By Jim O’Neill, Chairman, Goldman Sachs Asset Management.
I returned from a quick trip through parts of Asia on Saturday, thinking that we have reached a critical stage in terms of economic policy and development in many parts of that region, especially in terms of whether this century will turn out to be “theirs” in the way that so many of us believe. On my trip, I spent time in Australia, Hong Kong and Singapore. And while I didn’t visit any of the big five economies – (mainland) China, India, South Korea, Indonesia, and Japan – their developments, especially China’s, is what I spent most time discussing. I shall be returning to the region and the majority of the bigger economies in November.
Of course, it was not possible to avoid discussion of Europe, the US and elsewhere with clients as I travelled, especially as there is so much in the news about them. I shall touch on those parts of the world briefly before I turn to Asia. Before I do that, to emphasize the relative importance of regions for just this second decade of the century, let me repeat something key from our economic assumptions that I occasionally refer to. We are assuming that the eight economies we define as “Growth Economies” – Brazil, Russia, India, China, Indonesia, South Korea, Mexico and Turkey – will contribute around $15 trillion in real terms to the world this decade. This contribution will allow for faster, yes faster global GDP growth of around 4.2% than for each of the past three decades. Of this $15 trillion, one-half will come from China, and another quarter of the total will come from the other Asian Growth Economies. This $15 trillion total will be more than twice that of Europe and the US combined. The Next 11 (N-11) economies, which as well as including South Korea and Indonesia, include another four Asian economies – Bangladesh, Pakistan, the Philippines and Vietnam – will contribute nearly as much as the G7 and more than either the US or Europe.
More Mixed Signals in the US.
As we await the all important payrolls and ISM data, last week was another mixed week in terms of data with only the drop in weekly job claims to encourage the optimists and the notable weakness in durable goods, the highlight to excite the bears.
As from my meetings in Europe the previous week, I found that most people I met in Asia didn’t seem to think that QE3/QE infinity was that important a positive for the real economy, with many thinking that it wasn’t the force that would unleash the private sector animal spirits and might only serve to raise inflation expectations. My view is that while other policy developments are also necessary, especially from Congress post election, I think the Fed’s decision is a step on the road to nominal GDP targeting. Giving such an asymmetric bias to policy until unemployment figures fall is a big development and positive for both nominal US GDP growth and US and global asset prices. In my view, for Asian markets, it is a clear net positive, with the balance of the asset market benefit depending on the currency policy of the specific country. It is a supportive factor for many equity markets in the region.
Europe Woes Back, At Least in Many Minds.
While much of my discussions focused on the region, it was impossible to avoid discussion about Europe of course, especially as last week appeared to be one in which policy co-ordination regressed somewhat following much of the late summer of European “togetherness”. The objections to the presumed terms of the banking union as well as the specifics in Spain show just how non linear the European path ahead is. For Spain, the weekend’s remarkable floods are the last sort of natural intervention they need, with plenty of human dilemmas still to resolve. Nonetheless, I maintain as I suggested to clients on my trip, that as a result of the Mario Draghi-led ECB stance, I think investors should have a subtle mindset change of behaviour post his July speech. Instead of “fading the policy-induced rally” as was appropriate the previous two years plus, I believe that the right stance now is to “fade the disappointing-news event” as we kind of know that policy will be there to help, especially when it comes to the Euro break-up risk. While many are increasingly comparing the Outright Market Purchases (OMP) to the Long-Term Refinancing Operation (LTRO) of late last week, I think the decision for the Outright Monetary Transactions (OMT) is bigger and broader, not least as the German government effectively chose to ignore the advice of its own central bank, arguably for the first time since unification between east and west when their recommended exchange-rate conversion was not accepted. In this context, the OMT development is a kind of very pro “more Europe” kind of move for all current 17 member countries.
Back to Asia – Adjusting to Quality, Not Just Quantity.
In the first decade of the Asian Century, much of the story has in effect been about the “quantity” of growth rather than the quality and sustainability. This is especially true with respect to China as I shall discuss in more detail, but also for India, Indonesia and others (if not, of course, in Japan where it has been and remains the absence of either). I introduce the aspects of my trip in this context because I think part of the challenge right now is that markets had become used to the drug of the quantity of growth in the region. And importantly, in terms of our expectations, we never were and are still not, assuming that the same intensity of nominal and real GDP growth will continue. For this decade, 2011–2020, for example, we are assuming that China will grow on average by 7.1%, down from 10.5% the last decade, and India 6.5% down from 7.5%. We are expecting the N-11 countries to see their real GDP accelerate to around 5.3% from 4.2%, but this would not be powerful enough to offset the softer Chinese and Indian growth in aggregate.
