Getting a seat on the China bus

There are huge opportunities for Australian investors as China accelerates globally.

It’s a mere 265 kilometres from Colombo on Sri Lanka’s west coast to the east coast port of Trincomalee. In the mid-1990s the bus trip could take a day. The suicidal drivers and meteor-sized potholes were bad enough, but it was the army roadblocks that got you in the end.

The country was in the midst of a civil war and ‘Trinco’ was a base of the Tamil Tigers. By the time the fifth roadblock came into view, overcome by sweat and tedium, I was ready to pay anything for a fresh t-shirt and a beer.

The memory returned this week whilst reading the media’s paranoid-tinged coverage of China’s One Belt, One Road (OBOR) initiative. The program is new to us but not to Sri Lanka or other countries in the region, many of which have been beneficiaries of massive Chinese investment for almost a decade.

During the 30-year Sri Lankan civil war, defence spending went as high as 6 per cent of GDP (the equivalent Australian figure is 2 per cent). Seemingly not much, although this research paper says it represented a near-100-fold increase in per capita defence expenditure, from $US0.89 in 1975 to $US87.55 in 2013.

That figure gives the lie to the notion of a “peace dividend” – GDP kept growing throughout the war. In the words of the paper’s authors, there was “a unidirectional causality from defence spending to economic growth.” Yes folks, war can be good for business. When China moved in, much to India’s chagrin, the pace of change accelerated. Three years after the war’s end in 2012, Sri Lanka’s GDP growth hit 9 per cent.

China’s housesitting began not in Trinco, where colonial powers have traditionally put their feet up, but Hambantota in the island’s south. The town now hosts a $US1.4bn deep-sea port, an international airport, multi-lane highways and a cricket stadium, many of which remain under-used (this Forbes story covers the white elephant airport’s tracks).

That might not worry China, or former president Mahinda Rajapakse, a man not short of self-regard. Born in the town, many of its glittering trinkets bear his name. As The Economist map below shows, Hambantota is a port of strategic significance. About 80 per cent of China’s oil moves through the Malacca Strait. Should the US ever choose to block it, China’s oil supply from the Middle East can be routed to Kunming via the pipeline that begins at Kyaukphyu, perhaps with a meal stop at Hambantota to enjoy some idli and string hoppers – two of the world’s great breakfasts in my view.

Call it serendipity, but the Chinese play a long game, an entwining of the commercial and the strategic over timeframes that Western politicians can’t hope to comprehend because, you know, elections. Then there’s the money. OBOR encompasses 75 overseas economic and trade cooperation zones in 35 countries, plus a $US1.3 trillion investment in projects already underway, with more to come.

US policymakers might recognise the template from the Marshall Plan, a $US13bn investment (in 1948 money) in the rebuilding of Europe, which created goodwill and a post-war international market for US consumer goods, plus the rationale to contain the USSR with US airbases dotted across the continent. The Marshall Plan laid the foundation for an incredible period of post-war economic growth.

Will OBOR do likewise? Perhaps. China is a huge country with growing economic wealth and power. By 2030, ANZ Research indicates that most Chinese will be affluent, with disposable incomes in urban areas averaging $US30,000 a year in purchasing power parity terms, three times the current level.

The country is also moving up the value chain, as it must, building a high-speed rail for the Indonesians using finance from the China Development Bank. It also has burgeoning hi-tech sector that includes biotech, aircraft and huge enterprises like Tencent and Alibaba.

Source: World Intellectual Property Organization

Chinese companies, despite a well-known disregard for intellectual property rights, are also lodging trademarks, patent applications and industrial designs in unprecedented numbers (see above). Why not see poorer neighbours as potential new markets, and help them to get richer so they can buy your stuff? It’s not as if this hasn’t be tried before.

These factors are already helping China snare a growing share of global GDP, a trend that is likely to continue. One of the interesting things about this isn’t just the recent growth but also the long term historical trend. Two hundred years ago China was a dominant force in global trade. We might see growing Chinese influence as something new but many Chinese see it as a rightful return of influence and muscle.

Why am I telling you this? Well, it’s a fascinating turn in geopolitical power, not a passing of the baton but, in the way of these things, a gradual taking of it. As the US retreats from the world China is pushing into it.

Already, this has had profound implications for the region and Australia’s economy. But this is only the beginning. For one, I expect to see more media coverage of the potential “opportunities” this shift will bring to Australian investors. There will be more wave-riding stocks like A2 Milk and Bellamy’s, almost all of which will dump investors into a deep water port of their own making.

As Intelligent Investor’s research director James Carlisle said a few years back in response to a member question, “Rather than focusing on growing markets, focus on companies that produce products that add value in a sustainable way and that have competitive advantages. If a company ticks those boxes it’s likely to do well, whether it’s selling its wares to China, Chile or Chad.”

