hongkongen
The conundrum: China or the US?

The conundrum: China or the US?

15-04-2020 | Column

If you ask me what keeps my mind busy at the moment, I can tell you that it is not market volatility. It is not global equities declining at the fastest speed ever seen or the S&P 500 Index bouncing back by almost 20% in the last two weeks. Markets have a way of going down and then up again. In the end, fundamentals, and more specifically the earnings, will level the playing field and determine the outcome of the game. What keeps my mind busy is trying to figure out what comes next for investors. Within equities, after the recent panic and subsequent bounce, the biggest question to ask is how to allocate our capital from a regional standpoint.

  • Fabiana Fedeli
    Fabiana
    Fedeli
    Global Head of Fundamental Equities

Speed read

  • Biggest question now is how to allocate our capital regionally
  • US outperforms in recessions but N. Asia fundamentals are recovering sooner
  • Stay selective: country allocation will be a key discriminating factor

We have only seen a glimpse of what lies ahead, with the very first cuts to macro numbers and earnings revisions

Markets have a way of humbling us. We thought we had seen it all, or almost all, and then the ball comes out of left field. In the last quarterly, in the section ‘’What could go wrong”, we had mentioned geopolitical risk, but a global pandemic was nowhere near the top of our list. Kudos to Mr. Gates, who was far more prescient than us. Not that we are taking any of this lightly. No loss of life should ever be taken lightly. The tragedy that we are living in will stay firmly imprinted in our minds and hearts for the years to come. 

Governments and central banks have taken unprecedented measures to deal with the coronavirus outbreak, limit its spread, and contain the impact on our livelihoods. The global economic shutdown that has ensued is unlike anything we have ever experienced in our lifetime. The restrictions on people’s movements, the so-called ‘lockdowns’, now affect more than half of the world’s population. The economic disruption from these measures will be enormous, with the flow of people and goods severely curtailed, and a global recession is all but inevitable.

Think of countries, not regions

We have only seen a glimpse of what lies ahead, with the very first cuts to macro numbers and earnings revisions. Earnings are a key driver of equity markets. Until now, it appears clear that first half 2020 earnings will be significantly affected around the world. However, countries that have been able to resume activity earlier than others should fare relatively better. This also explains the outperformance of the Chinese (CSI 300 Index), Taiwanese (TWSE Index) and Korean (Kospi Index) equity markets since the beginning of the selloff, as the three countries managed to tackle the coronavirus emergency and the impact thereof earlier than others, and have managed to go back to more normalized levels of economic activity and demand.

Taiwan and South Korea, in particular, learnt some important lessons from the SARS outbreak in 2002-2004 and were better prepared for another outbreak, facing even lesser economic disruption than China did. All three markets have outperformed the S&P 500 Index (in US dollars) since 21 February, although Taiwan and China lost some ground during the global rebound.

These three countries make up approximately 65% of the MSCI Emerging Markets Index. In comparison, the US, Continental Europe and the UK, where containment measures that severely affect economic activity are still being implemented, make up more than 80% of the MSCI World Index. This divergence is evident in the latest earnings revisions, which are currently far more negative in developed (-62%) than in emerging markets (-38%). It is also visible in GDP growth estimates for 2020. 

Most economists that we follow still expect very modest growth for emerging markets (to the tune of around 1%), with China, Taiwan, and (barely) Korea still in positive territory. Meanwhile, for developed markets, a decline of close to 3% is now expected, with all major countries in negative territory. Of course, all of these forecasts are fluid at the moment and could continue to deteriorate. The EM-DM gap, however, is likely to remain. 

So, does this mean that emerging markets as a region will outperform developed markets for the foreseeable future? It is here that lies my conundrum. Of the emerging investable universe, 65% – consisting of China, Korea and Taiwan – is back to, or in the process of, getting back to normal economic activity. Of course, all three countries are likely to suffer from a global recession but – arguably – less so than European countries and the US, which are still in lockdown. Looking at equity markets, we have had the selloff, and now the bounce. It is very unlikely that we will see a straight line up from here, and we should get ready for another correction.

