With current market valuations now exceeding those of 1929, and even of 1999, the term ‘peak insanity’ is coined. Arnout van Rijn, CIO Asia Pacific, is less concerned. “It is not as bad as 1999. It's just a small segment of the market that is really at multiples that are hard to defend. The bigger segment of the market that now trades at relatively elevated multiples are just healthy cash flow-positive stocks that the market is willing to pay up for because of the TINA argument – ‘there is no alternative’. Tune in to hear it all.
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Erika van der Merwe (Erika): Asia-Pacific is one of the world's most dynamic and varied regions. It's also dealing with a set of complex challenges that include a looming property crisis in its largest economy, nail-biting geopolitical and ideological clashes, a supply chain drama, and, of course, a pandemic.
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Erika: Arnout van Rijn invests in this region. He's Robeco’s CIO for Asia Pacific and lead portfolio manager of Robeco Asia-Pacific Equities. Good to have you with us again Arnout, welcome.
Arnout van Rijn (Arnout): Thank you, Erika. That sounds like quite a mouthful of problems there that you’re proposing to me.
Erika: And yet you bravely soldier on! Well, it's been a year and a half since we last spoke to you, believe it or not. What's your assessment on how Asia is faring and progressing with Covid-19?
Arnout: Well, initially, of course, Asia did very well because although, the breakout started here, actually the ramifications, particularly in China, have not been that large because it's been all contained very quickly. Later on, we've actually found out that that zero-Covid strategy, that particularly here in China, but also many other countries were pursuing for the longest time, also resulted in their economies being under quite a bit of pressure and also particularly from the service industry. They're not catching up, as other economies did. So on that net, I'm not so sure whether this is the right strategy, and it also, for me, leaves a kind of vulnerability in the back of my mind that, actually all of the people here in China in particular, but also in other countries, in Japan for instance also, almost nobody has really built immunity to the disease through natural infection, but all through just vaccinations. And we know that that's not as effective. So therefore, there is still that risk that the virus will rage here at some point. And let's hope that it's done in a very muted or dampened down format and therefore will not cause a lot of harm to the society.
Erika: So, talking about the contrast between cultures, you recently tweeted: “If China can successfully manage the two main crises thrown at it, firstly, the property and debt crisis and secondly, the climate and energy crisis, then we should adopt its governance model in the West”. This might be one of your more provocative statements, and I see you're not afraid of making such statements. That aside, let's take the first of those crises. Robeco’s Credit team warns in its latest quarterly outlook that, with a quarter of China's GDP and 40% of its domestic lending being related to real estate, one can't afford to be too sanguine about its property sector. So how concerned are you?
Arnout: Yeah, it's definitely a tail risk in in my mind also and is one of the reasons why I'm underweight the Chinese equity market in a regional fund. And it does worry me a lot that they've let this crisis linger for a very long time and actually it was only last week that they tried to put some containment around it, actually on the announcement of the Evergrande default. There was also some loosening measures coming from the different provincial governments, as well as from the central government, which made it sound like, OK, this is over and the market actually rejoiced on that quite a bit. And then this week we have that new news about the company named Shimao that is actually now looking like there is a lot of off-balance-sheet financing being done that nobody was aware of and thought that this company was actually in a healthy financial position. So now you're putting another factor of distrust into the market that people feel like, I can't even trust the formally published accounts and audited accounts anymore, in which case, who knows how big the problem is then. So we'll go through another few months of guessing, then, how bad the problem is. And the real risk I see there is maybe not even so much from the corporate side, but it's going to be the buyers. If buyers are going to say, well, this company, I don't want to buy an apartment from anymore, but I'm happy to buy from that government-backed property developer. Then it becomes a self-fulfilling spiral that people will indeed cause a sort of a bank run on these private developers because they don't want to buy their apartments anymore. And if they do want to buy an apartment, they will make sure they will do it with the most credible developer that is supported by the local or by the central government. And in that case, then, things can turn nasty again. So that's the risk I'm seeing, and I sympathize with the view from the bond investors. And it's always been something I learnt as an equity investor that you’d better pay attention to the bond market because they're more often right than the equity market. Because the bond investors are, how would you call that, manically depressed, and are always looking for problems, where the equity investors are always a bit too optimistic. And in this case, that appears to be true again. Although, of course, the equity of these companies has also fallen a lot over the last 12 months.
Erika: Now, looking beyond China, and you said you are underweight China in your regional strategies. If we look at broader financial market movements, what trends have you seen in markets over this past year? Certainly, there have been twists and turns in how investors have approached, say, growth stocks relative to value stocks, for instance.