Let me re-emphasize that if China, India and the Asian N-11 countries achieve what we assume, their share of global GDP will rise sharply and the world will probably grow faster than previous decades, despite their softer growth rates.
Australia and Asia.
This was my first visit to Australia in two years and it was a great time to go in view of the issues related to China and elsewhere. I had given an interview to a prominent local financial newspaper that was published just as I arrived, suggesting that Australia had to deal with China’s transition from an era of “quantity” to one of “quality” and that I thought Australia wouldn’t perhaps benefit so much, and in the search for net winners and losers of the new China, I didn’t think Australia was a likely net winner. Philip Moffitt, our senior fixed income portfolio manager for the region, said at a couple of shared events on the trip that his favourite trade was “long the Mexican peso and short the Australian dollar”. I find great sympathy with this view thinking about the new China.
On my return, I find myself thinking that one of Australia’s lesser well known but important exports, education, will be a much bigger beneficiary than industrial commodities.
In terms of client views and response to our thoughts, during two intense days in Sydney and Melbourne, I don’t recall meeting one person that appeared to be bullish for the Australian dollar. In that sense, it was quite striking how much Australian investors are already thinking about the new China, and there is widespread belief that a slowing in Australia’s terms of the trade benefits of yesteryear are underway. It was less clear whether export volumes were going to head the same way as prices and many cited that as of yet, they haven’t.
What was also interesting to listen to was the debate about possible Reserve Bank of Australia (RBA) policies against a shifting China as well as what, if any, the consequences for the local property markets and banks would be. Here views were more mixed. I left suspecting that, if indeed, the terms of the trade benefits of China have peaked, the consequences for Australia might be broader than some imagine, and I left certainly thinking that the Australian dollar is not likely to stay above parity for too much longer.
One final thought from this part of the trip is how little discussion I encountered about other potential Asian giants, especially geographically close Indonesia. And where I did raise that country, the few that engaged were not especially excited.
What Exactly is the New “Quality” China?
A number of people in Australia asked me what I meant by China shifting more towards quality, and as you will read below, aspects of it became quite dominant themes elsewhere. So what do I mean?
I mean, first and foremost, a China in which the leadership has deliberately decided it doesn’t want to achieve 10% plus real GDP growth anymore, and one that is happier with 7 to 8%. I mean a China where we should respect more closely than in the past what the five-year plan outlines in terms of priorities; and in this regard, one in which private consumption becomes a bigger share of GDP at the expense of exports and state-backed investment. One in which income differentials decline – greatly because of higher incomes for the less beneficial, but also one where the highest find it more likely that the income has to be earned rather than gifted. A China that is genuinely focused on energy efficiency and alternative energies, and crucially, one that is moving towards more creativity and innovation and with that, some more individual freedoms.
It is a China that many people – especially from the West – simply think is not possible to achieve, and in this regard, that is part of the investing dilemma – and opportunity.
As I returned to Europe, I found myself pondering about a couple of meetings I had just before I left, as well as what I had heard on my trip regarding the China quality issue. I had a most interesting meeting with the senior education researcher from the OECD who was rapturous about the schooling system in Shanghai and its development, describing it as better than any OECD country since 2009, after being an average performer as recently as 2003. I also participated in a board meeting of Teach for All, a global umbrella organisation for many country entities that strive to encourage and support some of the best graduates to choose teaching, especially for the needy. Teach for China, as I have mentioned before, shows plenty of dynamism each time I hear any anecdotes, and given how critical education is for productivity and change, I don’t see why so many western observers are so fundamentally dubious.
A Quick Jaunt Through Hong Kong.
I spent less than a full working day in Hong Kong, although given the hectic schedule it felt like a full one, with a number of different meetings as well as speaking at a large private client event we hosted. Amongst the most interesting things I picked up were twofold, one that planned mainland “traffic” for this week ahead’s holiday seemed rather sizeable, which contradicted some past signals I had been given that this sort of holiday shopping was being discouraged these days. The second was an interesting discussion with a well-placed local about the “new” China in which it was suggested a true test as to whether the new China will have adjusted will be when the true quality of the five-star hotels in Beijing and Shanghai will be of the same standard of those in Hong Kong. Or another way of putting the same point, as this person did, this will be the real opportunity for the rest of us, as this kind of service quality is not so easy to replicate.
