Wayne Bowers is chief investment officer covering Asia Pacific, Europe, the Middle East and Africa for Northern Trust Asset Management, where he has worked since 1999. The firm has $900 billion in assets under management and offices across 20 international locations. He discusses the implications of the US Federal Reserve’s more dovish stance and China’s capital market reforms.
Q The Fed appears to be backing off from raising interest rates. What impact is this having on emerging markets (EM)?
A Investors are starting to close out their underweight EM positions. We saw this start about one to two months ago when it became clear there weren’t going to be the four to six rates rises many had been forecasting. Now maybe there’ll be one, if that.
Investors are looking for yield. They need risk and they’re looking to rotate out of developed equities into EM. The trimming is likely to take place in large cap US stocks.
Q As money comes back to EM where’s it likely to start heading first?
A It will be equities ahead of debt and Asia ahead of the rest of EM. The Hong Kong and China universe is looking particularly attractive. There’s been a significant fall in valuations without a corresponding fall in economic activity.
South East Asia is still looking a bit rich on a relative basis. But investors want broad based allocations and diversify so these markets will also benefit.
Q Do you think Asia has been unfairly sold off over the past few years given its superior economic performance relative to the rest of EM?
A Yes that’s certainly the case. There were some very broad-brush moves to reduce exposure across EM without really thinking about regionality and Asia has definitely been penalised to a certain extent. This is something we really try to talk to investors about.
However, institutional asset owners have very robust asset allocation processes. The first thing they tend to do is divide the world between developed and developing markets. Only then do they consider style bias, or fund managers. They haven’t been nuanced enough about making regional allocations.
Q How underweight are they now?
A Net net, they’re still underweight. Having said that, long-term focused asset owners maintained their risk profile in emerging markets throughout the sell off. However, what they didn’t do was re-balance as valuations dropped. So, for example, if an asset had a 10% valuation, which dropped to 7%, they didn’t top back up to 10% again.
Q You said South East Asia was still looking a bit rich, but currencies in these markets have had a storming first quarter. How much more upside is left?
A Currency is always a very important consideration. I think the Malaysian ringgit and Indonesian rupiah may have small room to appreciate a little more, but perhaps the more obvious move is for a sideways move. This sudden appreciation is not going to do their export sectors any favours.
Q What’s your view on the competitive currency devaluations we hear so much about?
A Global growth is not going to improve dramatically over the next six to nine months. It’s going to be lower for longer and it will take much longer than anyone expected for developed economies to return to trend growth.
A good analogy is to think of the global economy as a very shallow boat. Everyone is in the same boat. Very few countries can jump out and achieve higher growth than the rest. Very few will fall through the bottom. So in order to increase exports one country needs to take the export share of another. Weakening the currency is a very good way to do this.
Q What does that mean for Asia’s export sector?
A Historically Asia has benefitted from low level unit labour costs and high productivity combined with stable or weak currencies. That’s been highly beneficial for exports.
But the outlook is not looking so good in a world where the European Central Bank is ratcheting up the quantitative easing for currencies pegged to a stronger US dollar. Asians tend to forget that Europe has some very strong manufacturing companies with very flexible and well-established supply chains.
Q So what’s the end game for this spiral of lower exchange rates?
A Negative rates are going to get deeper. Central banks are still trying to move money out of the banking system into the real economy to create growth and positive inflation. It’s too early to say it won’t be successful.
Perhaps we won’t get to the desired 2% inflation, but at the moment we’ve got low growth and zero inflation. Everyone wants self-sustaining economic recovery and moderate inflation. We’ve been waiting for it for five years.
Q Where does China fit into all this?
A I’m positive on China. There is a hard landing unfolding but it’s being managed. The big fear was a hard landing and capital flight, but the latter’s been contained. I was in China in early April and I’m always impressed.
The Chinese are very good at playing the long game. They know people will come if they build the infrastructure first. SOE reform is bearing fruit. I meet young people now who want to work in these companies because they think they’ll get the best of both worlds – the ability to innovate and job security.
Q What more could China be doing?
A There’s room for more capital markets reform and the big issue of convertibility on the capital account. The authorities are clearly worried they won’t be able to wield control if they take those final few steps. Control is always very important to the Chinese.
I think MSCI picked up on an important issue when they mentioned the continuing existence of foreign quotas as one reason why they aren’t including A-shares in their indices. I don’t think they will move on this issue until the restrictions are dropped.
We’re a big global investor and our clients want to enter and exit markets when they want. There shouldn’t be a distinction between and onshore and offshore.
More foreign equity investment will only benefit China’s stock markets. Had there been no quotas last year I don’t think we’d have seen the huge run up and collapse. The big problem was the existence of one investor segment: leveraged retail investors who were all pushing the market in one direction. Had there been more foreign investors they would have been on the other side of the trade taking profits and providing natural resistance on the upside.
Q What about China’s bond markets? Do you access it now the restrictions have been removed?
A Not yet. We’ve haven’t seen that much interest from our clients at the moment either. It’s still early days. Their concern is always: how liquid is a market, what’s the underlying corporate risk, how transparent is it?
