementing the reforms needed to allow entrepreneurs of all sizes to thrive.

The chart below looks at the evolution of the rankings for those countries  that are important for emerging market investors. This data covers 10 years, which is, more or less, two full business or electoral cycles and enough time for government policy reforms to have an impact. What we see are dramatic changes, both on the positive and negative sides. On the positive side, Russia, India, Indonesia, China, Poland, Taiwan and Turkey have achieved transformational results. On the negative side, we see a very concerning collapse occurring in South Africa, and significant declines in Colombia, Nigeria, Thailand and Peru.

Change in Ease of Doing Business Rankings.  Best to worst over 10 years
Russia 89
India 56
Indonesia 49
China 43
Poland 38
Taiwan 33
Turkey 30
Vietnam 24
Brazil 20
Philippines 20
S Korea 14
Malaysia 8
Argentina -1
Mexico -3
Chile -7
Peru -12
Thailand -15
Nigeria -21
Colombia -28
South Africa -48

 

The criteria that the World Bank uses in its Doing Business methodology are shown in the chart below.

The full rankings for the 18 countries that make up the core of our EM universe for investors are shown below. The chart shows the rankings from 2006-2019. The World Bank currently ranks 190 countries, and the full ranking can be found on the World Bank website (Link). 

We can consider the top 25 to be the global elite, the absolute easiest places to start and run a business. The top 50 can be considered good; 50-100, mediocre;  and 100-130, bad.  Any ranking above 130 indicates a very hostile environment for entrepreneurs.  Countries above 100 are highly dominated by inefficient bureaucracies and by extractive entrenched interests such as oligarchies and politically connected rent-seeking agents.  Typically, in these countries you have to be big and politically connected to be successful, and most entrepreneurs are  forced into the underground economy. Four important markets – Brazil, Philippines, Nigeria and Argentina –  persistently rank very poorly and show little sign of progress. India, Indonesia and Vietnam in recent years have moved out of this group of “dysfunctionals,” showing clear signs of improvement.

 

We can dig deeper into the survey by looking at the rankings on a regional basis.

Asia

The evolution of the rankings for Asian countries is shown below.  This is the world’s most dynamic economic region and also where we see both the best and the most improving business conditions. We can separate this group into two cohorts: the “Asian Tigers” and the Asian laggards. Of the Asian Tigers, South Korea, Malaysia, Thailand are in the elite and have been so throughout the period. Korea, Malaysia and Taiwan have continued to improve over the period, while Thailand has shown some moderate slippage. China is between the Asian Tigers and the laggards, but appears to be moving rapidly towards the former. We also see in recent years that the laggards are making significant progress. India, Indonesia and Vietnam all have made large leaps forward. The case of India is noteworthy; Prime Minister Modi publicly committed to improving India’s ranking when he took office, and he is delivering through a major deregulation push.  (The tweet below from Modi shows the focus that he has on this measure.) The main exception in Asia is the Philippines where we see very little progress. It appears that the all-powerful oligarchs in the Philippines are not being challenged.

Latin America

The evolution of the rankings for Latin America are shown in the chart below. This region is characterized by the “middle-income-trap” malady: after reaching middle-income status, these countries fail to both invest in public goods (human capital and infrastructure) and to implement pro-business reforms. Like Asia, the region is divided into the good (Chile, Mexico, Colombia and Peru) and the laggards (Argentina and Brazil).  Of the better-ranked countries, none has made progress over the period. Worse, Chile has seen a worrisome decline from its former elite status, and Peru, after showing signs of improvement, has regressed. On the side of the laggards, Argentina has deteriorated significantly while Brazil is stable.

Europe, Middle East and Africa

This region is diverse and shows great divergence in results. Both Nigeria and South Africa are cause for concern. Nigeria has joined the camp of highly dysfunctional economies, and South Africa has gone from elite status to mediocrity and it shows no signs of halting this trend downward. Fortunately, all the other countries in this group show positive trends. Turkey and Russia, both run by nationalistic, pro-business “law-and-order” autocrats, have made remarkable progress. Poland, in line with most countries in Eastern Europe, has also risen sharply in the rankings and now borders “elite” status.

Macro Watch:

Trade Wars

  • Henry Paulsen gets negative on China (WSJ)
  • U.S. accuses Cina firm of stealing Micron secrets (Wired)
  • Asia’s next trade agreement (Brookings
  • Wisconsin has econd thoughts about Foxconn deal (New Yorker)
  • Australia blocks China pipeline takeover (SCMP
  • Firms shifting plants to ASEAN (SCMP)

India Watch

  • Can the rupee become a hard currency? (Livemint)
  • Can India become the next $10 trillion economy ?(Wharton)
  • Apple is losing share in India to Chinese (Reuters)
  • India’s central bank under pressure (NIKKEI)
  • India-sponsored Iranian port is a problem for th U.S. (WSJ)

China Watch:

  • China and Myanmar approve port project (Caixing)
  • Four reasons to manage China’s rise  (Lowy)
  • The reforms China needs (Project Syndicate)
  • China’s Eastern Europe push (WSJ)
  • Self-reliance is the new mantra in Beijing (Washington Post)
  • China’s southern Europe strategy (Carnegie)
  • The big story in China; no talk of autumn policy meet (SCMP)
  • The world is awash in waste after China ban (FT)
  • Trump’s decoupling with China will hurt Asian allies (Lowy)
  • Cruise companies rethink China bet (WIC)

