Abney Associates Financial Advisory: Confidence key to emerging markets
At the beginning of the year, there were three potential areas of asset allocation that very few global portfolio managers wanted to consider seriously. As I travelled around the United States and elsewhere in the world, almost none of our clients wanted to hear about Japan, commodities or emerging markets, Ameriprise Financial Abney Associates Team.
So far they have been wrong about commodities, which are a part of my radical asset allocation and have broken out of their trading range and headed higher. The standard of living continues to improve in the developing world, and one of the first things consumers do when their income increases is start to eat better. This means more meat and poultry where grains are used for feed as well as more consumption of grains by individuals. As a result of continuing growth in the developing world and flat to uneven agricultural production because of variable weather, prices for corn, wheat and soybeans have risen.
The Russia/Ukraine situation has also had a broad influence in the emerging markets because it has highlighted the second reason for investor concern, the issue of political risk. The governments in many of these countries have only a tenuous hold on the power to influence the future course of economic growth. While Ukraine was never an area of investor interest, Russia’s action there caused concern throughout the developing world.
At this point, I do not believe Putin will move further toward strong military action, although there is much informed opinion on the other side. The new presence in Ukraine of armed gunmen in unmarked uniforms occupying government buildings replicates the situation in Crimea prior to the referendum. If Putin moves to take over eastern Ukraine, I think it would be a strategic mistake for him. The response from the West would be a strong, and the sanctions already imposed have had a negative impact on Russia.
He would be much better off waiting until later or moving very slowly now. Some of Putin’s closest advisors are for cooling the situation down but Russia’s leader is both ambitious and unpredictable. One would be wrong to be complacent about the situation. Ukraine has revived concerns about political instability in the developing world hurting emerging market equities across the board.
During my trip I had an email exchange with my former Morgan Stanley colleague Steve Roach, who was in Asia discussing his book on the rebalancing of the Chinese economy. He and I have been in a dialogue over the last few months about how much the Chinese economy will slow down if the consumer segment becomes the dominant driver of growth rather than credit-driven spending on state-owned enterprises and infrastructure.
CHINA’S POLLUTION PROBLEM
Several discussions in Beijing yielded insights worth passing on. One investor was concerned about similarities between China now and Japan in the 1980s. During the 1980s numerous books were written about how Japan was doing everything right, with robotics increasing productivity, very strong export growth and soaring real estate values. Japanese technology and consumer electronics stocks were US sharemarket favorites back then. Suddenly it was all over and the Nikkei 225 declined 75 per cent, and today it is trading at 35 per cent of its peak level.
I pointed out some significant differences. China has a population 10 times that of Japan. Its per capita income is one-tenth of that of the US, and by improving its standard of living, China can hope to see its economy grow for a long time, especially if it is successful in shifting the components of growth toward the consumer. Also, China has a centralised government structure that can make decisions quickly and implement them without delay. This is in sharp contrast to the Japanese Diet, where the legislative process can drag on endlessly in a manner similar to the US Congress.
WIDE-RANGING GEOPOLITICAL CONCERNS
Everywhere I went in Asia, investors were sceptical about their home markets, but Japan was extreme in this respect. Perhaps it was because the Nikkei 225 had a difficult first quarter and is down 14 per cent in yen and 11 per cent in dollars so far this year. In the longer term, the ageing population will cause the work force to peak in the next few years and this would make growth difficult. The country has initiated a guest worker program to mitigate this.
Investors wondered why my asset allocation had a 5 per cent position in Japan in the face of all of these problems. My response was Japan was clearly out of favour, few institutions held positions, the economy was finally growing and recent data was quite positive. Finally, there were a number of reasonably valued stocks available. I thought the risk of a further decline was low and there was an opportunity to make money from these levels if and when investors turned constructive.
In discussions with Asian investors, I addressed their geopolitical concerns, which focused on Russia and Ukraine, Israel and Palestine, the Iran nuclear threat and, particularly, the disputes between Japan and China over islands and fishing rights in the South China Sea. The thrust of their questions was whether the world is on the brink of armed conflict in a number of different places and this would destabilise the markets.
My views on Russia/Ukraine were described earlier. Regarding Iran, I think the sanctions are working and I probably would have demanded that Iran dismantle its centrifuges before offering any relief, but that may have been diplomatically impossible. Now we have to hope that Iran is serious about reducing its nuclear effort; we should have the answer to that in a few months.
The Israel/Palestine conflict seems unresolvable. Neither a one-state nor a two-state solution appears possible. The Arab world refuses to acknowledge Israel’s right to exist and Israel refuses to reduce the settlements in territory it feels is legitimately part of Israel. Even US Secretary of State John Kerry is frustrated by his inability to make progress there.
As for the South China Sea, which is so important to that region, I am hopeful that a diplomatic solution can be reached. China is very proud of its military progress, but is more concerned with the growth of its economy and not anxious to be distracted by armed conflict with anyone at this time, in my opinion. Perhaps I am naïve in thinking hostilities are not going to take place in any of the major trouble spots in the near term, but over the past decade I think everyone has learned how little has been gained by going to war.