Arnout: Yeah, I'm happy to talk about that. I also want to come back to your point about the provocative statement there, if you allow me 30 seconds to stay on that. I think a lot of us in the West are looking at China in a very, you know, are very negatively predisposed, to put it like that, towards China and are thinking that it's all bad what's coming from there. There’s a lot of pollution there, there is a lot of poor human rights and things like that. And I can't completely deny that, of course. But it's not that the government politicians are not aware of that and are not trying to do something about it. And that's always what has positively surprised me about China, that whenever there is a problem, they do act very quickly and in a very efficient way. Also, because of the way that their government structure works, they can know they don't have to care about democratically elected politicians. So they can just say, we're going to do it like this. And that has worked time and time again, which is why I made that statement that I think, if they can actually do it with these very big crises overhanging and then didn't even speak about the Covid crisis that potentially may still be coming, but they consider that to be already solved. So maybe that's one in the past. But if they can manage this debt crisis and the energy crisis, I think that is really a laudable system that we need to study, because I would like to think that our democratic system also doesn't always work fantastically well in addressing big problems, including climate change.
Erika: And big problems that require a very long-term perspective.
Arnout: Right, exactly. Yeah, that's often the problem, then. So getting back to your question on the nature of markets this year. Indeed, this year has been a lot more enjoyable for us as more value-oriented investors, as we've actually seen from the latter part of 2020, things turn around a little bit, also driven by the enormous money put into the systems, that the economy started to rebound and therefore interest rates found the bottom and inflation picked up a little to the extent now that it's a problem in some countries. But that is generally an environment where value stocks can do better because they are short-duration stocks, as we like to call them, so they have cash flows nearby. And last year, it was all about cash flows in the distant future. So now we're having more of a balance in our markets where value stocks also have some buyers because people actually are keen on the near-term cash flows and also are seeing that some of these companies that are sometimes more cyclical will also have decent cash flows and have seen very good earnings growth in 2021, and next year also looks quite decent. So then you have the combination of low multiples plus actually quite decent earnings growth that is driving these stocks higher. So last year, I really had a problem in the portfolios because we call our investment process in one sentence that we're value investors with momentum awareness. And yes, there was value, but there was no momentum in value. So therefore it was impossible to actually execute on the basis of our investment process. This year, we're seeing that a lot of value stocks also do have positive earnings momentum, do have positive price momentum. So therefore, it's much easier to compile a portfolio that is actually where we want it to be, with both strong value components, i.e. we buy stocks that are a lot cheaper than the benchmark and also stocks that have good momentum and also better-than-benchmark momentum. So that's a very positive environment. But next to that I would also state that the infatuation with long-term growth and ‘we're going to change the world’ and ‘everything is going to look different in 5 or 10 years’ time’ is still there. And you still see a lot of attention on stocks that offer the prospect of changing the world, and it's just not something that I would easily invest in because you have to make a lot of assumptions there. The value investor says, well, I don't have to make assumptions. I just assume basically that things are continuing as normal. And of course, I know that the world is changing, but it's happening very slowly. Whereas the growth investor then says, well the world is going to change so dramatically that these stocks that now look very expensive, in five years’ time will no longer look expensive, may actually look cheap.
Erika: I'm going to pick up on the references you made to the seemingly balance returning to the market because I've seen references to the term ‘peak insanity’, that current market valuations now exceed those of 1929, and even of 1999. So it's good to hear that you are concerned, but I want to hear how worried you are. But before you respond, here are two market veterans both invoking lessons from the past. And yet with completely different perspectives on what it means for investing. The first is ARKs Cathie Wood, and I think she reflects exactly what you were referring to now about saying, you know, we're going to change the world. She's referring to tech innovation stocks in this short clip. And the second is Goldman Sachs CEO David Solomon. Both of these were taken from CNBC.
Cathie Wood: What I like about this period is many, many people are saying those stocks were in a bubble and they deserve to correct. That tells me we are nowhere near a bubble. In fact, quite the opposite has happened. And here we are. We're ready for prime time and we've got all this fear, uncertainty and doubt. As a portfolio manager, I actually love that backdrop.
David Solomon: One of the things that I'm concerned about or I think about a lot is people have kind of lost the historical perspective on what markets look like and what is normal from a monetary policy perspective. What we've had over the last decade is truly unusual. And I remember and I know historically, I've been around doing this, you know, since the 1980s. I remember when we had a very, very different environment, and we could have a different environment again. And so I do think that while we've had inflation below trend for quite a significant period of time, there's a reasonable chance that we're going to have inflation above trend for a period of time. And so I think you've got to be cautious and manage your risk appropriately for the distribution or the chance that that might happen.