China Technology Watch

  • Tencent’s social responsibility drive (WSJ) (SCMP)
  • China’s giant transmission grid (Tech Review)
  • AI will develop under two separate spheres of influence (SCMP
  • BAIDU and Volvo team up 0n self-driving cars (SCMP)
  • An AI war would be a huge mistake (Wired)
  • China robotic firm seeks to buy German competitor (Caixing)

Brazil Watch

  • President Cardoso’s speech at the Wilson Institute (Wilson Center)
  • Brazil may move embassy to Jerusalem (WSJ
  • Brazil’s new president (Wharton)
  • Brazil’s economy boss looks to Chile (FT)
  • A european view on Brazil’s new foreign policy (GGPI)
  • Trumpism comes to Brazil (Foreign affairs)
  • How will Bolsonaro deal with China (Caixing)
  • Brazil’s new foreign policy (Brookings)

EM Investor Watch

  • The age of disruption, Latin America;s challenges (Wilson Center)
  • Rwanda, poster child for development (WSJ)
  • The passing of the conscience of Venezuela’s left (NYT)
  • Poland moving back to the center (NYT)
  • Why Mexico and the U.S are getting closer (Wharton)
  • The short term case for EM (Disciplined investing)
  • China’s inroads in the Andean amazonian basin (Asia Dialogue)
  • Are developing countries converging (PIIE)

Tech Watch

  • Pathways for inclusive growth (BSG)
  • Paraguay is a bitcoin powerhouse (The Guardian)

Investing

  • Learning from investment history (Forbes)
  • Interview with Doug Kaas (RIA)
  • Investment value in an age of booms and busts:
    A reassessment (Edelweiss)
  • Monish Pabrai’s ten commandments (Youtube)
  • A profile of Paul Singer (New Yorker)

 

 

 

 

 

AMLO Shoots Himself in the Foot

 

The ability to invest in fundamental public goods – human and physical capital — is a primary characteristic that differentiates one emerging market country from another. The process of building-out infrastructure is particularly fraught with risks because of the complexity and flexibility of contracts, so countries also differentiate themselves in their ability to conduct business ethically and complete projects at reasonable costs.

Over the past weeks, we have seen this process at work, with very different outcomes. On the one hand, in China two enormous infrastructure projects were inaugurated – 1. The Hong-Kong Macau Seabridge;2. The Hong-Kong to the Mainland Bullet-Train link. On the other hand, in Mexico the incoming president canceled the new Mexico City Airport, the country’s largest and most needed project.

The decision this week by Mexico’s President-Elect, Andres Manuel Lopez Obrador (AMLO), to scuttle the new $13.3 billion airport being built on the outskirts of Mexico City is emblematic of the political obstacles face by many developing countries to provide basic public goods.

No one disagrees that Mexico City needs a new airport. The city’s main  airport has been saturated since the 1990s, which is very problematic for a country with a growing tourisn industry. Nevertheless,  over the past two decades multiple proposals for a new airport have been abandoned after fierce opposition from indigenous communities and environmentalists.

AMLO’s opposition to the current project, which is about one third completed, has been known for over two years, and he expressed it many times during the presidential campaign. He decried the complexity and cost of the project, as well as environmental considerations. But his main objection has been a belief that the contracts were awarded without transparency to political cronies of the outgoing party.  During the campaign AMLO had said: “It has been proven that this airport is going to be very costly for the country… It’s a bottomless pit… This isn’t a good deal for the country, for Mexicans. It is for a small group of contractors, they are going to make a lot.”

In an essentially symbolic process aimed at justifying his decision, AMLO hastily organized a “popular referendum,”  to “let the people decide.” This occured this past Sunday and resulted in 70% of the one million votes counted agreeing with the candidate to cancel the project.

The following day, a visibly delighted AMLO held a press conference praising the exercise in direct democracy: “The citizens took a rational, democratic and efficient decision. The people decided. And we have to keep on creating the democratic habit. Where there is democracy, corruption does not exist.”

AMLO’s decision to cancel the project, the biggest infrastructure project of the administration of President Enrique Peña Nieto, will result in very large losses (estimated by the WSJ at $5 billion) for bondholders, suppliers and contractors, including Mexican magnate Carlos Slim, one the biggest supporters of the project.

What has just happened in Mexico is not unusual at all in emerging markets. Ironically, as many countries have become more democratic, they have also lost the capacity to invest in public goods. This is particularly true in Latin America where democratization since the 1980s has implied a more free and inquisitive press, a more activist judiciary and independent regulatory agencies captured by special interests. In a country like Brazil where this has been accompanied by a dramatic expansion of the welfare state aimed at providing “social justice,” the state has found itself handcuffed, without funds and facing an incredibly laborious process to get anything done.

Ironically, in many emerging markets when the “grease” of corruption is not allowed to work things come to a complete stop. One of the companies involved in the Mexico City airport project, Grupo Hermes, is related to Carlos Hank Gonzalez, a well known Mexican politician linked Pena Nieto’s party, who famously quipped “a poor politician is a poor politician.” In a similar vein, it used to be said about a former governor of Sao Paulo, “he may steal, but he gets things done.”

The case of China is interesting. China’s unprecedented build-out of public infrastructure since the 1980s is a truly remarkable achievement which has brought the quality of infrastructure from one of the worst in the world to a very high level. However, it is no secret that the construction sector is ridden with corruption and that many of the great fortunes of China have been created by the unethical ties between contractors and municipalities. Not surprisingly, when President Xi Xinping came to power several years ago promising a total crackdown on corruption, for a while, activity came to a stop.

The same goes for India, where kickbacks in construction contracts essentially finance all political campaigns. Politicians and construction contractors in India have long worked under the assumption that the relationship is mutually beneficial and sustainable as long as contractors deliver the promised service. This has resulted in a certain risk aversion, where politicians will only work with the most efficient and technically competent contractors.

A similar approach goes in Turkey, where construction firms have worked closely with the Erdogan regime. As in India, Erdogan has been a tough task-master, demanding competency from contractors.

It is interesting to look at the connection between infrastructure and corruption. We can do this by looking at both the World Economic Forum’s 2019 infrastructure ranking (WEF) and Transparency International’s Corruption Index (Link).The first chart below shows the top 100 of WEF’s infrastructure ranking of 142 countries. The next chart shows the top 90 of the 154 countries covered by the corruption index. A final chart looks at where the primary EM countries fall in this infrastructure-corruption matrix.

Transparency International, Corruption Ranking

 

We can draw some interesting insights from these charts. Basically, there are three distinct groups of countries:

Group 1 – Good Infrastructure with low cost of corruption.

  • This includes all developed countries. We can venture to say that the ability to provide public goods at a low corruption cost is an intrinsic characteristic of development.
  • In EM, only Chile, Taiwan and Poland make the cut, and, in this sense, these countries can really be considered developed. Korea is borderline. Corruption has become a major political and social-media issue in recent years, and it may well fall rapidly from the current high levels.

Group 2 – Relatively Good Infrastructure with High Corruption.

  • These are the “He may steal, but he gets things done” countries. Corruption is high and costly, but politician and contractors have worked it out so that both sides benefit and infrastructure gets built.
  • In EM, China is the master of this group; Mexico, Malaysia, Turkey, Thailand, India and South Africa also qualify.
  • The direction that Mexico will take under AMLO will be interesting to see.

Group 3 – Bad Infrastructure with High Corruption.

  • In these countries, politics have become so dysfunctional that the “return” on corruption is near zero. Included in this list are: Brazil, Argentina, Indonesia, Vietnam, Columbia, Peru and the Philippines. At the extreme of this category and in a class of their own are semi-failed states: for example, Venezuela and Nigeria.
  • Most emblematic of this condition has been Venezuela under its Bolivarian regime. Thirty years ago, Venezuela had one of the best infrastructures of any developing country; today it ranks 118th in the WEF report. Venezuela now has zero capacity to invest in public goods, all of its fiscal resources either dedicated to welfare programs or syphoned-off to the offshore accounts of regime cronies.
  • Brazil faces an interesting situation today. It currently has the worst-of-all worlds, with very high corruption and close to zero capacity to carry out infrastructure public works. The election of Jair Bolsonaro was a repudiation of the kickback-driven political system, so going back to that model is impossible. To a considerable degree, the success of the new government will depend on quickly finding a new way to do business.

Macro Watch:

  • Gary Shilling interview on the global economy (Shilling)
  • Martin Wolf comments on Paul Volcker’s book (FT)
  • Is the Business cycle dead? (Robert Gordon)
  • Trump pushes Japan and China closer (Brookings)
  • Trump’s misguided trade war (SCMP)
  • Trade conflict and systemic competition (PIIE)

India Watch

  • India’s central bank under pressure (NIKKEI)
  • India-sponosred Iranian port is a problem for th U.S. (WSJ)
  • India partners with Russia in energy deals (Lowy)

China Watch:

  • The big story in China; no talk of autumn policy meet (SCMP)
  • The world is awash in waste after China ban (FT)
  • Trump’s decoupling with China will hurt Asian allies (Lowy)
  • Cruise companies rethink China bet (WIC)
  • Xi’s sothern China trip (WIC)
  • Chinese buy homes in Greece (reuters)
  • Chinese farmr live-streams her way to fame and fortune (New Yorker
  • The world’s longest sea-bridge opens (CNN) (QZ)
  • China provinces compete for talent (EIU)
  • China’s influence on global tourism is growing (SCMP)

China Technology Watch

  • BAIDU and Volvo team up 0n self-driving cars (SCMP)
  • An AI war would be a huge mistake (Wired)
  • China robotic firm seeks to buy German competitor (Caixing)
  • China aviation industry’s steep climb (SCMP ) (SCMP)
  • China’s AI ambitions (SCMP)
  • U.S. attacks China chip industry (FT)
  • China’s smart-phone offerings (The Verge)

Brazil Watch

EM Investor Watch

Tech Watch

  • The plan to end malaria with CRSPR (Wired)

Investing

  • Learning from investment history (Forbes)
  • Interview with Doug Kaas (RIA)
  • Investment value in an age of booms and busts:
    A reassessment (Edelweiss)
  • Is your alpha big enough to cover taxes (Alpha Architect)
  • Systematic vs. discretionary investing (Integrating Investor)
  • KKR white paper on asset allocation (KKR)
  • Hedge funds fleecing investors (SL advisors)
  • Monish Pabrai’s ten commandments (Youtube)

 

 

 

 

 

 

Interview with Doug Kaas (RIA)

A Reading List for Emerging Markets

Here is a list of books that I think are useful and interesting for any investor seeking to understand investing in emerging markets. The list reflects my bias for long-term investing rooted in knowledge of history and business cycles. I have included only books published in English, which is a big restriction. Also, I have not included basic investing books, which is an entirely sparate list.

The list is divided into three sections.

  • Macro Economics and Business Cycles
  • Development and Economic Convergence
  • Regions and Countries

The books in each section are listed in no particular order.

1 Macro-economics, business-cycles and financial bubbles

 The Volatility Machine by Michael Pettis

This Time is Different by Reinhart and Rogoff

The Bubble Economy by Chris Wood

Inflation and Monetary Regimes by Peter Bernholz

Money and Capital in Economic Development by Ronald McKinnon

How to Make Money with Global Macro by Javier Gonzalez

Business cycles: history, theory and investment reality by Lars Tvede

Emerging market portfolio strategies, investment performance, transaction cost and liquidity risk by Roberto Violi and  Enrico Camerini II (Link)

Against the Gods by Peter Bernstein

 Alchemy of Finance by George Soros

The Fourth Turning: What the Cycles of History Tell Us About America’s Next Rendezvous with Destiny by William Strauss, Neil Howe

Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages by Carlota Perez

Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay

Manias, Panics, and Crashes: A History of Financial Crises, by  Charles P. Kindleberger and Robert Z. Aliber

Devil Take the Hindmost: A History of Financial Speculation by Edward Chancellor

 

2 Development and Economic Convergence

 

 

Civilization and Capitalism, 15th-18th Century, Vol. I: The Structure of Everyday Life by Fernand Braudel

The  Pursuit of Power: Technology, Armed Force, and Society since A.D. 1000  by William H. McNeill

The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor by David S. Landes

Energy and Civilization: A History  by Vaclav Smil

Barriers to Riches (Walras-Pareto Lectures) by Stephen L. Parente, Edward C. Prescott

The Great Convergence: Information Technology and the New Globalization

by Richard Baldwin

A Discussion of Modernization Li Lu (Link)

Slouching Towards Utopia?: AnEconomic History of the Long 20th Century, Brad Delong

Breakout Nations. In Pursuit of the Next Economic Miracles by Rushir Sharma

Why Nations Fail: The Origins of Power, Prosperity, and Poverty  by Daron Acemoglu and James A. Robinson

The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor by David S. Landes

The Birth of Plenty : How the Prosperity of the Modern World was Created by William J. Bernstein

Why Did Europe Conquer the World?    by Philip T. Hoffman

Empire of Cotton: A Global History  by Sven Beckert

The Pursuit of Power: Technology, Armed Force, and Society since A.D. 1000 by William H. McNeil

The White Tiger by Aravind Adiga

How to get Filthy Rich in a Rising Asia by Mohsin Hamid

AI Superpowers: China, Silicon Valley, and the New World Order by Kai-Fu Lee

Growth and Interaction in the World Economy by Angus Maddison

 

 

3 Regions and Countries

 

Latin America

 

Guide to the Perfect Latin American Idiot by Plinio Apuleyo Mendoza, Carlos Alberto Montaner, Alvaro Vargas Llosa

Left Behind: Latin America and the False Promise of Populism by Sebastian Edwards

 

 

Brazil

 

Brazil: A Biography by Lilia M. Schwarcz and Heloisa M. Starling

The Military in Politics: Changing Patterns in Brazil by Alfred C. Stepan

Brazillionaires: Wealth, Power, Decadence, and Hope in an American Country 

by Alex Cuadros

Brazil: The Troubled Rise of a Global Power by Michael Reid

Lanterna na Popa by Roberto Campos

A Concise History of Brazil by  Boris Fausto

A History of Brazil by E. Bradford Burns

 

Mexico

 

The Course of Mexican History by Michael C. Meyer and William L. Sherman

Mexico: Biography of Power. A History of Modern Mexico, 1810-1996 by Enrique  Krauze

 

Turkey and the Middle East

 The Political Economy of Turkey by Zulkuf Aydin

Midnight at the Pera Palace. The Birth of Modern Instanbul, by Charles King

The Prize: The Epic Quest for Oil, Money & Power by Daniel Yergin

The Yacoubian Building by  Alaa Al Aswany

 

Russia

 

Wheel of Fortune. The Battle for Oil and Power in Russia by Thane Gustafson 2012

Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice by Bill Browder

The Future Is History: How Totalitarianism Reclaimed Russia  by Masha Gessen

 

 

 

Asia

 

Asian Godfathers: Money and Power in Hong Kong and Southeast Asia by Joe Studwell

How Asia Works: Success and Failure in the World’s Most Dynamic Region

by Joe Studwell

Lords of the Rim by Sterling Seagrave

 

 

China

 

Factions and Finance in China by Victor C. Shih

Capitalism with Chinese Characteristics. Entrepreneurship and the State by Yasheng Huang

China’s Crony Capitalism: The Dynamics of Regime Decay  by Minxin Pei

CEO, China: The Rise of Xi Jinping by Kerry Brown

Factory Girls: From Village to City in a Changing China by Leslie T. Chang

Avoiding the Fall. China’s Economic Restructuring by  Michael Pettis

The River at the Center of the World by Simon Winchester

Mr. China by Tim Clissold

The China Strategy by Edward Tse

River Town  by Peter Hessler

The Economic History of China: From Antiquity to the Nineteenth Century

by Richard von Glahn

Understanding China: A Guide to China’s Economy, History, and Political Culture 

by John Bryan Starr

China’s Economy: What Everyone Needs to Know  by  Arthur R. Kroeber

Modern China by Jonathan Fenby

The Chinese Economy: Transitions and Growth by Barry Naughton

Wealth and Power. China’s Long March to the 20th Century by David Schell and John Delury

China’s New Confucianism by Daniel Bell

China Fireworks: How to Make Dramatic Wealth from the Fastest-Growing Economy in the World by Robert Hsu

Cracking the China Conundrum: Why Conventional Economic Wisdom Is Wrong

by Yukon Huang

Little Rice: Smartphones, Xiaomi, and the Chinese Dream  by Clay Shirky

Alibaba: The House That Jack Ma Built  by Duncan Clark

 

India

 

India – A Wounded Civilization by by V. S. Naipaul

Behind the Beautiful Forevers by Katherine Boo

 India’s Long Road: The Search for Prosperity by Vijay Joshi

The Billionaire Raj: A Journey Through India’s New Gilded Age by James Crabtree 

Capital: The Eruption of Delhi by Rana Dasgupta

Investing in India: A Value Investor’s Guide to the Biggest Untapped Opportunity in the World by Rahul Saraogi

 

Macro Watch:

India Watch:

  • India’s strong economy leads global growth (IMF)
  • (King coal rules India (Economist)

China Watch:

  • China vs. the U.S.: the other deficits (Caixing)
  • Media warns to avoid Japan’s mistakes (SCMP)
  • China needs to get its house in order (SCMP)
  • China resumes urban rail incestments (Caixing)
  • Chinese firm will take over Iran gas project (Bloomberg)

China Technology Watch

  • How WeChat conquered China (SCMP)
  • Why do Western digital tech firms fail in China (AOM)
  • Hayden Capital on China tech investments (HaydenCapital)
  • A deep look into Alibaba’s 20F (Deep Throat)
  • China’s rise in bio-tech (WSJ)

EM Investor Watch

  • Turkey could be worse than Greece (dlacalle)
  • The West’s broken relationsip with Turkey (Project Syndicate)
  • Africa cannot count on growth dividend (FT)

Tech Watch

  • Drones in mining (Youtube)
  • The future of batteries (Wired)

Investing

  • Li Lu’s lecture at Beijing University (Himalaya Capital)
  • Charlie Munger and Li Lu Interview (Guru Focus)
  • Interview with Bill Nygren (Youtube)
  • The 8 best predictors of market returns (WSJ)

The Impact of Trade Wars on Emerging Markets

The main goal of American diplomacy now appears to be to disrupt the post-war rules-based global economic order. President Trump viscerally believes that the status quo is rigged against the United States and in favor of America’s most important trading partners. In this scheme of things, traditional allies like Canada, Mexico and Germany are “ foes” and a rising economic power like China becomes an existential threat to American hegemony. On the other hand, countries do not export large amounts to the U.S are irrelevant (e.g. South America) or potential friends (e.g. North Korea, Russia)

According to the Trump Doctrine, global trade and investment are zero-sum games which should naturally be dominated by the U.S. because of its heft and competitive advantages. Trump believes that the U.S. is entitled to dictate terms to those countries that seek access to its markets, capital and technology. Central to this view, the U.S. has only two real rivals that challenge its hegemony: Germany and China.

Germany is seen as having taken control of Europe through the European Union, exploiting divisions to its own benefit, in order to further its global mercantilistic ambitions. Trump fervently supports Brexit because a divided Europe weakens Germany. Brexit would allow the U.S. to impose its own terms on a bilateral U.S.-U.K. trade deal.

China is seen by Trump to be a highly disloyal competitor which exploits the current global order to its own advantage. Allowing China into the WTO was “the worst deal ever,” and caused enormous damage to the U.S. economy. According to Trump, China’s business practices are utterly unfair for the following reasons:

  • Currency manipulation.
  • High tariff and non-tariff trade barriers.
  • Violation of intellectual property rights.
  • Highly restricted access for foreign investment, and imposition of JV requirements and technology transfer agreements.
  • State control of the economy, with huge subsidies provided to both state-controlled and private Chinese firms.

Moreover, as China steadily moves up manufacturing value chains, the U.S. has become obsessed with potential  future competition in high-technology goods. The focus of Washington’s anger is President Xi’s “Made in China 2025” plan to promote Chinese competency in key industrial technologies. Trump’s recent tariffs imposed on China are heavily targeted on the sectors that Xi has determined to be strategic, as shown in the chart below.

Consequences of the Trump Doctrine

As the U.S. questions the transatlantic alliance and the post W.W. II global institutional framework it will abdicate its role as the leader of the project. Without U.S. leadership new alliances will form in unpredictable ways. Though the current situation is highly dynamic and the future is unpredictable, some thoughts are in order:

  • The Trump Doctrine is isolationist for America. As Henry Kissinger has pointed out, the U.S. stands to become a “geopolitical island… without a rules-based order to uphold.” Nevertheless, as the largest and most diverse economy, the U.S. may have the least to lose.
  • America’s neighbors Mexico, and Canada will have no choice but to begrudgingly cave-in to U.S. bullying and accept Trump’s terms. Any deal will be better than no deal.
  • As it undermines the Western Alliance, The Trump Doctrine furthers the interests of both Russia and China. Ironically, both these dictatorships are more comfortable  dealing on a bi-lateral transactional basis than the U.S. with its checks and balances and elections. China is in a good position to trade access to its growing consumer economy on a transactional basis.
  • American isolationism and unilateralism also strengthens China’s hand in its One Belt one Road (OBOR) initiative which has as its primary objective the control of the Eurasian steppes (the old Silk Road, linking China with Europe and the Middle East.) Russia and China are enjoying the warmest diplomatic ties since the 1950s as they see eye-to-eye on this Eurasian strategy; for the Chinese it secures its borders and opens up commerce; for Russia it extends its geo-political reach. As Kissinger has noted,  Europe may become “an appendage of Eurasia.” Key targets here are Iran and Turkey, both of whom are currently at odds with American policy.  China has become Iran’s main trading partner and investor and is committed to buying its oil.
  • Both China and Russia see American “sanctions diplomacy” as a fundamental violation of the global rules-based economic order. U.S. imposed restrictions on Russia, Iran and other countries on the use of the SWIFT global financial transfer system and recent sanctions on Chinese telecom firm ZTE on the import of U.S. components have highlighted the urgency for reducing dependence on the U.S.  This will strengthen China’s resolve to achieve competence in key technologies and further efforts to develop alternatives to the U.S. dollar.  India is also dismayed by American strong-arm tactics, as sanctions are interfering with its commercial ties to Iran and the Middle East and its strong ties with Russia.
  • American antagonism towards the E.U. may also push Germany towards China. Germany may increasingly play its cards in Asia, which is increasingly the center of gravity of the global economy. It is probably not a coincidence that as Trump has launched his trade war against Beijing there has been a sudden rapprochement between Germany and China, and the announcement of a slew of important business transactions. First, BASF was given the go-ahead on a $10 billion fully-owned petrochemical plant, an unprecedented concession by the Chinese in a sector where Germany and the U.S are chief rivals. Second, German companies are securing preferential treatment in the auto sector, now by far the largest in the world and the focus of activity for electric vehicles and, increasingly, autonomous vehicles. In recent weeks, Daimler was awarded a permit to test driver-less cars In Beijing, a first for a foreign firm. Daimler is partnering with Baidu Apollo, a leader in mapping and artificial intelligence applications in China. Also last week Chinese Premier Li Keqiang said BMW may get control of its JV with Brilliance by 2022. BMW, which already has China as its largest market producing about 25% of global profits, has committed to a large increase in capacity and a partnership with Baidu. BMW also secured the right to take an equity stake in CATL, the world’s largest electric vehicle battery producer by sales, after the carmaker agreed to purchase $4.7bn worth of battery cells from the Chinese company. Finally, Volkswagen announced a partnership with FAW for electric vehicles and autonomous cars.
  • The announcement by Tesla last week that it would build its cars in a fully-owned plant in Shanghai is another sign of how companies are adapting to the Trump Doctrine. Chinese tariffs on American cars have increased the price of Teslas in China at a time when dozens of very well-financed local start-ups are coming on stream. Though the move is a significant market opening benefit for an American firm, it can also be seen for Tesla as a desperate attempt to remain relevant in China’s EV market at a time when sales are expected to ramp up dramatically. Still, it may be too late for Tesla, as its plant will not come on stream until 2020.
  • Access to the Chinese market is of great importance to multinationals. In a transactional world, the Chinese can provide access judiciously to secure powerful allies in developed countries. In the case of the U.S., China continues to offer incremental access to financial services, a long-standing demand of American firms.
  • “Winners” in the age of the “Trump Doctrine” are large countries with strategic importance. China is likely to come ahead, as it has strategic importance, a huge market and leadership with long-term objectives. India is not considered a rival by the U.S. and has high strategic value, so it also is in a good position to secure favorable terms. Brazil, though of no strategic value for the U.S., is not considered a rival by Trump and is also in a good position to negotiate.
  • “Losers” are small countries with no strategic value for the U.S.. As global value chains are disrupted by American unilateralism, those countries most dependent on exports to the U.S. are the most vulnerable. The chart below from Pictet Bank gives a good idea of which countries face the most downside: Mexico, Korea, Vietnam, Thailand, Taiwan, Indonesia and Malaysia. They will face unclear rules which will hurt investment. At the same time, the two largest economies in the world,  the U.S. and China will become more insular and self-sufficient.

