Investment opportunity knocks amid global economic divergence

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This article first appeared in Capital, The Edge Malaysia Weekly on October 23, 2023 – October 29, 2023

A repeat of a near shutdown of the US government, persistent inflationary pressure and surging oil prices on the back of an escalation in the Israel-Hamas conflict have led to greater apprehension among investors. Even so, uncertainty and volatility make for better investment opportunities, says Ricky Tang, managing director and head of client portfolio management at Value Partners Group Ltd.

The once prevailing narrative of interest rate cuts has shifted as inflation appears to be more sticky than expected. The spectre of a US recession, predicted for 2023 but seemingly pushed to 2024, looms large with the backdrop resembling the prelude to the 2008 global financial crisis (GFC).

China, the other super economy, once seen as the saviour of global growth, is now grappling with massive real estate troubles. In this complex financial terrain, investors are left pondering whether divergent global dynamics provide opportunities or uncertainties, and what the future holds for asset allocation.

Value Partners’ Tang points out that while the asset management firm has regional exposure and a multi-asset portfolio, there are different considerations when investing in an inflationary environment versus a deflationary environment.

“The different market dynamics provide us with more alternatives in terms of asset allocation. It is really this divergence in the global economy that presents us with more opportunities. If everything is moving in one direction, as we have seen in the past 15 years with monetary convergence and everyone printing money together, you don’t really have many options,” he tells The Edge in a virtual interview.

“Today, most countries in the world are facing inflation problems, but China is the opposite. As a fund manager, it’s more interesting when we see divergence. We can apply our skills differently in different markets.”

Tang, who has more than 15 years of experience in the asset management and financial industry, concedes that he is growing “a little bit more worried” over the global situation.

“A few weeks ago, the US government came to a near shutdown. Then, we also have an inflation issue, while global oil prices are looking like they could hit US$95 to US$100 per barrel,” he says, noting that a common narrative has centred on the easing of inflationary pressures, and the likelihood of interest rates trending down as a consequence, in the past six to nine months.

In fact, certain quarters were of the view that interest rate cuts could potentially be instituted by as early as next year.

“But now, many people are starting to realise, ‘Wait a minute, inflation isn’t going away anytime soon. It could actually get more persistent.’ This market sentiment has been reflected in the performance of global equities, fixed-income markets, as well as Asian stocks,” says Tang.

The recession that hasn’t come

Theoretically, as supported by decades of historical evidence, a dramatic increase in interest rates to dampen inflation may result in a recession. Therefore, when the US Federal Reserve made its most aggressive rate hikes since the 1980s — raising its benchmark federal funds rate 11 times for a total increase of five percentage points since March 2022 — many predicted that the US would fall into a recession in 2023.

“Obviously, it didn’t happen. We think the possibility of a US recession has been kicked down or pushed back to about six to 12 months, which means it could still happen in 2024,” Tang warns.

Given the cyclical nature of the economy, he observes that the current backdrop for 2024, coinciding with the US presidential election year, bears a resemblance to the GFC.

“Don’t get me wrong, I am not saying next year will be a repeat of 2007/08, but it does feel a little bit like it. Everything seems to be still doing well, although things have started to slow down. There are some signs of pressure in the US economy, just like what we saw in 2007. Then came 2008, which coincidentally was also a US presidential election year,” he says.

According to him, the Fed is likely to hold interest rates at above 5%, while the rate cut could only begin when the presidential election draws nearer.

“In terms of risks, this is a global perspective that keeps us awake at night,” says Tang, who was a director and multi-asset investment strategist at BlackRock prior to joining Value Partners. Before BlackRock, he was deputy head of multi-asset product for North Asia at Schroders, where he helped lead the team in building a multi-asset franchise.

In March, the world witnessed the collapse of Silicon Valley Bank, as well as other bank failures. Since then, the Fed has created a new Bank Term Funding Program (BTFP), offering loans of up to one year to banks, savings associations, credit unions and other eligible depository institutions pledging US Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral.

Tang says if the Fed does not resume the BTFP, the programme will expire in March next year.

“The discussion on whether or not they will continue the programme could also cause volatility in the market. This is definitely something that we have to watch out for,” he elaborates.

While Value Partners does not have a house forecast for the Fed rate, Tang’s personal view is that there could potentially be “one more rate hike probably this year or early next year, and that’s it”.

“By then, we should be very close to the peak of interest rates. But the difference between now and a couple of months ago is the expectation of the interest rate cut, which may not come so soon because people now realise that inflation and interest rates could stay longer than expected,” he reiterates.

Tang observes that inflation is “an interesting thing” as it is “a self-fulfilling prophecy”, explaining that when people expect inflation to accelerate, they tend to make their purchases earlier and, as a result, contribute to the inflation.

“Having said that, I do believe that compared with 2007/08, the US today has more tools to manage prices. It also has more experience in dealing with another potential crisis,” he says.

The number of further rate hikes is “probably less important now” as he believes the real question is, “When will the Fed start cutting rates?”.

“That, to me, is a more important point to consider now. The market sentiment should improve as soon as global investors form an expectation of a rate cut, depending on the Fed’s guidance and language. Personally, I think it could still happen next year.”

Diversify from the US to China

With total assets under management (AUM) of US$5.9 billion as at Aug 31, Hong Kong-listed Value Partners was co-founded by Penang-born value investor Datuk Seri Cheah Cheng Hye in 1993.