This is a point often lost on the theme-loving funds management industry, which is undergoing a structural shift of its own. A few years ago, an ‘adviser’ from MLC drove 180km to offer advice on my wife’s superannuation fund. The sum wasn’t huge and I couldn’t understand his commitment, until I saw the 4 per cent management fee on her statement.

Those days are over. The rise of passive investing, via the popularity of low-cost index trackers and ETFs, is hitting active managers hard, to the point where their future is being questioned.

This is an unqualified good thing. For too long terrible managers have been paid too much to do an awful job. The AFR reported recently that, “the majority of Australian active funds in most categories fail to beat the index over three and five years”.

Investors are waking up to the fact they’re being ripped off, especially by bank-run retail funds and active managers that can’t deliver on their promises. Once you understand that a 2 per cent fee on a fund earning market returns of 6 per cent is a 33 per cent commission, an industry fund or index tracker with negligible fees and market returns seems rather attractive.

Genuine stockpickers have nothing to fear and much to gain from this trend. In the way that a rugby union player leaving to play league raises the intelligence of both codes, ridding the industry of dud active managers lifts the intelligence of the industry. If you’re happy with market returns there are more cheaper options to get them. And investors seeking outperformance have more chance of finding it because there’s less competition for cheap stocks.

It’s all good in my view, except for the banks’ iron grip on distribution in the sector, preying on unsuspecting clients that think Count Financial, Godfrey Pembroke and BT Financial are independent advisers. For a bit of weekend fun, check out Count’s website and see if you can find the solitary mention of Commonwealth Bank, its owner. Or NAB on Pembroke’s. There’s a free consultation with one of their advisers up for grabs for the first correct entry.

I have no sympathy for the banks moaning about a new tax, especially when you consider this chart, via Macrobusiness.

That said, a genuine move to increase competition in the sector, as opposed to a Government-led attempt to skim money off the banks that the banks have skimmed from us, would be welcome. Forcing them to divest their financial planning arms and a level funding playing field would be a start. Bank account portability would be even better.

So please Ian, Andrew, Brian and Shayne, stop your whinging. If you’re not on a bus to Trinco you have no idea how lucky you are.

Enjoy your weekend.

Last week

Shane Oliver, AMP Capital

Investment markets and key developments over the past week

Share markets rose over the last week, reversing the Trump FBI/Russia Bump from the previous week as investors bought the dip supported by mostly good economic and profit news, which took US and global shares to new record highs. The gains in Australian shares were relatively constrained though by ongoing worries about the banks, retail shares and weakness in the iron ore price. Bond yields were little changed, commodity prices were mixed with oil and iron ore down but metals up, and the $A fell.

The past week saw terrorism rear its ugly head again, this time in Manchester in the UK and our thoughts are with those affected. Despite some fears to the contrary, the financial market impact proved yet again to be minor, with UK shares only falling 0.1 per cent the next day before rebounding and there was no sign of any impact on other share markets. This is consistent with the experience since early last decade that has highlighted that terrorist attacks on targets like crowds, buildings and entertainment venues, etc, don’t really have much economic impact. While the 9/11 attacks had a big short-term share market impact, with US shares falling 12 per cent, they had recovered in just over a month; the Bali and Madrid bombings had little impact; the negative 1.4 per cent impact on the UK share market from the London bombings of July 2005 was reversed the day after; the French share market only fell 0.1 per cent the next trading day after the November 2015 Paris attacks; and 0.3 per cent the day after the July 2016 Nice attack. The experience across the UK and Europe with the IRA, ETA, Red Brigades, the Red Army Faction, etc in the 1970s and 1980s highlights that terrorist attacks can come to be seen as the norm, with people getting desensitised to them. So while terrorism is horrible for those affected, it would need to cause more damage to economic infrastructure to have a significant economic impact and hence a significant impact on investment markets.

Moody’s downgrading of China’s sovereign credit rating from Aa3 to A1 is unlikely to have much impact. China’s debt problems are well known with China’s policy makers seeking to restrain debt; most investment in Chinese bonds is internally sourced, and China is not dependent on foreign capital being the world’s largest credit nation.

As widely expected, OPEC agreed to extend its production cuts to March next year but for the oil price it was a classic case of “buy on the rumour, sell on the fact.” OPEC is basically in a bind: if it cuts supply further it will lose more market share to shale oil, but if it hiked production oil prices will plunge again. So it chose the middle path.

President Trump’s fuller budget request released in the last week is best ignored. As always, Congress will put the budget together - Trump doesn’t even need to sign it off.

