GOLDMAN SACHS COMMENT: Apple, China and the Growth Markets

By Jim O’Neill, Chairman, Goldman Sachs Asset Management.

This past week, I spent 3 days in the US, in New York and Chicago. The main purpose of my NY visit was to host our 2nd GSAM Growth Markets Summit, which was quite an event, with many interesting speakers, panels and a great list of clients. Thank you to everyone who participated in making it such a success. I have done hundreds of these events in my career, and frankly, this one was right up there.

In terms of the concept of the Growth Markets, the event couldn’t have had been better timed. Literally an hour before the opening dinner, Apple released its Q1 earnings and it was a blockbuster. Even I, as so-called Mr. BRIC, was blown away by their staggering sales to China. Is there anyone out there that still believes the Chinese consumer isn’t important?

It became my obsession of the week. In Chicago, I had a number of group meetings and in each of my meetings, I asked the audience how many owned Apple stock. Three of the meetings had quite large numbers, and the answers varied, but it was usually at least 20 pct.  In one meeting, it was closer to a third. I followed up that question with another, “how many of you realized you were making a bet on the Chinese consumer?” The answers to that were very small. But that is what it was in Q1. Twenty percent of the company’s astonishing revenues now come from China. It is literally fantastic. The company’s own statement alluded to the remarkable opportunity afforded by the Chinese consumer, and suggested many others could benefit dramatically too.

In much of the market and media discussion I followed last week about Apple’s future and its value, not surprisingly, many worry that they may end up with the same fate that came across other past market champions and one can see why.  The challenge of sustaining this degree of growth is not easy. But if you look at Apple in the context of the Goldman Sachs 2050 scenarios for China and their consumer, the potential sales are multiples are what they are today.  And, if the brand can stay fashionable, wow.

As I said at the conference and to virtually anyone I met in the US, I can only hope that someone in Washington close to both Presidential hopefuls paid attention to those results.  After this, I can’t quite see how any US political figure can seriously contemplate trade sanctions and accuse China of unfair trade behavior and persist with – in my view, increasingly irrelevant – exchange rate issues.

Our Growth Market Conference.

As I mentioned, we had a remarkable array of guest talent in attendance, ranging from ex central bank leaders, Greenspan and Meirelles, to a panel including Divya Keshav, a woman from GS’s exciting 10,000 Women initiative.  It would be unfair for me to try and summarise what each speaker said, but I can repeat the two core themes I presented at the start to frame all the subsequent discussions.

First, a number of so-called emerging economies are now so big, that it is ridiculous to think of them as traditional emerging markets. Currently, we think this applies to a group of 8, each of the 4 BRIC countries, Brazil, Russia, India and China, along with Indonesia, Korea, Mexico and Turkey. Collectively, they are already 25 pct of the world economy.  And, in the decade we have started, their combined GDP will contribute more than 2 times that of Europe and the US put together. At GSAM, we call them Growth Markets.

China, at the core of them, alone will contribute more than the US and Europe together (assuming 8 pct real GDP growth). As you have seen me write before, China is currently contributing the equivalent of another Greece every 11 and ½ weeks.  But I also threw in that they are creating another Spain every 15 months.  And, the 4 BRICs collectively last year nearly created the equivalent of a whole new Italy in one year. Italy is the 8th largest economy in the world, and for the BRIC countries to be creating the economic equivalent of another one at that speed is remarkable, and demonstrates the speed at which the world is changing.

I have seen some observers pay more attention to the Q1 earnings results of Caterpillar, more than Apple, picking up on their weaker-than-expected sales to China. This was undoubtedly interesting, but simply confirms that investment and the infrastructure spend has eased. As I suggested to one of the people who sent me the Caterpillar information, the contrast between Apple and Caterpillar in some ways is a really neat reflection of how China is already rebalancing its economy. Reports on this past week’s Beijing Auto show talked of an absolutely packed event with all sorts of exotic ranges selling well.  To me, this is a further sign that the Chinese consumer is rather lively.