Fed Watch:

India Watch:

  • Samsung opens world’s largest smartphone factory in India (Bloomberg)
  • Scarsity of visas is shaking up Silicon Valley (SF Chronicle)

China Watch:

China Technology Watch

  • Interview with AI expert Kai-Fu Lee (McKinsey)
  • JD.com is driving commerce in rural china (Newyorker)
  • Tesla-foe Xpeng’s $4 billion valuation (SCMP)
  • China’s tech lag highlighted (SCMP)
  • Tesla’s move to Shanghai (FT)
  • Tesla’s China plan (NYtimes)
  • BMW enters China’s fast lane (WSJ)
  • Daimler and Baidu get ahead on driverless cars in China (Reuters)
  • China wants high-tech cars with German help  (NYT)

EM Investor Watch

  • An update to the big mac index (Economist)
  • Interview with Kissinger (FT)
  • Erdogan’s “New Turkey” (CSIS)
  • Why Bolsonaro is leading Brazil’s polls (Foreign affairs)
  • Pundits are down on EM (Research Affiliates)
  • Indonesia takes control of mega copper mine (WSJ)

Tech Watch

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

 

 

 

 

 

 

 

 

India, Urbanization and a New Commodity Bull Market

Around the turn of the century, China’s economy entered in a phase of very high growth which was fueled by investments in infrastructure and heavy industry and was extremely intensive in the use of hard commodities. A surge of demand from China caught producers by surprise and drove prices  for commodities, such as iron ore and copper, to very high levels for an extended period of time (2003-2011).  A typical boom-to-bust cycle ensued, with overinvestment by producers eventually resulting in over-capacity and a return to low prices.

Commodity markets have been depressed for the past five years and valuations for the stocks of the producer firms have reached record lows relative to stocks in other sectors.

China’s impact on commodity prices, though extraordinary, was not atypical. Historically, countries have entered periods of commodity-intensive growth when they reach a certain level of wealth and experience high urbanization rates: for example, the U.S. in the 1920s, Japan in the 1950s, Brazil in the 1960s and Korea in the 1970s. All these countries saw a period of massive growth in commodity consumption, which eventually leveled off. U.S steel consumption today is at the same level as in 1950, while the Japanese consume steel at 1975 levels.

We can see in the following chart the recurring pattern, when countries suddenly ramp up urbanization rates. High income nations have largely stabilized urbanization levels, while China, India and  all lower-income developing countries still have several decades ahead.

 

If we can identify the next countries experiencing high growth and urbanization, we can go a long way towards understanding the next upcycle in commodities. From looking at historical data, it is the case that urbanization rates ramp up when countries reach a level of wealth around $2,000 per capita (2016, constant USD). The table below shows the progression by decade of new countries entering this wealth level, according to IMF and World Bank data. During the decade ending in 1980, Korea, Poland and Thailand entered into this group; none entered in the 1980s; Russia (and other Eastern European state) appear in the 1990s; and China, Nigeria, Ukraine and Indonesia enter in the 2000s. In this current decade only Vietnam has appeared, so far; but if we look through 2022, we see a massive swell led by India but also including Uzbekistan, Myanmar and Kenya.

It is not the number of countries that matter, of course, but rather the population impact that they represent. The chart below shows the population impact by period, in terms of new entrants as a percentage of global population. We can see a huge surge representing 21.8% of the global population (23%, including Vietnam), surpassed only by the China-led surge of the 2000s.

Equally important, the upcoming surge will happen at a time when China sustains relatively high growth and increasing urbanization, so that we will have both China and India sustaining demand at the same time.

A new upcycle in commodity prices is obviously bullish for emerging market producers, such as Chile, Brazil, Indonesia, Russia and South Africa. It also likely points to a weak dollar and good performance for emerging market stocks in general.

Fed Watch:

India Watch:

China Watch:

 

  • US politics gets in the way of Ant Financial’s US plans (SCMP)
  • Making China Great Again (The New Yorker)
  • Geely invests in AB Volvo trucks (SCMP)
  • China’s commodity demand (Treasury)
  • Ground broken on China-Thai railroad (Caixing)

China Technology Watch:

EM Investor Watch:

 

  • France seeks closer ties with Russia and China (WSJ)
  • Latin America’s rejection of the left (Project Syndicate)
  • Indonesia’s bullet-train project stalls (Asia Times)
  • Boeing’s bid for Embraer (Bloomberg)

Technology Watch:

  • Apple’s share of smartphone profits is falling (SCMP)
  • Fanuc’s robots are changing the world (Bloomberg)
  • Battery costs coming down (Bloomberg)

Investor Watch:

 

 

 

 

Putin’s Embrace of “One Belt, One Road”

The national identity of Russia is intrinsically tied to the mastery  of the Eurasian steppes, the grassland plains that  stretch from Hungary to Northern China. The territorial expansion of Moscow, from the 16th century onward, required  wresting control of the steppes away from the Mongols and securing the fertile black earth plains of modern-day Ukraine and Central Russia. The eventual collapse of the Mongol empire in the 17th century allowed the extension of the Russian empire to the pacific. Russian geo-political control over the steppes, Siberia and the Pacific coast has been largely uncontested for centuries.