We should expect more negative news: companies with refinancing issues in high yield markets, further or more persistent than expected spread of coronavirus, delays in policy response, possibly a second contagion wave. More importantly, we should also expect deteriorating fundamentals and poor earnings. Once earnings will be announced, they will affect stock performance and market volatility. And here is my conundrum: as we move into a global recession, the traditional outcome for equity markets is an underperformance of equities versus other assets classes and, within equities, an outperformance of the US stock market relative to other regions. Needless to say, this is due to the perception of the US as a safe haven and a preference for US dollar-denominated assets. 

So, should we favor developed markets to emerging markets at this point, despite the differences in the economic outlook? Or are we perhaps too negative on emerging markets and should we continue to trust and follow the relative earnings expectations? 

Country allocation will be an important discriminating parameter over the next couple of quarters; in fact, it will be more important than ever

The one answer that I believe makes the most sense is that we need to be more nuanced, and not simply look at EM as an homogeneous group versus DM. Country allocation will be an important discriminating parameter over the next couple of quarters; in fact, it will be more important than ever. 

Favoring North Asia to the US doesn’t mean that all emerging markets will recover either quickly or soon. I am especially concerned about those countries where the policy response is proving to be rather slow (such as Brazil and Mexico), and/or where the country dynamics are such that a spread of the virus will be very difficult to contain, which is the case for India, and/or where fiscal constraints limit the government’s ability to intervene (South Africa).

Stay informed on our latest insights with monthly mail updates
Stay informed on our latest insights with monthly mail updates
Subscribe

Stay selective

‘Stay selective’ will be the name of the game, also from a stock viewpoint. Don’t think in broad strokes. Experience tells us that this is not a market to buy indiscriminately. We need to make sure that we are picking the right  countries as well as the right stocks. In a rebound, the tide will lift all boats, but once the earnings impact becomes clear, we will start being able to distinguish the winners from the losers. Some companies will have more difficulties in recovering; some might never recover. We need to make sure that the stocks we hold in our portfolios can weather the current crisis. Their earnings outlook and liquidity/balance sheet risk are key aspects to monitor.

Some companies are ‘easier’ to read: companies that face bigger difficulties include those in seasonal businesses, where there are short periods for goods to be sold before these become inventory. Another example is those companies depending on complex and global supply chains that are facing disruptions. Demand may recover at some point, but supply could take longer to fall back into place. Other industries could see a significant and sudden recovery in demand, but the extent of the prior decline may have rendered them unable to operate.

Companies with weak balance sheets, that are unable to finance their working capital needs, might not survive. We are likely to see restructuring and consolidation ahead. For some other companies, risks will be less clear-cut: beware of companies that will have to do ‘social service’, such as banks, particularly public banks. These are likely to see their credit quality deteriorate. Also, beware of regulated sectors, as well as areas where taxes are low. Governments will eventually have to fill their coffers up again.

All of our investment teams have been gradually and selectively buying in the last few weeks. As long-term equity investors, we have learnt that the best strategy is to slowly and gradually pick our entry points. Picking the bottom is next to impossible, as it depends on many exogenous and difficult-to-predict factors, such as timing and content of policy decisions, and the progression of the outbreak.

Most likely, we will get another chance to buy at some point in time. News of the coronavirus spreading and the related economic impact, as well as further strains in high yield markets, could rattle equity markets further. Earnings estimates will also have to see another round of negative revisions. But we remain patient. While it is never fun to be in the midst of a market meltdown, we have learned that this is a good time to be long-term active investors.

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

Subjects related to this article are:
Logo

Disclaimers

1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. The Company does not hold client assets and is subject to the licensing condition that it shall seek the SFC’s prior approval before extending services at retail level. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is to be accessed by “professional investors” only (as defined in the Securities and Futures Ordinance (Cap.571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong). The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
This website includes material from third parties or links to websites maintained by third parties some of which is supplied by companies that are not affiliated to Robeco. Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage. Third party off-site pages or websites are provided for informational purposes only.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click the “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree