Third Quarter 2018: A Market Built on Trump Tantrums & Everyone Else’s Discipline

I write quarterly updates for my investors and high-net-worth clients, in my capacity as a financial services consultant at AIA.  It is a long, technical read.  It also explains, in plain terms, how your funds have performed and where they are likely headed next quarter.  Most of the industry – wealth relationship managers, brokers, financial consultants alike – prefer to go quiet during turbulence and hope the client does not look too closely.  I do the opposite.  A professional relationship survives on trust, and trust survives on honesty, not silence dressed up as reassurance.

The Trump Variable

Equity markets closed 2017 strongly, and that momentum carried into January 2018, one of the best months in recent memory, visible in your fund activity statements.  We genuinely expected record growth this year on the back of that momentum.

Nobody could have predicted Donald John Trump’s particular flavour of self-sabotaging protectionism.  His tariff threats in January slowed the market by February, and a series of new US tariffs followed, targeted squarely at China, the largest trading partner Washington seems determined to alienate.  China runs on dignity, on “face,” and anyone who understands the country knows Beijing was never going to back down.  What followed was an undeclared trade war, complete with Chinese retaliatory tariffs, a weaponised US dollar, emerging-market turmoil, a bear market in Chinese equities, and the growing possibility of an oil shock.

Global growth slowed.  Equity markets corrected.  Bond yields retreated.  The US dollar strengthened, benefiting from its reserve-currency status even as the administration causing the turmoil tried to weaponise that very status.  The MSCI World Index stayed virtually flat from the end of 2017 to June 2018, giving up only 20 basis points in US dollar terms.  The United States and Japan, both relative underperformers in 2017, became the outperformers, with modest single-digit returns.  Asia excluding Japan absorbed a total market-weighted loss of 5%, erasing part of last year’s spectacular gains.  The benchmark MSCI Asia Pacific Index fell roughly 5% in recent weeks, wiping out close to US$700 billion this year alone.

Regional Casualties

No Asian market escaped unscathed.  North Asia suffered considerably less than South Asia.  Southeast Asia produced a mixed picture, with currency pressure compounding losses in the weaker performers.  Indonesia made the baffling decision to raise tariffs rather than simply defer payments to protect its current account, a solution with a considerably lower cost to long-term competitiveness.  Malaysia suffered a separate confidence problem entirely of its own making: Tun Dr. Mahathir bin Mohamad’s insistence on relooking or tearing up existing contracts with major trade partners did nothing for investor confidence in a market that already had enough headwinds to manage.

As the market adjusted into the third quarter, bond markets grew concerned about further policy normalisation from major central banks.  The 10-year US Treasury yield rose 70 basis points to a year-to-date high of 3.11% by mid-May, before easing to 2.86% by the end of June as fears of additional US tariffs on Chinese imports drove capital toward safer assets.

Investment-linked policy funds registered negative returns over the last few months, with Asian-themed and emerging-market funds hit hardest.  None of my clients holds emerging-market funds.  There are simply too many political variables in that space for me to consider it viable capital allocation for you.  While others absorbed losses of up to 20%, the worst performer among your holdings sits at a 9% year-to-date loss, with most funds ranging from a gain of 1% to a loss of around 4%.  These remain paper losses, not realised ones, and the distinction matters considerably more than the headline number.

The Three-Year Picture

Over a three-year horizon, every single one of your funds generated positive returns, a direct result of an investment strategy built for a long horizon rather than this quarter’s headlines.  The AIA Acorns of Asia Fund and AIA Regional Equity Fund continue performing strongly, exceeding 8% per annum over three years.  The AIA Global Technology Fund returned 15.2% over the first six months, driven by strong 2018 corporate guidance and a 3.3% outperformance from the fund manager’s stock selection, and 20.8% per annum over three years.  The AIA Regional Fixed Income Fund returned -0.6% as Treasury yields rose alongside widening corporate bond spreads, still cushioning losses elsewhere in the portfolio.

In August 2018, Singapore Telecommunications Limited issued US$500 million in corporate bonds at 3.875%, despite having no operational need for the capital.  Singtel functions as a proxy for Singapore Incorporated, and this issuance was Singapore’s own message to institutional investors: the government is watching regional currency pressure and capital flight, and has just locked in half a billion US dollars of liquidity for a decade.  This is precisely why the Singapore dollar has appreciated against regional currencies such as the Malaysian ringgit, a dynamic that benefits both the AIA Regional Equity Fund and the AIA Regional Fixed Income Fund directly.