More broadly, many people were similarly worried about both the likely post-QE3 challenges for the volatility of the Hong Kong economy given the inevitability of the Hong Kong peg being maintained, and when, if at all, the Chinese equity market would recover. The topic of why the stock market has so badly underperformed the economy was discussed at great length here, as it ended up being in Singapore, too.
On the Chinese stock market – note that the A-share market had one of its best weeks for many and continues to correlate very little with the S&P – I suggested, as I did in last week’s Viewpoint, that perhaps it is a time for true stock pickers and private equity rather than passive index investing. That being said, I return thinking that, at these valuations, being long the A-share market also against a short Australian dollar position is pretty compelling despite all the questions about the A-share market.
Singapore.
My last leg was a day plus in Singapore where I met with the most important local investment organisations, enjoyed a group breakfast and dinner, and spoke to a huge audience at lunchtime. At all the events there was plenty of interesting dialogue that also focused most on China, but in contrast to Australia and Hong Kong, there was some discussion about the other Asian giants, too.
On China, there appeared to be quite broad belief in the soft-landing scenario, especially from those I have known a long time and that I believe understand China well. Some of them were quite scathing of the western media’s obsession with the current leadership handover, regarding it was all predetermined, and as one experienced person suggested, unlike the US, most of the leaders in China all agree on the direction they wish to go and have embraced it.
Rather like in Hong Kong, some believe that China needs to back up its drive for more creativity and innovation to be reflected in deeds rather than just statements. During the dinner, we had an interesting discussion about what was really going on with “gifting”, with the majority suggesting that the apparent sharp slowing in the practice recently reflected a sort of fashionable trend within the Chinese but also suggested it was part of the culture and would not be driven out of business etiquette completely.
The road traffic in Singapore seemed to be particularly chaotic which led me to suggest that was somewhat at odds with the talk of a shallow recession afoot, and led to being asked about some of the broader influences on the city state. A number alluded to Singapore’s growing attraction as an alternative to established western banking centres and being a more true diversifier for mainland Chinese wealth owners than elsewhere, as well as benefiting from the ongoing rise of both India and Indonesia.
While I often receive a number of emails these days, as well as actual requests from local policymakers, that I should seriously consider adding another I for Indonesia to the BRIC acronym, neither in Singapore nor Australia did I encounter people banging the drum much. In fact, whoever I raised the topic with believed that Indonesia still have to demonstrate that its strong success of recent years was anything other than a commodity boom, with some quite worried about governance matters of old remaining a deep issue.
India.
As I joked as I travelled around, I was keeping my fingers crossed that the government would not reverse its announced policy intentions of now two weeks before my trip had finished. Many people remain quite sceptical of India’s ability to execute policy even when it is announced with good intent, but I have found myself increasingly contrasting the impressive behaviour of the Indian stock market against that of the fashionable trend amongst sell-side economists to lower their GDP forecasts. And as I mentioned earlier, we believe that India “only” has to grow by 6.5% this decade to achieve what we have assumed. Given their demographics, it would be quite easy for India to grow by more than this – possibly a lot – and if their recent announcements are enacted and followed up by more, India can easily now positively surprise in my view. If!
Japan.
I happened to find myself watching quite a bit of financial TV news during my jetlagged hours in hotels and by coincidence, one time was during Japan’s latest economic data releases. It led to me joking at my big speech in Hong Kong and Singapore and at a press conference that Japan seems to somehow find bad outcomes from almost everything. Whether it is the global economic cycle, their own energy requirements, this highly unwelcome and both economically and, otherwise, dangerous spat with China, and to top it all, the politics appears to be getting murkier once more with the Liberal Democratic Party (LDP) threatening to re-elect one of the more nationalist figures of the recent past. That doesn’t strike me as a shift that will be too helpful. What they also desperately need is for the Bank of Japan to get just a small part of Bernanke juice into their veins. The fresh renewed rise of the yen is really quite mad.
Anyhow, a fascinating trip. I believe this century probably will be Asia’s century but it is clear that markets need to think more about “quality” than “quantity”, as do a number of the policymakers in key countries.
Talking of quality, what a remarkable second half at Old Trafford on Saturday evening. Shame about the previous disastrous 45 minutes…
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