The Minus Touch
The Momentum Investment Summit was held on 12 June at Fancourt Hotel in George. The Investment Summit is Momentum Wealth’s flagship annual event. Going into its seventh year, the Summit is a well known and much publicised industry event that is eagerly anticipated each year by financial advisers, representatives from leading asset management companies and the media.
Following on last year’s theme (Is the glass half empty or half full?), when the possibility of a global recession was swiftly becoming more pronounced, it was perhaps impossible to imagine that a few months later, some of the best known names in international banking would have failed, been bailed out or nationalised. Those that survived after extensive assistance and severe write downs retained only a fraction of their previous dominance and size. Millions have lost their jobs, bringing the total unemployment figures to over 2.3 million in the UK alone. The financial centres of the world seem to be in the midst of a shift, with China’s uprising being lauded by many. Investors who had become accustomed to the sterling performances of asset values across the globe (2003 to early 2008) are still reeling from their losses.
The first speaker was Nasmeera Moola, Head of Macro Strategy at Macquarie First South. Discussing the longer-term implications of US policy-makers decisions to bail out US Banks on the global economic landscape, Nasmeera began by stating that the global economy will be on life support for a long time to come. US consumers borrowed too much and mortgage lending grew dramatically since 1998 while house prices exploded. Housing prices have corrected dramatically after almost doubling from 1998 to 2009.
As is typical with other recessions, household savings start to increase – this is already so in the US and has been the case since mid 2008. This means that consumers are spending less and saving more. The consequence of this is that production should also fall. According to IMF research, output losses are larger and last far longer where a financial crisis has triggered a recession. It also takes the economy far longer to recover.
To ease the situation in the US, the Federal Reserve Bank has been printing money - but this is not much help, as the money is not getting into the system, unlike in China, where lending has increased. On a positive note, while loan growth remains weak, there are limited inflation risks.
Nasmeera noted that financial markets, since bottoming in March, have recovered strongly, with a dramatic rally in stock prices. Both corporates and sovereigns have been able to issue debt paper, a clear sign that the system is easing.
Comparing the developed and the developing worlds
According to Nasmeera, emerging markets banking systems (BRIC countries) are relatively intact and more importantly, still lending. Spurred by strong credit growth, China’s real estate and construction activity is picking up. To ease the fall in private borrowing, US government has boosted spending to prop up the economy in the face of collapse in private sector borrowing. US government debt has subsequently increased by 27% in the last nine months. This is not sustainable! Given this scenario, the US government is forecasting national debt to rise to 100% of GDP, and even this might be too optimistic! Nasmeera noted that crises in other countries suggest that on average, there is a real 86% increase in government debt levels following a banking crisis.
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US Household Mortgages
Source: Federal Reserve, Macquarie Research, May 2009
Nasmeera contends that the fact that inventories have been sharply run down suggest that Q4 2008 and Q1 2009 will likely prove to be the trough of this cycle. US Production was down 22%YoY in April and consumption was down 9%YoY. Production & inventories have fallen far faster than demand has. So it is safe to say that production is recovering….however, the key is to watch how long inventories remain stable. Even with this scenario, imbalances remain, in that, the over-extended US balance sheets, principally household, need to be repaired before demand returns; and the US govt balance sheet is fast eroding – fiscal spending will still need to be curtailed.
Nasmeera concluded that global growth has bottomed, but expects a prolonged recovery in US and the rest of the developed world. Emerging markets (particularly China) are likely to be far more robust and Government bond and the US dollar are likely to continue weakening as the year progresses.
On the domestic front, commodity prices will be underpinned by an emerging market recovery. The rand is likely to (unfortunately) be well supported by a weaker USD. She projects that we could be nearing the end of the rate cutting cycle, with potentially another 100bps left in the cycle. SA growth is likely to have bottomed in Q1 2009 – but the domestic recovery will be slow. There will be continued focus on infrastructure leveraging off the emerging market footprint.
