SINGAPORE (Apr 2): In a week in which fears of a trade war dictated market sentiment and spurred volatility, news of homegrown ride-hailing service provider Grab buying out Uber’s operations in eight Southeast Asian countries came as a welcome change. And not just because it is the largest-ever deal of its kind in this region.
I have previously talked about how the network effect and near-zero marginal cost, particularly for digital-focused tech companies, would eventually result in the creation of natural monopolies, on a global scale. We see this playing out, most successfully out of the largest markets (the US and China), in the cases of Amazon.com and Alibaba Group Holding.
The Grab-Uber deal underscores an opposite force to the network effect. It is a timely and important reminder that localisation and customisation can compete and succeed against a global player. It is affirmation that in-depth knowledge and understanding of the local environment as well as the lifestyle and demands of customers are still invaluable competitive advantages.
Uber modelled its services after the comparatively more affluent US customer profile, a market where it has been most successful. For instance, payment can only be made via credit cards. This is great in terms of convenience. However, a good portion of the population in emerging countries simply does not have credit cards (or bank accounts). Transactions are made with cash, which Grab accepts as a payment option.
More recently, Grab introduced its own mobile wallet payment solution, with prepaid credits. Take, for example, its inclusion of motorbike taxi services in Vietnam, the most common mode of transport for the locals, months ahead of Uber. It has not looked back from this first-mover advantage.
For me, and all the budding Asian tech entrepreneurs out there, the biggest takeaway from the Grab-Uber deal is this: David can beat Goliath in our digitalised world.
Coming back to the increase in volatility in financial markets. The multi-year bull market marked by only a few short and shallow corrections has translated into rich valuations for stocks.
We have shown this before, by comparing prevailing valuations and growth against what they were historically. Rich valuations, in turn, make for nervous investors — when stocks are priced to perfection, they are more susceptible to downside surprises.
Having said that, stocks are also showing remarkable resilience, bouncing back quickly from selloffs. I suspect this is because people are already heavily invested, whether directly or indirectly, through funds. It serves no one for the market to drop and, thus, investors and fund managers will keep looking for reasons to buy and for the markets to rise.
Fears of a full-blown trade war between the US and China — the world’s largest and second-largest economies — sent stocks tumbling in the week ended March 23, after President Donald Trump proposed tariffs on some US$60 billion ($78.5 billion) worth of Chinese imports and placed limits on China’s investments in American technology.
This was followed almost immediately by a sharp turnaround on “news” that the two countries are negotiating to avert the said trade war. Markets perceive the US as using the threat of tariffs as a negotiation tactic for better trade deals and China’s restrained response, so far, as a signal of willingness to offer some concessions.
Nevertheless, it is a dangerous game. We all know that there is no winner in any trade war, only losers of varying degrees.
The table on the right shows the ratio of exports to GDP for selected countries. Clearly, the most open economies, which have the greatest reliance on trade, will be hurt the most. That would include Malaysia and Singapore.
But the impact will be wider than just trade. While China will see a greater impact from trade loss, US consumers will suffer more in terms of higher prices and inflation. The question then becomes which country has a higher threshold for pain.
Rising trade barriers have a deep and lasting impact on the global supply chain, GDP, inflation, interest rates — and stock valuations. All companies will be affected, directly or indirectly.
Remember, a company’s valuation is equal to the discounted cash flow of future earnings: Valuation = Earnings ÷ (1+r-g)
We know that stock valuations around the world have risen, to the higher end of historical ranges. Why?
The higher valuations are justified by sustained earnings, margins and growth, g (as demand and sales recover) as well as low interest rate, r. The latter, in turn, is due to persistently subdued inflation, despite massive quantitative easing efforts by major central banks.
This we attribute to downward pricing pressure from two major structural trends — technology/digital transformation and globalisation — that go hand in hand in a virtuous feedback loop.
The free flow of goods and services, human resources and capital — and the creation of global supply chains and trade — has produced significant cost reduction and enhanced efficiency. China and many low-cost emerging countries such as Mexico became the factories of the world.
E-commerce provided an almost frictionless platform connecting buyers with sellers, lowering traditional barriers to entry and resulting in transparent price discovery and competition throughout the ecosystem.
Big data and analytics helped businesses understand their customers better as well as improve process efficiency and enhance productivity. The sharing economy, meanwhile, leads to more productive use of assets, reducing the cost of stranded investments.
Technology innovations — in fracking and horizontal drilling, wind and solar power generation, battery storage — have significantly lowered energy costs.
The list goes on, all of which leads to lower selling prices (and inflationary pressure) for end-consumers.
It then goes to reason that trade barriers and a reversal of globalisation will have the opposite effect on prices, inflation and interest rates. And as the formula shows, higher r plus lower g would translate into lower valuations.
The chart shows the historical movements for US inflation and GDP growth. Historically (1978 to 1988), there was a high correlation between the two. But this relationship broke down during two periods, 1989 to 1999 and 2010 to 2017, which were the years associated with what I call the “China effect” and “digital-tech revolution” respectively — omitting the years between 2000 and 2009, which were distorted by two major crises.
In view of the increased and unpredictable stock-price gyrations, I made no change to either the Global or Malaysian portfolios. Cash holdings are currently about 16% and 28% of total value for the two portfolios, respectively.
The Global Portfolio is now up 4.5% since inception and continues to outperform the benchmark index, which is down 1.9%.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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