As you may remember last week we informed you that we had raised the risk profile of our main funds as we felt we had entered a new phase, phase 2, of the crisis, one of instability and no longer of outright shock, because all the bad news still out there where being balanced out by outsized policy action, a cleaned out positioning, and more realistic macroeconomic expectations. And of course, some better trends on the containment of the propagation.
Two weeks ago we had raised the equity exposure level to fairly moderate levels (close to middle of the range on Carmignac Patrimoine, a little less on Carmignac Emerging Patrimoine, a little more on Carmignac Patrimoine Europe). The reason why, despite this cautious approach, the funds did quite well even in relative terms in these past weeks of strong equity markets was that because each fund delivered a good amount of alpha both in the equity books and the credit books. In this period which we continue to see as instable, that is the way we hope to continue generating performance, through a moderate equity exposure on average, even if of course we’ll keep managing it tactically, and through maximum alpha generation.
Two areas of focus have to be watched closely going forward
1. One is the political will within Europe to take the opportunity of this economic crisis to make a material move forward, towards more political solidarity. As of today, the Jury is still out. The European Leaders summit is scheduled for Thursday next week. A proposal for a recovery Fund is being put on the table by France. So maybe next Thursday, we’ll have more reason to hope, or to despair. So stay tuned.
2. The second concern was about emerging markets. The availability of off-shore dollars visibly remains quite tight so that emerging countries running Current account deficits still remain under pressure. And we have very much streamlined our exposure to Emerging Markets in our big funds. But of course the elephant in the room here is China.
The political pressure coming from the US on China has moved up significantly in the last days. Economically, the threat of re-shoring of industrial activity has been rising.
Actually, this threat is already a reality:
The proportion of manufactured goods imported in the US to total domestic manufactured output shows a downward trend which started with the trade war last year, and there is no doubt it will continue. It will probably also concern Japan, or Europe as the rebellion against globalization is certainly getting some tail wind from this pandemic.
Incidentally, some countries are already turning out to be beneficiaries of this move away from Chinese manufacturing. For instance, the quantity of US imports of manufactured goods from Mexico is rising as a proportion to US production. So, one point of note is that, at this stage, what is happening is not just re-shoring, or “deglobalization”, but rather some rearrangement of globalization. It remains that the trend will certainly be adverse for China, but one should not lose sight of four positive factors.
1. The economic impact of the lockdown in the western world is such right now that actually, the growth differential between China and the US or Europe is becoming wider than before. This is partly because this crisis is very different from a classic economic downturn in that it hits services very hard. Harder than manufacturing. And of course, in Emerging Markets, including China, services still are a smaller proportion of GDP than in the US or Europe. 60% vs 80 or 85%. So it makes sense that western economies are actually suffering more now from the lockdown than China, from a macro perspective.
2. The efficiency of local subcontracting in China and fast return to production are turning out to be very appreciated by western industrial companies today. The crisis has actually been well managed in China, from an industrial standpoint. So yes re-shoring will happen, if only for political reasons, but the economic value of global sourcing; and notably from China, is not going to disappear. Far from it in our opinion.
3. Third, Chinese tourism overseas used to be a big cost to the country’s current account balance. The fact that Chinese tourists do not travel overseas any longer therefore helps and compensates to some extent the hit to the balance created by the fall in goods exports.
4. Finally, as the overall economic, health and political situation in the western world is deteriorating, the pressure of capital outflows from China has clearly dried up. This is definitely one less concern to worry about today for China.
So, for all the noise that surely is going to be quite negative about China, we would not be surprised that, at least in relative terms, China actually comes out stronger of this whole period.
This explains why, in particular as we are positioned on very specific high visibility growth stocks targeting the domestic market, we feel quite confident about our investments in Chinese equities.
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