Erika: So I’d like to take it a little further and ask you if you hear, when you hear this kind of commentary, does it trigger memories from past crises and excesses? I mean, you've been around the block a few times.
Arnout: Yeah, 30 years now. To me, it's almost a generational conflict that you're hearing there. Cathie, I don't know exactly her age and it’s probably not fair to ask her, clearly is part of the new generation, whereas the Goldman Sachs gentleman clearly is probably what people now call a ‘Boomer’. And the question here is where am I? Well, and I think that's easy. I'm on the Boomer side probably, because that's my age also, because I do believe that we should pay attention to history. And that is exactly what some of the growth investors are not doing, indeed, and I think there is a generation investing in equity markets now that hasn't even seen the 1999 crisis, so therefore they think trees grow into the sky. I must also say, Erika, because there's always a nuance, that this to me, is not as bad as 1999. It's just a small segment of the market, and that happens to be where Cathie Wood is invested at the moment, that is really at multiples that are hard to defend, I would say. But it's just a small segment of the market, right? The bigger segment of the market that now trades at relatively elevated multiples are just healthy cash flow-positive stocks that the market is willing to pay up for because of the TINA argument – ‘there is no alternative’. What else are you going to buy in a world where interest rates are still continuing to be very, very low? So that is just the flip side of that argument. Yes, these stocks are very vulnerable to interest rate increases, but if you look at it, if anything, interest rate increases are not going to be very large because nobody can afford that. Particularly central banks can not afford that, and most of the governments would quickly get into trouble if interest rates were to go anywhere near 4% or so.
Erika: So a good warning there. We're now going to change tempo. I contacted some of your colleagues to hear what they'd like to ask you, and I put these questions together as a sort of a rapid-fire quiz. So the idea is, I'm going to put the questions to you and you give us your immediate and brief thoughts on this. You don't have to go too deep. Not value-investor style, deep-thinking introversion, but just tell us what you think. So are you ready?
Erika: You are underweight China in your portfolio. With the market correction, especially in high-growth sectors like internet stocks, are valuations now more attractive? And in particular, are you considering adding to China or will there be further regulatory crackdowns that are not yet discounted in the price?
Arnout: I stay underweight because I think that the derating still has the legs into it. I still remember when China was trading below 10 times multiple. So there is, if people start to doubt balance sheets in China, then markets can fall a lot further. And it's also, again, the momentum part of our process that dictates that China is at this point in time a negative-momentum market in many respects and therefore deserves us to remain underweight. Although I do see that some of the large stocks are now also showing very healthy free cash-flow yields, and as much as there may be somewhat further crack down, and that may dampen the earnings growth outlook for these companies, I don't think that earnings will completely be taken away. So I do realize that the valuation argument is starting to build. But I've also always been taught that valuation is not a good timing instrument, and I think the timing is just still wrong for China.
Erika: Second question: You are overweight Korea, yet it has underperformed other Asian markets. What happened and are you still positive on the outlook for Korea?
Arnout: I think two things happened in Korea and I should be concise. But one of them, of course, was the semiconductor cycle got into a bit of trouble. And with Samsung Electronics and Hynix and a lot of other companies in Korea being closely affected by whatever happens in semiconductors, that caused the pause in that market, also because the fourth quarter of 2020 has been exceptionally strong for the Korean equity market. So I don't worry too much about that because the longer-term demand-supply is very favorable for the semiconductors. The second thing that happened is I think there's been a bit of a pull back away from the corporate governance improvements in Korea that we've seen. Some companies do things that are clearly not in the interests of minority shareholders. So that has caused also a bit of disappointment in the markets throughout this year.
Erika: On to question 3. South-East Asia traditionally is among those segments of the market that's least correlated with US growth. These markets are also approaching their golden age of mass affluence, which historically is a period when leading companies are created. So what's your view on prospects for markets in South-East Asia?
Arnout: Well, we're clearly turning more bullish on markets like Indonesia, and that's also because you see that, indeed, some of those high-profile companies are now coming to list in those markets. So it shows that equity is still alive in those markets after many years of not much happening. Now, some really bellwether companies are coming to market, particularly in Indonesia, I would say. So that's a very positive backdrop. The other side of most of the Asian countries is that they're generally seen to be vulnerable to rising US interest rates. So that's one thing to keep in mind. But like I said, I don't see interest rates go up dramatically. I do see them go up, but not dramatically enough to pull capital out of those bond markets.