However, the economic rise of China over the past decades and its increasingly outward-looking pretensions, as highlighted by President Xi Jinping’s ambitious “One Belt, One Road Initiative” (OBOR) changes everything for Russia.  While Russia has seen the steppes mainly for their value in securing geopolitical control of the Eurasian center, Xi envisions a return to the commercial dynamism of the historical Silk Road, which united the Far East with the Middle East and Europe for centuries, until the collapse of the Mongol empire. The Chinese have been aggressively executing Xi’s vision, building infrastructure to connect China with the West and becoming the largest investor in the natural resources of the former Soviet Republics.

Surprisingly, perhaps because of pragmatism and acceptance of Xi’s promise that the OBOR is aimed at benefiting all participants equally, so far there appears to be little resistance on the part of Russia to Xi’s grand and transformative plan. To the contrary, there has been a rapprochement between Putin and Xi, who have met on frequent occasions over the past several years. In a recent state visit to Moscow, Xi announced $10 billion in agreements for OBOR-related infrastructure investments and told the media that relations between the two countries were currently at their “best time in history” and that Russia and China were each other’s “most trustworthy strategic partners.”

Russia’s cuddling up with China is probably its best strategic option at this time. First, neither China nor Russia have to worry about business relations being undermined by volatile domestic politics or high-minded demands for human rights, and, in that sense, they see themselves as reliable partners. Second, both parties have an interest in weakening what they consider to be the arbitrary and hegemonic power of the United States. For example, both would like to see a weakening of dominance of the U.S. dollar and America’s discretionary control of the global financial system, so it is no surprise that Russia is accepting payment in yuan for commodities and that China is setting up a Petro-yuan-gold trading infrastructure in Shanghai and Hong Kong to facilitate non-dollar transactions.

Most importantly, however, is the fact that Asia will be the driving force of global growth and that its center of activity will be in China and its Far East neighbors. Driven by China, Asia’s share of world GDP will grow to 35% by 2022 (IMF forecast), and almost all of global growth in marginal output will come from Asia.  With its abundant energy, mineral and farm resources, Russia is best positioned to meet growing demand for natural resources in Asia.

A remarkable essay written by President Putin this week clearly states Russia’s current state of mind regarding Asia, and the seemingly total embrace of Xi’s OBOR vision. In a remarkable turn of events, Putin and Xi have become the defenders of open markets and predictable rules of commerce, in stark contrast to Donald Trumps “America First” ideology.

Putin writes: (excerpts, full note available here.)

“As a major Eurasian power with vast Far Eastern territories that boast significant potential, Russia has a stake in the successful future of the Asia-Pacific region, and in promoting sustainable and comprehensive growth throughout its territory. We believe that effective economic integration based on the principles of openness, mutual benefit and the universal rules of the World Trade Organization is the primary means of achieving this goal.

We support the idea of forming an Asia-Pacific free-trade area. We believe this is in our practical interest and represents an opportunity to strengthen our positions in the region’s rapidly growing markets. Indeed, over the past five years, the share of APEC economies in Russia’s foreign trade has increased from 23 percent to 31 percent, and from 17 percent to 24 percent in exports. We have no intention of stopping there…

On a related note, I would like to mention our idea to create the Greater Eurasian Partnership. We suggested forming it on the basis of the Eurasian Economic Union and China’s Belt and Road initiative. To reiterate, this is a flexible modern project open to other participants.

Comprehensive development of infrastructure, including transportation, telecommunications and energy, will serve as the basis for effective integration. Today, Russia is modernizing its sea and air ports in the Russian Far East, developing transcontinental rail routes, and building new gas and oil pipelines. We are committed to bilateral and multilateral infrastructure projects that will link our economies and markets — such as the Energy Super Ring that unites Russia, China, Japan and the Republic of Korea, and the Sakhalin-Hokkaido transport link.

We are particularly focused on integrating Russia’s Siberian and Far Eastern territories into this broader network. This includes a range of measures to enhance the investment appeal of our regions and to integrate Russian enterprises into international production chains.

For Russia, the development of our Far East is a national priority for the 21st century. We are talking about creating territories of advanced economic growth in that region, pursuing large-scale development of natural resources and supporting advanced high-tech industries, as well as investing in human capital, education and health care, and forming competitive research centers…

We intend to engage in substantive discussions on all these topics at the 25th APEC Economic Leaders’ Meeting this week. I am confident that, acting together, we will find solutions to the challenge of supporting the steady, balanced and harmonious growth of our shared region, and securing its prosperity. Russia is ready for such a collaborative effort.”

Fed Watch:

India Watch:

China Watch:

China Technology Watch:

  • Google tries to enter China again with AI Bloomberg)
  • How China will rate its citizens with AI technology (Wired)
  • China’s focus on practical AI application (Arxiv.org)

EM Investor Watch:

Technology Watch:

  • The power plant of the future is your home  (WEF)
  • The Future of the car, Bob Lutz (Auto News)

Commodity Watch:

Investor Watch:

  • ETFs are no bonanza for Wall Street (WSJ)
  • Jeremy Grantham, why this time is different (WSJ)
  • Isaac Newton’s lesson on financial gravity (WSJ)
  • Caxton Partners on macro investing (Bruce Kovner)
  • The frustrating law of active management (Thinknewfound)
  • Fees on active share eat up returns (Thinknewfound)
  • What makes a great investor (Macro-ops)
  • Buffett and the power of compounding (Collaborative Fund)