So, as we go further into 2021 I intend to stick with my two main investment calls – bullish on emerging markets (AND China) and commodities. I separate out EM from China for reasons already stated – they are increasingly two very different asset classes.
On this double asset class call, I have two interesting notes from researchers today.
The first is from Cross Border Capital which has just put an excellent primer on why they think Chinese liquidity will broaden in the next few months. On a side note, the point about liquidity is crucial – China flows are increasingly structurally, systemically important.
According to Cross Border “China accounts for 18% of World GDP, compared to 24% for the US, in current US dollar terms, but measured by her pool of liquidity, China outweighs the US 28% to 24%. In fact, in 2020, China supplied nearly one-third of the US$22.7 trillion surge in Global Liquidity, even besting America’s 23% supply. What’s more, the recent growth of China’s financial muscle has been immense: in year 2000, China provided only 7% to Global Liquidity or barely one-fifth of the then US contribution”.
So far data on liquidity has been fairly tepid for China – the People’s Bank’s (PBoC) balance sheet rose by 4.5% over the year, lifting the monetary base by barely 2%, including the near 20% build-up of PRC deposits at the PBoC.
But Cross Border rightly in my view emphasise the structural determinants i.e the fact that China is really a command economy wedded to market structures. These structural constraints almost dictate that liquidity must increase.
“China’s skewed income distribution restricts household consumption. This fact dictates the economic structure and underscores the need for government spending, largely on infrastructure, and on foreign export demand (note how the Belt and Road Initiative neatly harnesses both) to drive GDP. In turn, this economic model requires funding through ‘forced savings’ (e.g. fixed deposit rates) and ‘directed lending’ (e.g. policy banks and SoBs), which necessitates loose liquidity policies and debt accumulation”.
And there is another factor to consider. “China plainly wants to increase the use of the Yuan but the problem for China’s policy-makers is that wider use of the Yuan will push up the Yuan’s real exchange rate and so damage Chinese export competitiveness”.
So, China will want to curb any liquidity outflows out of the US into China badly impacting its exchange rate. Thus, it’ll need to constrain domestic currency appreciation. “Such interventions have nearly always led to positive increases in domestic liquidity”.
And for investors the message is simple: Buy commodities. Buy China ‘A’ shares
I agree with that analysis but would adda third leg. Buy emerging markets.
On that note, I’ll segway to the excellent note below from Charles Ekins of Ekins Guinness, a small research-driven fund manager who runs multi ETF portfolios. I find Charles’ asset allocation analysis is usually spot on. His latest note suggests that now may be the time to move back into emerging markets stocks.
According to Charles
“The attraction of Emerging Markets is a combination of valuation and improving relative trends. Emerging Markets have shown modest but sustained outperformance against World Equities since May last year, which has caused trends in the relative price index to turn up for the first time in a while. Asia has been strong in relative terms (our model has already been overweight in Asia for some time) but Emerging Markets overall have been held up by poor performance in Latin America.”
“This recent outperformance of Emerging Markets versus World Equities is very modest compared to the significant underperformance since the relative peak in 2010. Our model has for the most part avoided Emerging Markets since this relative peak in late 2010 (red shading below) but the graph is now turning green again and our allocation to Emerging Markets is likely to increase further.
“The peak in relative price by Emerging Markets in 2010 (above) coincided with the trough in relative Value Yield (below) of nearly -2%. Emerging Markets have underperformed for many years chiefly because they had, by 2010, become very expensive in relative terms. The underperformance slowed in the last few years despite having rebuilt in value because of other (economic) reasons which have held them back from outperforming. However, relative Value Yield of +1.1% now is attractive and investor sentiment seems to be improving.
“This is a classic Value and Trend/Momentum reason to start re-investing into Emerging Markets.”
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