Erika: Bonus question now. You're a man who understands cycles and peaks. You also understand bicycles and mountain peaks, and we notice from your latest activity on Strava that you seem to have a strange obsession with the peaks and hills in Hong Kong. Is this ‘peak insanity’?
Arnout: For me, it is, and my wife also thinks like that. You know, the fact of the matter is that in Hong Kong, you can't really leave the country at the moment, so you have to look for alternatives within the country. And yeah, we have a number of nice mountain peaks there, and I will never find those in the Netherlands, so I better make the most of it. And therefore, I've decided to participate in something they call Peak Master, where you climb 125 peaks around Hong Kong. And I was a bit scared to realize that some of my friends had already climbed more than 100 or maybe have even been finished, may have even finished all of them. And I was still lagging way behind in 40. So I was, yeah, my competitive nature came back and I was thinking ‘Oh, I need to catch up with these guys’. So now every opportunity I have, I try to efficiently climb a few peaks here in Hong Kong. And meanwhile, also enjoy the lovely winter weather.
Erika: Well done and handled with the composure that one would expect from a seasoned value investor. Back to the serious business. And as we move towards the close, when we look at the broader outlook for the Asian region, if the US does taper and if it accelerates that tapering and it starts raising rates next year, what would this mean for Asian equity markets?
Arnout: In principle, history will tell you that that's not a good thing for Asian equity markets. I do feel, however, that we've priced in a lot already in 2021 because, as you are probably aware, and that's been a major frustration for me, Asian equity markets have lagged way behind European and US equity markets for no good reason, really, maybe, except that their handling of Covid was good in 2020, but didn't turn out so good in 2021. But we've had massive earnings growth here in Asia, too, to the tune of about 40%. Yet our markets have been flatlining or well in the China case, of course, have been down and in US dollars also. Most of our markets are actually down for the year, with the exception of India and Taiwan. So I think that interest rate risk to a certain extent is already priced there. And I do believe that Asia therefore deserves to see more inflows. We've seen some inflows in 2021, but it's nothing nearly as big as the US equity market or even the European equity markets have seen. So from a flow perspective, I think that there is everything to go for in 2022 for Asia, particularly if indeed next year also will be a decent one for earnings growth. And you've just seen a very aggressive, I would say, too aggressive derating of multiples in Asia this year, with the wonderful performance of corporate profitability. And the worry there a little bit, Erika, is also the lack of an equity culture. So the few markets that have done well in Asia are the ones that are heavily supported by retail investors. You were just talking about Korea there. That market also came down because Korean retail investors pulled out, and a lot of them, I'm sure, have gone into crypto and the likes. So they just lost their appetite suddenly. And it's still an issue. I feel also in the Japanese market that there is not enough long-term investing going on in Asian equity markets. People don't just buy and hold, and I may have reminded you of that anecdote already that my Chinese neighbor whom I occasionally hang out with, has told me in the past before: What do you think of the equity markets? Are we ready for a ride? I said: Well, yeah, you should invest for the long term. No, no, no. Long-term investing, I do via property and medium-term investing I do via bonds, and equity investing I do for the short term. And of course, we're trying to teach our clients something completely different. But I think that is still an issue amongst Asian investors, that they think of equity as a short-term thing. You buy it when the cycle is up and when the growth is up, and you don't just buy stocks for long-term value creation. And yeah, let's hope we can communicate that as Robeco to some of our clients here and foster some more of that equity culture. And of course, with the growth in institutional assets, you're seeing more and more of it. But clearly amongst the retail investors, you don't see much of a long-term horizon in equity yet, unfortunately.
Erika: And then on a final closing, looking at investing in Asia, what worries you, and I think you've certainly touched on some of those key points and, importantly, what gives you hope?
Arnout: Yeah, the hope I already stressed, already emphasized to you. It's high multiples in the US and low multiples in Asia, means that you have a lot more downside protection. I also think that Asian value is almost a low volatility asset class as Pim van Vliet likes to call it, that a lot of these companies have been left completely neglected. Yet I do believe that they will turn out their 5, maybe 10%, nothing great, earnings growth. But meanwhile, paying very healthy dividends. So that gives me a lot of hope.
Erika: Arnout, thank you very much for your time. Always a treat to hear from you.
Arnout: Thank you very much. My pleasure.
Erika: Thank you for listening to our podcast. We'd love to hear from you. So please do send us your comments, feedback and suggestions. You can send those to email@example.com and you'll find all our podcasts on your favorite podcast platform, as well as at robeco.com.
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