SINGAPORE (Aug 27): US policies — on foreign affairs, trade, fiscal as well as monetary — are creating geopolitical and economic uncertainties globally and are, in the process, causing havoc in stock, currency and commodity markets.
While there can be no winner in a trade war, threatening a trade war has benefited the US. This perhaps may be US President Donald Trump’s real strategy?
US stocks and the greenback are benefiting from investor flight to safety at the expense of perceived riskier emerging markets, so far. The Standard & Poor’s 500 and Dow Jones Industrial Average are at or near all-time highs, in stark contrast to the dismal performance of non-US stocks for the year to date (see Charts 1 and 2). The greenback has also strengthened against most emerging market currencies (see Chart 3).
Trump has taken a combative approach on trade, slapping tariffs on the world at large and China in particular. This is contrary to the past, where the US has mostly acted to stabilise the global economy in the belief that it benefits as the sole superpower and the world’s largest economy.
Trump believes the US can win the standoff because its economy is on a stronger footing. GDP grew at 4.1% in 2Q2018, the fastest clip since 3Q2014, supported by government and consumer spending that is buoyed by tax cuts.
China’s economy, on the other hand, is cooling, owing to its earlier deleveraging measures as well as uncertainties from new and impending trade tariffs. The former is by design as the government cracks down on shadow banking and curbs risky and unproductive debts, especially at state-owned enterprises and local government levels.
Chinese stocks have been among the worst-performing markets in the world so far this year. China has eased credit conditions and may step in to boost infrastructure spending to counter the trade fallout.
Protectionism objectives aside, the trade war is likely part of the US’ strategy to roadblock China’s longer-term push into high-tech industries, spearheaded under the latter’s Made in China 2025 initiative. It remains to be seen how effective the strategy will be.
The US has also taken the hard line in an escalating diplomatic feud with ally Turkey, doubling tariffs on steel and aluminium and threatening additional sanctions. Its moves exacerbated the country’s economic crisis. The lira tumbled to record lows against the US dollar.
Turkey’s crisis stems in part from profligate investments over the past decade when money was cheap and readily available. The country relied heavily on foreign capital to fund growth and the widening current account deficit. That flow of liquidity is now reversing.
The US Federal Reserve has started shrinking its balance sheet as well as raising interest rates. Its decisions so far have focused solely on domestic data despite growing stress in global financial markets. The Fed is on track to raise rates four times this year as inflation ticks higher on robust growth.
Add to the mix the potential repatriation of billions of dollars in cash held overseas by US companies following last year’s tax cuts, and we have a steady stream of capital outflows from the rest of the world.
Turkey’s troubles are emblematic of risks for emerging countries, which were the biggest beneficiaries of years of quantitative easing. That is why even though its economy is relatively small and the actual fallout is largely contained within local shores, it still generates contagion fears.
We remember how the falling Thai baht triggered the Asian financial crisis in 1997. Positively, Asian economies are on a much stronger footing today than back then. And the risks of a similar event happening are low. Nonetheless, prevailing uncertainties have still sent investors rushing for safer havens.
Capital outflows sent currencies seen as vulnerable, including the Indian rupee, South African rand, Argentinean peso and Indonesian rupiah, spiralling. Falling currencies make it harder to service foreign debt, thereby raising default risks and all other associated spillover impacts, including systemic banking risks as well as runaway inflation.
Given the possible dire consequences, central banks are under pressure to raise interest rates to halt the slide. Indonesia’s central bank, for instance, have hiked rates by 125 basis points since May and spent billions to defend the rupiah. But such moves come with a price — a higher interest rate will hurt economic growth.
Growing worries over the impact of tariffs on global trade, US dollar strength, economic slowdown in emerging countries (especially China) and a shift to less risky assets have also resulted in a broader commodity rout.
As most commodities are traded in the greenback, a stronger US dollar diminishes buyer purchasing power and weighs on demand. Copper, a leading indicator for global industrial activity, slumped to its year-lows (see Chart 4).
Crude oil too has given back some of its gains from earlier in the year, though prices are supported by anticipated supply disruption due to yet another US foreign policy — sanctions on Iran.
There were some conciliatory overtures from China last week on trade, and mid-level talks are hoped to restart negotiations. But resolution is far from guaranteed. Given the prevailing sentiment, financial markets are likely to stay volatile in the near term.
My Global Portfolio has underperformed lately, owing to the broader market selloff as well as currency weakness against the greenback. Nevertheless, we believe the underlying fundamentals for our basket of stocks are intact.
Case in point, Sunpower Group’s latest 2Q2018 earnings were positive. The company is a multi-year growth story, underpinned by its nascent green investments (GI) business.
It has invested-committed RMB1.3 billion ($259 million) in eight projects (including the almost completed acquisition of Yongxing steam-thermal power plant and two other projects to be commissioned in 2019) since 2H2017.
The five projects that are up and running contributed RMB211.6 million and RMB60.6 million to sales and earnings before interest, taxes, depreciation and amortisation, respectively, in 1H2018. In fact, the internal rate of return has averaged roughly 20%, exceeding expectations of 15% returns.
The company expects earnings to be stronger in 2H2018 and beyond, on the back of continued pipeline network expansion and rising utilisation for its centralised steam projects, sale of electricity with new grid connections as well as a slate of projects under construction and in the pipeline. Sunpower aims to invest up to RMB2.5 billion on GI projects by 2021.
On the other hand, sales growth for Nine Dragons Paper Holdings is expected to moderate in the financial year ending June 2019 instead of achieving double-digit growth as in the past, if the trade war persists. And as the company’s rapid growth was fuelled by debt, near-term earnings may be impacted. That said, the longer-term outlook remains positive and our investment rationale remains intact.
We are likely to make a few stock switches — for both the Global and Malaysian portfolios — in the coming weeks, to reflect the near-term outlook on growth, currencies and interest rates.
This week, we disposed of all our holdings in G8 Education at a loss. The stock performance has been disappointing and a turnaround does not appear imminent. At the same time, we acquired 70 and 120 shares in Facebook and Apple, respectively.
Following these transactions, the Global Portfolio is now 78.9% invested. Total portfolio returns since inception now stand at 2.6%. The portfolio is underperforming the MSCI World Net Return Index, which is up 3.9% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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