There was plenty more discussion about China (and all the other Growth Markets) in the various panels and sessions.  Two recurring themes were the issue of innovation and the political structure of China, especially in view of current events in the country. On the topic of innovation, one of our highest profile US guests expressed a degree of inability to understand the Chinese miracle, and doubted it could continue without more innovation, which required political change. Another high profile domestic Chinese media host presented at lunch time and showed us plenty of evidence of change and innovation actually occurring. I didn’t find the opportunity myself to point out that at a meeting I participated in the previous week with one of China’s top policymakers (often perceived to be a non reformer), he cited innovation as the first of 5 goals of the current 5 year plan. Most interestingly, when I returned to the UK Friday morning, it was fascinating in view of all these discussions to see the front page FT article headed “Drive for Reform boosted by Bo’s fall”. This is my impression too.

Asset Allocation and Growth Markets.

Views of Investors.

Before the conference, we solicited client views by sending them a questionnaire on various topics relating to most of the sessions we planned. As they related to global and Growth Markets macro issues and the markets, the following questions and answers are perhaps interesting for readers: 

  1. I believe the world can grow faster over the next 10 years than it has over the past 10 years.  50 pct of those who responded (about half responded) said Yes; 40 pct, No. I joked that I would try to persuade some of the No’s during the day.
  2. How likely is it that Africa will be a significant force in the global economy by the end of this decade? 51 pct Yes; 32 pct No.
  3. Could the US dollar ever be replaced as the dominant international reserve currency? 64 pct answered Yes; 28 pct, No.

I will mention some of the other questions and answers below.

The second key part of my scene setting was to present GSAM’s views on the way to approach fixed income and equity markets from a global asset allocation and benchmark perspective against the background of how we see the world evolving.

For equities, I mentioned our recently launched “GIVI” index, a passive Global Intrinsic Value Index, (formerly called Equity 3.0) that is built around the idea of combining restrained volatility, valuing companies relative to their book value and analyzing companies’ earnings growth potential globally irrespective of their home location. If you optimize such a model, it gives you close to double the benchmark allocation to Growth Markets than a market cap benchmark would, despite less volatility. It is, by definition, less exposure than those that prefer GDP-weighted benchmarking.

For fixed income, where our latest Monthly Insight published some of our preliminary findings, a GDP-weighted benchmark approach seems more appropriate than equities (In equities, many Western companies can give you the exposure through them).  I showed that more than 20 pct increased allocations to Growth Markets debt markets (7 of the 8 countries coincidentally would satisfy the stringency of the original Maastricht fiscal criteria, unlike virtually any of the current EMU members), most of it coming at the expense of Japan.

In our pre-conference questionnaire, we had also asked clients:

  1. What is the optimal way to access the Growth and Emerging Markets consumer in your investments? 71 pct responded that it was through both developed and local companies; 18 pct said through developed companies; and just 11 pct said through local.
  2. Do you think benchmarks that incorporate an element of GDP-weighting could present a viable alternative to market capitalization weighted benchmarks? 25 pct said they didn’t have an opinion, 49 pct said Yes; 18 pct said an alternative was needed, but that GDP-weighted benchmarks were not the right one; and 9 pct said no alternative was needed. (I mentioned in my opening comments that we hoped to persuade some people to get the percentage to Yes above 50 pct.)
  3. How is your allocation to investments in the emerging markets likely to change in the coming year? 68 pct said they were going to increase allocation; 27 pct said they would maintain their current allocation; and just 2 pct said they would reduce.
  4. How helpful do you believe a local presence is in the pursuit of alpha generation in emerging market equities? A large 81 pct said Yes; 15 pct answered marginally; and only 1 pct said not helpful.

The US Economy and Markets.

Last week was a mixed week for US economic data, with the first estimate of Q1 real GDP growth disappointing at 2.2 pct, and within that aggregate, the degree of support from inventory growth was higher than most expected. All of this added more fuel to those expecting slower growth ahead and to those worried about the forthcoming “fiscal cliff”. At any of the sessions in our conference where the US was discussed, there was unanimous agreement that fiscal issues were worrying.

A further modest rise in weekly job claims also added to the evidence that the US has lost some momentum, although how much of this is weather related remains debatable. It was interesting to see Fed Chairman Bernanke last week elude to the weather as distorting previous data to the better, but also possibly recent data to the worse.

