During May the strategy outperformed the MSCI Emerging Markets index by 0.1%.
Positive performance came from our Latin American exposures as well as smaller markets like Saudi Arabia and Greece. This was offset by a weaker relative performance in our China portfolio.
During the month we added a new position in Korea while taking profits on a stock in China where valuations had become stretched. We also exited one of our financials in Poland and continued adding to existing positions in Latin America.
While we follow the twists and turns of US-Chinese negotiations on trade and tariffs, it is interesting to look at the imbalances at the heart of the issue. The trillion dollar US trade deficits that the Trump administration wants to reduce, approximately mirror Chinese trade surpluses. Those surpluses are driven by Chinese production capacity in excess of domestic consumption.
It is well understood that Chinese household savings rates are high and result in large amounts of disposable income not being spent. This has led to an unprecedented build-up of consumer savings. Currency restrictions meant that these largely had to stay onshore.
Historically spare cash was invested in the property market, to a lesser extent in the stock market as well as various “guaranteed return” products linked to both of these. As the property bubble burst and many investment schemes were wiped out alongside a weak stock market, consumers have become more reticent. The result has been a spectacular growth in bank deposits.
According to latest HSBC data, Chinese household deposits now exceed USD22 trillion. That is greater than Chinese GDP and equivalent to three years’ worth of Chinese consumer spend. In comparison US households only have around three quarters of a year of spending in the bank.
Economics tells us that Savings = Investment, so unsurprisingly these deposits are being redirected into capital expenditure via banks. Historically, this meant infrastructure spend by local governments and of course property investment. With local government balance sheets now destroyed, infrastructure overbuilt and the property developers insolvent, these avenues have been choked off. The slack has been picked up by the manufacturing sector, driving up overcapacity and trade surpluses.
The high savings rate is not only depressing local demand but also promoting excess production. This is the engine of the global trade conflict. Increasingly it appears the Chinese government is aware of the problem. Unfortunately, it turns out that forcing people to spend more is hard, even for an absolutist government with huge control over its population.
Interest rates have already been driven down so as to become ineffective in forcing dis-savings. Various targeted consumer subsidies and incentives have been locally successful but do not move the needle. The Chinese consumer would need a real shot of confidence to awaken animal spirits. It is unclear as yet as to where this might come from. Experience shows that people do not remain depressed and spendthrift forever – perhaps the wealth effect from a stock market recovery and a bottoming of house prices could turn things around. If so, this could become the single most important factor in addressing global trade imbalances.