China’s Long Game

China has absorbed short-term tariff pain without losing its underlying position as the factory of the world, with alternative markets available across Europe, South America, and Asia, and a deliberate, decades-long push into Africa.  Beijing is playing a fifty-year game.  Our own positioning should match that horizon rather than react to this quarter’s noise.

This downward valuation of Asian equities will eventually correct.  Valuations become attractive, funds circle, and the best bargains sit in East Asia and Southeast Asia.  ASEAN, South Korea, and Greater China remain growth regions.  Growth has slowed, not stopped, and the market, as it always does, has overreacted, which is exactly what short-sellers and short-horizon traders are built to exploit.  None of you are short-term investors.  Your average investment horizon runs seven to fifteen years, which means the correct action, with stocks due for a rebound, is to increase exposure into the right funds now, not retreat from them.

Technology as the Shovel Trade

For the more adventurous among you, greater weighting toward the AIA Global Technology Fund deserves consideration.  The MSCI Asia excluding Japan Index is dominated by technology names, Tencent, Alibaba, Samsung, and Taiwan Semiconductor among them, with information technology accounting for almost 32% of the index and Chinese companies filling seven of the top ten holdings.  Tencent and Alibaba alone command nearly 11% combined weighting.  People are not going to stop buying handphones or scrolling social media because Washington and Beijing are having a tantrum.  Manufacturing and traditional industry absorbed this slowdown.  Technology walked through it largely untouched.

Individual country indices track large-capitalisation, often state-linked names, Temasek Holdings and the Government of Singapore Investment Corporation among Singapore’s own examples.  Economies and stock markets are distinct animals across East Asia, and investors hoping to capture the region’s genuinely fast-moving industries will not find them sitting inside a headline index.

Beyond Trump’s belligerence, the trade cold war, and emerging-market turmoil, real structural transformation continues underneath.  Retail is migrating online, cementing Alibaba’s dominance.  A growing middle class is moving up the value chain in its shopping habits.  The genuine future market is the coming hundreds of millions of new middle-class consumers across China, India, and Indonesia, a demand base an American consumer slowdown will eventually become irrelevant against.  Entrepreneurship is surging across fintech, online retail, and the gig economy, riding China’s growth curve.  None of this shows up cleanly in a quarterly index chart, and none of it disappears because Washington had a bad month.

Selling Shovels, Not Panning for Gold

As I have told many of you before: during the California Gold Rush, it was the people selling shovels and pans who made the real money, not the prospectors panning for gold.  None of the funds I recommend is glamorous, and that is precisely the point.

Smartphones illustrate this well.  China remains the world’s largest smartphone market, shipping over 100 million units every quarter for several consecutive years, with Chinese manufacturers now commanding nearly a quarter of the global market.  Sunny Optical Technology, a smartphone camera component maker, recently reported a pick-up in handset-camera module shipments, a direct signal of the growth still embedded in this supply chain regardless of tariff noise at the border.

Banking tells a similar story, driven by simple underpenetration.  India had nine commercial bank branches per 100,000 adults in 2008; Indonesia had seven.  By 2016, those figures had risen to 14 and 17 respectively, and we expect that trajectory to continue as financial service penetration deepens across both markets, benefiting private banks with strong, experienced management.

Infrastructure completes the picture.  India’s logistics industry, worth roughly US$160 billion, is projected to reach US$215 billion by 2020, a compound annual growth rate of 10.5%.  Indonesia, the Philippines, Vietnam, and Myanmar are all investing heavily in infrastructure, financed substantially through export credit.

Why This Trade War Cannot Last

This trade war will not last, because the United States cannot actually afford to sustain it.  When Trump attempted to weaponise the US dollar against Iran, he shook global confidence in the dollar’s reserve-currency status.  While Washington has tried to walk that back, capital is already testing alternatives, principally the euro and the renminbi.  Capital is returning to the region, and once funds begin picking up bargains in earnest, valuations will rise accordingly.  Those who stayed the course through this quarter will be the ones rewarded for it.  That has always been the actual return on long-term investing, regardless of which president is currently making headlines.

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Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1% Playbook: The Billionaire Cheat Code