The latest Australian bank rating downgrades tell us nothing new but the drip feed of negative news around the property market in Sydney and Melbourne is continuing to mount: surging unit supply, bank rate hikes, tightening lending standards, reduced property investor tax deductions, ever tighter restrictions around foreign buyers, etc. Our view remains that home price growth has peaked in Sydney and Melbourne and that price declines lie ahead, particularly for units. The extent of the unit construction boom in Sydney is highlighted by the residential crane count, which has increased from just 62 in September 2014 to 292 in March.

Still prefer global over Australian shares. Much of the relative underperformance of the Australian share market versus global shares since 2009 – which reflected relatively tighter monetary policy in Australia, the commodity slump, the lagged impact of the rise in the $A above parity and a mean reversion of the 2000 to 2009 outperformance – has been reversed. However, the Australian share market looks likely to continue underperforming going forward, reflecting weaker growth prospects in Australia – with the economy looking like it may have stalled again in the March quarter, the housing cycle peaking and turning down, constraints on consumer spending (high debt, higher bank lending rates, slowing wealth affects, rising energy costs, record low wages growth and high underemployment, risks around the banks and uncertainty around the outlook for bulk commodity prices. We still see the ASX 200 higher by year end, but global shares are likely to do better on both a hedged and particularly unhedged basis.

Major global economic events and implications

US data was mostly good with the highlight being a rise in the overall business conditions PMI for May pointing to reasonable growth. Meanwhile home sales fell, but home prices continued to rise. The main dampeners were weaker-than-expected trade and inventory data, which will constrain the growth rebound in the current quarter. The minutes from the last Fed meeting confirmed that the Fed is likely to hike rates again in June and looks to be on track to start running down its balance sheet (ie, reversing quantitative easing) from later this year by letting a gradual amount of maturing bonds roll off each month. Rate hikes and balance sheet reduction all remain conditional on the economy continuing to behave though.

Eurozone business conditions PMIs remained very strong in April and business confidence rose in Germany and France which is all consistent with strengthening growth in Europe.

Japanese inflation rose slightly in April, but with core inflation still zero, the Bank of Japan is set to continue quantitative easing and its zero 10-year bond yield policy for a long time.

Australian economic events and implications

Australian March quarter construction data fell, adding to the downside risks to March quarter GDP growth. However, it’s not all bad as the 4.7 per cent slump in residential construction looks temporary and likely to reverse in the current quarter as the impact of Cyclone Debbie drops out and the huge pipeline of work yet to be completed kicks in, public construction is up strongly reflecting state infrastructure activity and December quarter construction activity was revised up significantly.

Weak March quarter construction activity along with very weak retail sales and a likely growth detraction from net exports highlights that absent an upside surprise in public spending, equipment investment or inventories March quarter GDP growth looks likely to be near zero with the risk of another contraction. Reflecting this along with ongoing softness in underlying inflationary pressures, there is far more risk of another RBA rate cut by year end than a rate hike.

Shane Oliver is head of investment strategy and chief economist at AMP Capital.

Next Week

Craig James, CommSec

Business investment and retail sales in focus

  • After a hiatus over the past week, the domestic economic data releases are back in focus. More than half-a-dozen key releases are scheduled and around a dozen events will dominate attention overseas.

  • In Australia, the week kicks off on Tuesday with the release of the building approvals publication from the Bureau of Statistics (ABS). In March, dwelling approvals fell by 13.4 per cent – marking the largest decline in almost 1½-years. But don’t read much into the slide in dwelling approvals. The data tends to be volatile on a monthly basis and the trend data is probably more interesting. In trend terms, approvals rose by 0.8 per cent – the first increase in ten months. For the record we expect approvals to rebound by 5 per cent in April.

  • Also on Tuesday the weekly consumer confidence data from ANZ and Roy Morgan is released. Confidence levels have risen for three out of the past four weeks. However it is clear that Aussie consumers are just feeling OK. The latest job figures are likely to be offset by the media discussion on the budget measures, with consumers wondering what the bank levy means for them.

  • On Wednesday, the Reserve Bank releases data on private sector credit (broadly, outstanding loans). Annual credit growth is holding near 5 per cent – essentially remaining near three-year lows.

  • On Thursday, investors and traders will have a lot to focus on with a number of ‘top tier’ indicators scheduled for release. Arguably the most important release from the ABS will be the March quarter estimates on business investment. This data is also an input into the calculation of economic growth. But also insightful are the estimates of planned investment for the coming year.

  • In the December quarter investment fell by 2.7 per cent, but hopefully the improvement in the global economic outlook and lift in business conditions results in a rebound in investment. The Reserve Bank will be interested in estimates of non-mining investment.

  • In addition, the ABS will release the monthly retail trade data on Thursday. No doubt the latest figures will garner plenty of interest given the slowdown in retail activity in the past couple of months. The Commonwealth Bank Business Sales index indicated that sales were flat in trend terms over May. For the record we expect that retail sales rebounded by 0.4 per cent in seasonally adjusted terms in April.

