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6/5/2018 0 Comments Chinese DebtChina has been in the news lately from trade wars and a tightening of power, also navigating the financial crisis and starting the belt and road initiative. The market has polarized viewpoints of where China is headed in this century. While some feel that China will become a rising threat as it grows into the largest economy in the world, others feel that the authoritarian system will collapse under the weight of free markets. The reality is more nuanced and will be somewhere in between. The polarization of China's future is a result of absolutism that works in politics but does not make for good investment strategy. We will use these polar theories as a basis for our theory and work our way back to an investable position somewhere in the middle.
China is taking over the global economy: Trade talks about intellectual property theft and unfair sanctions make it easy to see this as a war against the United States, on an economic front. I do agree that something needs to be done about the way foreign companies are treated in exchange for access to the Chinese market, this has been a long time coming. All free market companies that wanted to tap the gold mine of Chinese consumers must abide by the Chinese rules. This usually meant partnerships, technology sharing and only having minority positions in Chinese companies. All these companies had to go to China to look for growth to remain competitive and increase shareholder value, so they obliged. China is at a point where they are looking to move up the value chain which would seem to be direct competition with the developed world. This is a threat, but not one that came out of nowhere. There will no doubt be more challenges to China's expansion as the centralized government will have to start playing by international rules more often in the services sector. In the long run, China will become a competitive force around the world and will have to be accounted for by countries and companies. China's government will collapse from the free market: The communist government is trying to keep the benefits of a free market economy open while maintaining rule over social policies. Not allowing companies to fail in order to keep unemployment from creating unrest will eventually prove unsustainable. The high growth rates currently seen are bound to drop off, and as the government tries to stem spending and overcapacity (from the companies unable to fail) prices will be depressed, putting solvent companies into 'zombie' status as well. This cycle will continue until the government is propping up the economy by itself, running the country's finances into the ground. This will cause the social net of the country to break down and social unrest will lead to revolution and a collapse of the government. The reality in between: The rise of China has been remarkable and there are no signs that this trend is going to end. Growth rates are enviable, and the market is not struggling with the socialist government increasing censorship or scaling back sectors to prevent overcapacity. The transition of Xi Jinping to the 'party leader for life' hasn't caused any upheavals, in fact, having a longer term central ruler could allow the state to take the necessary solutions to some of their issues that wouldn't be possible in an election cycle like we see in western countries. Due to this, it is good to look at China as a focal point for growth into the foreseeable future. Knowing what is going right is one part of the equation, the other is to know what to keep an eye out for that could jeopardize the longer-term prospects of the country. While growth has been strong in the country, a lot of it is fueled by debt. This debt load is one of the largest factors to keep an eye on when assessing long-term risks in China. By having the ability to wait out geopolitical and cyclical storms, the government will be able to successfully navigate South China Sea concerns and temporary slowdowns in the economy. Debt is where there is cause for concern, by having too much debt on the books, smaller issues could turn into larger ones if payments become unmanageable. With bold investments like the belt and road initiative, China will be loaning out money to countries to make this a reality. The amount of money borrowed by these countries (usually from China) to build the infrastructure will have to be paid back or it could put China into a precarious position. Acting in these countries will create a costly precedent of intervention like we see with the US, with China spending even more money to ensure stability in all the countries in which it has interests. The other options are to assume that some of these loans will go bust or create a constant need for bailouts and investment (this could be why China created the Asian Infrastructure Investment Bank). Overall China should continue to be a big factor in any long-term portfolio, as part of an emerging market mix. The question is a matter of how much should be invested in the country and what to look out for in terms factors that could affect growth prospects. Keeping an eye on key factors like the debt load, overcapacity, and the financial markets in order to look for whether China should be invested into as part of a weighted emerging market allocation or have less money allocated to wait for a better opportunity to invest.
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1/31/2018 0 Comments European DisunityThe Eurozone has seen a strong recovery over the past two years. At the end of 2017 the ECB raised the projections of 2018 to be around 2.3 percent. This upward trend was seen across almost all Eurozone countries and is some of the strongest performance since the crisis. As a result, markets have rallied, the currency is at its highest point since the last quarter of 2014, and bond spreads between countries have narrowed. In order for the prosperity to continue there needs to be some changes taking place in this time of strength to address the underlying flaws still present with the current state of the union.
The two speed Europe did not entirely disappear. The success of the bloc could open up some of the rifts that prolonged the Euro crisis in 2011. All of the Eurozone countries are benefiting from the massive stimulus program implemented in the second half of 2015. While this program was extended out to September of 2018, the amount purchased per month has been cut in half. With strong economic numbers many are thinking the reduction in purchases and rate increases will have to come sooner than expected. This is where the politics, policy, and unity of Eurozone countries will play a decisive role in the continued success of the European recovery. In the past the Eurozone countries did the bare minimum to ensure that immediate threats to the bloc were addressed but on a larger scale, did nothing to bring the countries fiscal affairs any closer together. This isn't a pressing concern now because of stimulus narrowing the different costs of borrowing in each country, essentially bringing competitiveness back in line between countries. Now that stimulus is winding down these countries yields will have to remain low on their own merit. Failure for this to occur would out the bloc back into a two speed Europe as competitiveness of the periphery countries hasn't been addressed. On the other side of the spectrum, if these less competitive countries do not keep their growth rates in line with the likes of Germany and France the ECB will delay and rate increases farther out into the future. This will be acceptable so long as Germany participates in the slowdown as well. If not, and inflation in Germany rises, the German government will have to accept this to allow for other countries to catch up in competitiveness, or start to push the ECB to look out for its interests. This time truly is different in the political spectrum. In the early years of the euros crisis all of the countries would come together at the last minute to ensure a deal, and prevent countries from leaving the Euro or defaulting. Now the European landscape looks much different. Britain, while not in the Euro, has voted to leave the EU and shows how messy that can be in practice. Germany is still trying to hammer down a coalition government after Angela Merkel and her Christian Democratic Union lost their majority, and nationalists have taken a greater piece of the pie in parliament. This is not isolated, nationalistic parties have gained in popularity as the refugee crisis and an unequal economic recovery shifted the balance of power we saw in the last crisis. France was spared a nationalistic government but now needs Germany to form a government in order to press its agenda. Italy will be voting in March and, at best, we will get gridlock. Periphery countries are voting in leaders less willing to take more austerity, and core countries voting in governments less likely to agree to more bailouts. The current balance of improving growth, low inflation, and tight yield spreads will need to remain in an environment with more elections, less stimulus and immigration still a topic on everyone's mind. |