Cheah — often dubbed Hong Kong’s Goldfinger as he had made a name for himself in the former British colony — is ranked No 22 in Forbes Malaysia’s 50 Richest list, with a net worth of US$915 million in 2023. The investment veteran is known for his long-term bullish view on mainland China stocks.

Tang, who is responsible for the product strategy of Value Partners’ fixed income and multi-asset capabilities, believes that “purely based on valuation at this juncture”, it does make sense for investors to “diversify a little bit” from the US to China.

“If you look at the S&P 500, most of its returns are actually driven by the top 10 to 20 stocks, especially the Big Tech stocks such as Apple Inc, Microsoft Corp and Tesla Inc. But if you look at the S&P 500 Equal Weight Index, it has been very much flattish this year,” he says.

Tang emphasises that investors should diversify away from expensive Big Tech and artificial intelligence (AI) stocks in the US and put more money into small- and mid-cap companies in other industries. Alternatively, they could consider balancing their portfolio’s valuation by investing in China.

“Yes, short-term-wise, China’s outlook remains challenging. But once the Chinese economy receives policy support from the central government, we believe it could easily give you decent returns, just from the normalisation of stock valuations alone,” he explains.

Earlier this year, many expected the great reopening of China to potentially lift the global economy, but that did not materialise.

“In fact, what we do see is that China’s economy is really struggling due to the country’s real estate issues, which affect confidence in the property sector. Meanwhile, due to geopolitical tensions, some foreign investors have been trying to reduce their exposure in China,” says Tang.

He believes that most negative factors have been priced in by the market and points to the Hang Seng Index — trading at “a very depressing level” of about 10 times — as an example.

“If the US is really going into a recession and if the equities in China and Hong Kong remain cheap, it might present us an opportunity to capture a rebound. I am not saying that their stock valuations could revisit their previous levels, say 16 times and above, because that is unlikely to happen in the next 12 months,” he says.

“But if you look at the Chinese market, which is trading at a price-earnings ratio (PER) of about seven times, it is really cheap. And if it normalises to 10 to 11 times, that’s easily a 20% to 30% gain. To trigger that, we will probably need policy support from the government.”

Turmoil in China’s property market

Last week, Bloomberg reported that Chinese property stocks are on track for a 14-year low, as stress in the sector continues to rise amid slumping home sales and the deepening debt woes of major real estate developers.

At the centre of China’s ongoing property crisis are Country Garden Holdings Co Ltd and China Evergrande Group, its top developers.

Country Garden’s bondholders are reportedly seeking urgent talks with the company and its advisers after the beleaguered property developer missed a US$15 million coupon repayment last week, putting it at risk of default, according to Reuters.

Meantime, Evergrande, another embattled real estate giant, faces the possibility of asset liquidation on Oct 30 when a key court hearing takes place. Hui Ka Yan, the billionaire chairman of Evergrande, was taken by police last month and placed under residential surveillance.

Commenting on that, Tang says the crisis could be resolved if the Chinese central government comes out with a coordinated national policy that nationalises the local governments’ debt.

“Some might suggest that the Chinese government has done a lot already. But we found that these are very much piecemeal stimulus measures,” he adds.

Tang cautions that Chinese local governments had spent tons of money combating the Covid-19 pandemic and are now burdened with debt. “They have a lot of debts, but they don’t have much income. They simply don’t have the budget to support the economy,” he says.

Of late, much of the discussion has been on the possibility of the central government issuing special purpose bonds. In essence, China could nationalise all local government debt.

Tang believes this could be done, considering that the Chinese central government’s debt level remains “rather low and quite healthy”, which means there is still a lot of room to leverage up.

“It’s a little bit like the US in 2008, when most of its debts were in the household sector, and then they did quantitative easing (QE) to nationalise its household debt. When you bring the household debt to the national level, then private consumption will increase. So, what China might attempt to do is a little bit of a repeat of what the US did,” he says.

Tang also says policy support from China’s central government will definitely be a game changer for the country’s economic recovery. He is hopeful that more of such policies, like issuing special purpose bonds, will be implemented by as early as the fourth quarter of this year.

“Scholars and economists have been talking about this possible solution quite openly. The question remains whether or not the Chinese government will listen to it and actually do it. This is very hard for us to predict at this point in time. But they have done it before, so they have a blueprint to follow,” he says.

Tang notes that housing assets accounted for more than 70% of the Chinese population’s household wealth.

“Property prices are not going anywhere. Even if they didn’t go down, they were largely flattish. The problem now is that people are just not willing to spend, so China has to inject confidence back into its population,” he says.

“Hopefully, by nationalising its debt, the local governments could have more leeway to spend, and really try to roll out policies at the local level, to support private consumption. Property is an important part of the Chinese economy. They just cannot afford to let the property market die.”

Overall, Tang concedes that it is still too early to expect a strong recovery in the global economy.

“The US and China still need time to fix their economic problems, such as a potential recession and economic slowdown, as well as the property sector crisis. All these situations remain uncertain. We still have quite a few risks to watch out for,” he says. 

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​A repeat of a near shutdown of the US government, persistent inflationary pressure and surging oil prices on the back of an escalation in the Israel-Hamas conflict have led to greater apprehension among investors. Even so, uncertainty and volatility make for better investment opportunities, says … A repeat of a near shutdown of the US government, persistent inflationary pressure and surging oil prices on the back of an escalation in the Israel-Hamas conflict have led to greater apprehension among investors. Even so, uncertainty and volatility make for better investment opportunities, says … 

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