I recently read that “climate strike” was chosen as the word of the year for 2019 by Collins Dictionary, after its usage rose 100 times in the past 12 months.
I’d argue that “geopolitics” has been the dominant word in the global economy this year, with Brexit and trade wars monopolising the headlines – often for the wrong reasons. And it’s reached the point where you become slightly de-sensitised to the news flow, as both appear long-term, multi-year events.
However, at our recent Fundcalibre investment trust dinner I had the pleasure of speaking to Murray International trust manager Bruce Stout, who had some interesting opinions on the trade wars, and particularly why the US is facing a losing battle if things turn nasty.
I’m not going to give the back story on trade wars, but what we do know is the narrative and sentiment changes on a daily basis, thanks largely to an irascible US president and his very active Twitter account.
Bruce talked to me about just how much China has changed since he first visited in 1985, having travelled on a wooden train, for example, to get from Beijing to Canton. It goes without saying that China has done a great job of moving on since – with infrastructure, education and tourism all playing a major role.
According to figures from the International Monetary Fund, the US is still the largest economy in the world with a value of $20.4trn – with China second at $14trn* – but that’s changing fast, not only in terms of growth, but generational changes in the economy.
There is an argument that the undertone to the trade wars is nothing to do with currency manipulation, but rather the US being unable to accept it is going to have a decline in its standard of living – because the unfunded liabilities on the sovereign balance sheet are huge (under-funded pension and healthcare liabilities). These are what people bought into the American Dream for in the 1950s and 1960s – the ideal that the state would look after them at retirement age. Now they’ve got to retirement age to find out otherwise.
By contrast, China has large tailwinds. It’s moving to a consumption-led economy and, when that happens, households will start to leverage. They may end up with huge levels of debt like we do in the developed world in 20 or so years, but in the process they will buy a lot of goods – and who has all the consumer goods that they want? The US in abundance, making protectionist attitudes all the more questionable.
There are two important elements to consider in the US-China relationship. First is the import of food from the US to China – an area where China is vulnerable as it cannot generate enough to cater for the migration of people from rural areas to cities. On the other side, the Chinese own about 25% of the US bond market and have effectively financed the US current account deficits for the past 20 years.
There is huge inter-dependency which means protectionism again makes little sense. But if things do deteriorate badly – surely China will be the winner as it does not have the sovereign indebtedness – through unfunded liabilities – the US has. For the US, its national outlook cannot support its level of income – effectively living beyond its means.
The US also has a political cycle every four years – which means policy can be swayed– but the deficit it has got is a deficit in demand. The reason for this is that it had its golden generation in the 1950s and 60s ,when people started to own property and reached a level of income and acquisition – they have their houses and their cars. US demographics are also poor, with its baby boomers likely to be more disgruntled than Chinese baby boomers – who have not been promised healthcare and a pension.
These are trends the US will struggle to reverse. There is also more monetary and fiscal flexibility in China – two levers the US has already pulled.
One other tool China has in its armoury is the ability to wait and see if Trump does not make it past the next election in 2020. China has shown an ability to play the long game many times before, and it would not surprise me if it did so again.
If you want to invest in shift towards China you may want to consider the likes of the First State Greater China Growth fund, managed by Martin Lau and Helen Chen. The fund has an absolute return mindset and invests in quality companies for the long term. It looks for sensible company management and businesses that have both sustainable and predictable growth. Another to consider is Matthews Asia Pacific Tiger, a core Asian equity fund that currently has its largest weighting (43%) in Chinese and Hong Kong equities**.
Those wanting to go down the investment trust route may like to consider the Fidelity China Special Situations trust. When building his 120-160 stock portfolio, manager Dale Nicholls believes that the best investments are in those companies that have good long-term prospects: cash-generative business that are controlled by a strong management team.
*Source: International Monetary Fund figures 2018
**Source: Fund factsheet, 30 September 2019
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