The greener grass is in emerging markets
Next up was the irrepressible Dr Michael Power from Investec Asset Management. His topic, Emerging Markets – in search of greener pastures, kept audiences captivated. He began by saying that there is no global economic recession, but rather a Western economic recession – and that the developed world was having an emerging market crisis. Michael went on to say that China will once again resume its place as the centre of the world and that Shanghai will become the next Wall Street.
Steeped in economic history, Michaels conveyed how he traced the origins of the words capital and economics while busy with his PhD in Economics comes from the Greek word oikonomia (household management). Oikos is a clan known by its grazing rights and noma is Greek to search for pasture. Noma originally comes from Middle Egyptian: nmi to travel and mah is pasture, hence the word nomad. Capital and cattle both derive from kephale – Greek for head, sum of money. Therefore, capital is nomadic and will follow the greener pastures.
According to Michael, everything has a life cycle. He said, “As economists we like the middle of the cycle - where usage and profit is high. As the life cycle ages, the profit pool shrinks. Commoditisation happens near the end of the cycle and this is when we need to move capital. Don’t take your capital to overcrowded places.”
We are now at a turning point, essentially a changing of the guard; therefore, the turbulence. Michael says we need to look at today’s economy in this context.
While there is still capital in the US, it is insufficient for the cattle to graze on it profitably. Michael says that the migration has begun from the West to the rest.
“The US has basically gone nowhere since the 1970s, and after 35 years they are back to where they started.” Car sales are a case in point, where there are 1.2 cars for every one driver’s licence. This is a saturated market – unlike China, which now is boasts the largest car market in the world, and one that is set to grow. Next up is India, which he predicts will be the biggest car market globally by 2050.
Emerging markets, particularly the BRIC economies are growing at a phenomenal rate. In 2001, emerging market GDP growth share exceeded the West’s. Overall, GDP share of the world total is forecast to show a higher contribution from emerging markets within a decade. This year industrial China will overtake industrial US in terms of global manufacturing output.
In the 1990’s the value of BRIC imports were 30/40% of the total value of US imports. In 2009 BRIC imports will exceed USA imports. And the growth in BRICs is driven by urbanisation and the growth of the middle class. And let’s not forget that China’s biggest market is China.
The world has evolved significantly and continues to do so. This is evident in a memorable example that Michael used - the top 20 financial institutions in the world, ranked by market capitalisation. The first three are Chinese. Only 3 US banks appear on this list.
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"I shall ask you to accept the hypothesis that growing economies like many other structures, proceed along a path described by the Gompertz curve, starting slowly, picking up speed in growth, tragedies slowing them down, and then levelling off and declining. The process is often repeated, with new curves at some stage growing out of the old." Charles Kindleberger
Michael contends that the world has changed and that we should start thinking about investing in the new world – we ignore this at our own peril.
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He contends that BRICs should be promoted to the Premier League and that frontier markets are today’s true emerging markets.
“China’s creation outweighs the US’s destruction by 4 to 1.” A case in point is reduced demand in copper from the US, but this is more than offset by the increased demand from China – a fall of 1167 in 2000 – 2010 versus an increase of 4415. “China is huge and we underestimate it at our peril. Over the next decade Asia should be central to all our investment thinking.”
Emerging market valuations are not expensive and, since 1999, emerging market ROEs have more than doubled and since 2003, they have been ‘greener’ than developed markets.
“China – there lies a sleeping dragon. Let him sleep, for when he awakes he will astonish the world.” Napoleon
So why is everyone not rushing across? According to Michael, its home bias - 80% of all US equity investments are in US securities. “Essentially the Anglophone world has invested too much in itself.”
Emerging markets comprise 23% of market capitalisation today. Michael raised and discussed three concerns: Are western equities facing a lost decade? Is the US dollar’s ‘hegemonic’ status cracking? Will the West resort to financial mercantilism?
