Dear Valued Investors,
There is a popular notion at the moment that we are in an artificial world. Artificial in the sense that zero interest rates and incredibly easy monetary policies are creating immense distortions in financial markets, and that soon the day of reckoning will come when this fake edifice will come crashing down in a financial crisis. How this will happen is uncertain—an inflationary catastrophe? Or maybe rising interest rates? So pervasive is this idea that some people are arguing for an early rise in rates to get the inevitable pain over with sooner rather than later. I am not convinced that this view of the world's economies and markets is right.
In fact, in speaking with CEOs at a conference in Hong Kong in March, I found myself thinking just how “normal” things appear. I did not hear many stories from these executives that would fit with a “bubble- like” view of the world. 2014 was not, in the eyes of many, a particularly easy year. By and large, capital expenditure plans that companies are outlining for the coming years do not appear over-optimistic or based on assumptions that they can easily pile on new debt. Rather, they are more cautious and sober. Despite the low interest rates across the world, this is not 1997 revisited—not in general. Now, I realize that we can point to some parts of the region where taking on U.S. dollar debt because of low funding has been increasing. Thailand and Indonesia spring to mind. But I don't see those excesses shared across all companies in those countries. "We've learned our lesson!" one company representative told us, even as he admitted that others had perhaps backtracked. I have no reason to disbelieve him and I do not think that the excesses we see in some companies are repeated generally across the region. China for sure has increased its use of U.S. dollar debt dramatically, if one looks at the year-on-year growth, but the actual amounts are small in relation to GDP.
Nor do I hear the signs of hubris, either from CEOs or from the policymakers. Here, China is a good example. The slowdown in headline growth will continue, we are told. Stimulus is not the answer. What is needed is greater transparency and predictability in China's markets and legal institutions, in order to engender trust in its market economy among both domestic and foreign investors. We hear similar kinds of views from policymakers in Japan, South Korea and from the Association of Southeast Asian Nations (ASEAN). It is remarkable that Asia continues to embark on supply-side reform and institutional improvements, such as refocusing on corporate governance and driving economic efficiency. It is not the sort of thing that one usually associates with “easy money” environments in markets and economies.
If anything, one would be tempted to think that money has been anything but easy in the last three years. Prices for commodities—coal, oil and metals—are falling. Just recently, I heard of quite a deal of sensitivity from mid- to lower-wage consumers toward price increases for the products of an ASEAN food and beverage company. Plans for cost-cutting and rationalization are commonplace in the discussions I have. Investors also do not lately seem "starry-eyed." A shrug, a deep exhale and a wrinkling of the nose, appear to be the most commonplace response to the question: “What do you think about the markets?” Nobody seems to have unrealistic expectations.
My view on this is that sentiment gets like this in Asia when the U.S. dollar is strong and headline growth is weak. And we have been going through this for the past three years. But we have not had a crisis of confidence, nor have we seen economies slump. Rather, we are seeing companies competing in a tough pricing environment and in a regulatory environment that is pushing for more market-oriented reforms. Government and corporates are doing the hard yards—one is stimulating more competition; the other is trying to fight it off! Isn't this how things are supposed to be? This smacks to me of “normal” capitalistic growth in a low inflation world. I can see very little that is artificial about this. Rather the contrary! Indeed headline inflation rates in Asia have been falling along with nominal GDP growth rates. To use a well-known metaphor: the tide has been receding and weaknesses on individual corporate balance sheets, in the banking systems, or in government debt are generally exposed to all, if unable to be calculated exactly.
So, where do we get this idea that the markets are supercharged by false monetary policies? In my view, it is the confusion between interest rates as a policy tool and as an expression of current conditions. For, even as policy rates are close to zero, inflation rates are still low and long bond yields are tumbling in some parts of the world, as lower growth and deflation expectations are setting in. No, this is not a fake environment of easy money. If anything, the risks to global and Asian economies come from a further tightening of policy.
You can also see this in the reaction of the markets. As headline growth has been harder for companies to come by and as price competition has intensified, the valuations of companies that are able to maintain pricing power and continue to grow more predictably have held up. Those in weaker competitive positions have seen their operating results, and the valuations placed on them in the markets, diverge from their more competitive peers quite significantly. This has been helpful for the performance of our portfolios. It is not that we are trying to time this phenomenon, by any means. Rather, due to our singular focus on the region and our strategic view of stock selection, we are naturally drawn to those companies that we think are better able to navigate the bad times, instead of trying to pick those companies that rise to the top only in the good times.
So, it might be true that the last two to three years have not been as easy for Asia's markets as appears to have been the case for the U.S. But, in my view, creative destruction, where the strong replace the weak, has been hard at work in Asia recently. There may be more hard grind in the months ahead, but I do believe that it is laying the groundwork for better growth in the future.
As always, it is a privilege to act as your advisor for Asian investments.
Robert Horrocks, PhD
Chief Investment Officer