Against this data, the news flow about the housing market was to the better, and in discussions I had with people including some in Chicago, I hear more and more evidence that the housing market is turning. I also pick up anecdotes along the same lines from real estate contacts I know in Sarasota on the Gulf Coast of Florida, where the bust bit as savagely as many areas of the country.

It is also true, as I believe this weekend’s Barrons points out  , that if you exclude the drop in government spending, the GDP growth rate for the quarter would have been 2.7pct,  a rate that has been sustained for some time now.

Very interestingly, we asked clients about the US outlook also ahead of the conference.

“I am optimistic about the prospects of the US economy over the next 12 months.” A rather surprisingly high 66 pct answered “I agree.”

I can’t finish without some reference to the ongoing joys of immigration into the US these days at JFK. There have been recent stories about the horrors awaiting visitors to the UK about the lengthy delays as a result of staff shortages at Heathrow. Well, it is true at JFK also. For the second time this year, I endured a lengthy delay. This time, 1 hour and 5 minutes. Staggeringly, when I dared to mention my disappointment to one of the few staff in the AA arrivals hall, I was informed that between 2-4 pm, staff either disappear on a break or change shift.  And, as we experienced last Tuesday, there are often days when there are no devoted staff to process international visitors, so you just have to wait until all US citizens are checked through. Anyone ever heard of technology in the airport management business?

Europe. An Ongoing Mess.

Despite the fact it was a Growth Markets conference, this gloomy topic did get discussed with one of our most high profile guests mentioning at the Tuesday dinner that he believed the biggest re-election risk to President Obama was the Italian bond yield. It was not a good week again for Europe last week, although it is interesting that European equities had quite a bounce from the early week savaging. In addition to confirmation of advance polling that we might be looking at President Hollandes in France, domestic angst about the questionable rigours of the Fiscal Compact were on the rise everywhere last week, including fiscally responsible and conservative Netherlands.

On top of this, and in marked contrast to the better-than-expected IFO the previous week, the flash April PMI was highly disappointing, and there is some justification to fears that the Euro Area recession may be deepening. The evidence was enough to result in a marked change in tone from ECB President Draghi, and talk about “Growth Compacts” are suddenly all the rage.

Not surprisingly, many wise observers are once more extremely worried about the stability surrounding EMU and highly uncertain about forthcoming developments in terms of policy and economic matters. Perhaps the appearance of a left-of-centre French President may result in another fresh policy effort across the entire Euro Area, which gives more attention to supporting growth as opposed to deflationary fiscal retrenchment and reform? When I put this to anyone, it is met with almost derision, which given European policymakers ineffectiveness and ability to disappoint, is unfortunately not surprising. Of course, this means that if there were a genuine shift from the past few months in terms of the cyclical thrust of fiscal policy and with the underlying stance of the ECB, it would positively surprise us all. But I guess we shouldn’t hold our breath.

The UK back in a Double Dip?

As feared by a minority, the first estimate of Q1 GDP in the UK declined by 0.2 pct, allowing headlines of a “double dip recession” to dominate the airwaves here. The difference between the official GDP data and widespread useful survey data is even bigger than usual.  The number of observers that discredit the official data is rising, quite rightly in my view. Interestingly, this was the verdict of UK-related financial markets also.

Japan, the BOJ and the Yen.

The Bank of Japan eased more than expected on Friday, yet the markets reacted negatively and the Yen rose. This reaction is quite hard to explain, although the complex nature of how the BOJ is easing further and some unhelpful remarks from the Governor, Shirakawa, after the decision didn’t help. I had expected the easing decision as apparently did many others, but for the Yen to rally afterwards is quite perverse. It seems to me that the only reason the BOJ had decided to ease is to actually help the previously weakening Yen decline further. As I have discussed with a number of people before and since, without a notable Yen decline, it is not clear how the BOJ can get close to reaching its new 1 pct Inflation Target.  And, given that it appears to be reasonably genuine, they are simply going to have to do more. If the Yen strengthens further early next week, then the BOJ will be under immediate pressure to do “more,” irrespective of what the Governor said Friday. I continue to believe that the Yen will weaken considerably this year. The biggest risk to this view is that the recent disappointing data in the US is the start of a new trend and not, as I continue to suspect, some temporary softening.

And so to Monday Evening.

Has there, quite simply, ever been a bigger Premiership match? I am not sure quite what to do with myself.

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