  • Also on Thursday, CoreLogic releases its estimates of home prices for May, while the Australian Industry Group while release the Performance of Manufacturing index. By all accounts home prices are starting to show more sedate growth, given the tighter lending restrictions adopted by the banks. The CoreLogic daily home price index indicates that home prices have fallen by around 1 per cent in May.

  • On Friday the Housing Industry Association releases figures on new home sales.

Overseas: US jobs data pivotal to rate outlook

  • After a holiday weekend, a big slate of US economic data awaits investors on Tuesday. And gauges of manufacturing and services activity are due for release in China.
  • The week begins on Tuesday with US data on personal income and spending, consumer confidence and the CaseShiller measure of home prices. Both personal income and spending are expected to post firm 0.4 per cent gains for April. At the same time data will probably show home prices rising at a near 6 per cent annual rate while consumer confidence may have eased further from 16-year highs due to increased political uncertainty.

  • In the US on Wednesday, the Federal Reserve releases the Beige Book – a summary of economic conditions across Federal Reserve districts. Fed policymakers regard the survey results as a valuable input to their rate setting decisions.

  • Also in the US on Wednesday the usual weekly data on mortgage applications is released together with data on pending home sales and the influential Chicago purchasing managers index.

  • In China on Wednesday, the National Bureau of Statistics will release the results of purchasing manager surveys covering both the manufacturing and services sectors. As is the case in the US, the services sector is in the strongest shape of the two sectors.

  • On Thursday the private sector Chinese Caixin survey of the manufacturing sector is released with the services sector survey on June 5.

  • On Thursday in the US the usual weekly data on claims for unemployment insurance is released together with the ISM manufacturing index, construction spending, the ADP National Employment index, new vehicle sales data and the Challenger job layoffs series.

  • And on Friday in the US, the pivotal employment report (Non-farm Payrolls) is released with international trade figures and the ISM-New York index. Economists expect that 183,000 jobs were created in May, down from 211,000 jobs in April. But analysts forecast a modest lift in the jobless rate to 4.5 per cent while earnings may have only lifted by 0.2 per cent. Overall these results could temper Federal Reserve policymakers from lifting rates again in June.

Financial markets

  • There has been more volatility over the last couple of weeks but it is important to keep in mind that most indices have recorded healthy growth over the first five months of the year. So far over 2017 the ASX 200 index has risen by around 1.7 per cent, while the Japanese market has risen by 2.6 per cent and the UK market is up 4.8 per cent. However, the clear outperformer have been the US market. The Dow Jones has risen by 6 per cent in 2017, while the broader S&P 500 is up by 7 per cent. The clear winner is the technology heavy NASDAQ which has gained a staggering 14 per cent.

Craig James is chief economist at CommSec.

Readings & Viewings

The Australian share market headed down on Friday, largely thanks to OPEC agreeing to further cuts in oil output. Oil stocks here such as Woodside and Santos were hit hard, and so were their offshore counterparts. So now that the latest OPEC decision is out of the bag, which oil and gas stocks are worth looking into?

But it seems to real action this week hasn’t been in shares at all. If you really wanted to make some cash, you needed to be in cryptocurrencies. Bitcoin hit a new record, but the 2000 per cent returns from a rival currency make Bitcoin’s 137 per cent gain so far this year look mediocre.

Yet, here’s what one of the world’s leading fund managers believes is stopping Bitcoin from going mainstream.

Speaking of good returns, Netflix is definitely one to watch too.

If you bought one Netflix share at IPO 15 years ago, you would be laughing today, and holding onto shares in a completely different business.

We know Amazon is threatening global domination in the online retail world. But now it’s disrupting once again through another retail channel – bricks and mortar.

The more things change, the more they stay the same – even in the digital world. Just ask Apple and Nokia.

But Microsoft doesn’t think it’s important to be cool in the tech space.

Changing pace, in Australia credit ratings agency S&P made news during the week by cutting its ratings on a swag of smaller lenders, including regional banks. But the biggest ratings news was Moody’s downgrade on China. Who’s next on the emerging markets downgrades list?

And here’s what the China downgrade means.

Meanwhile, China’s Geely has bought iconic British sports car maker Lotus. But Aston Martin Aston has headed off stock market float talks.

At another car company, after firing its CEO, Ford has put the former head of an office furniture company in its driver’s seat.

And we found this reading rather interesting. What’s safer; a slaughterhouse, a sawmill or Tesla?

Over in the African country of Tanzania, it seems all that glitters isn’t gold.

The Governor of the Bank of England should also be careful of scams. He’s  just been caught by a prankster commenting on email about a predecessor’s drinking habits.

United Airlines faced a grilling from employees at its AGM during the week over its customer relations.

This could be one for Australian investors. US President Donald Trump is said to be looking at infrastructure privatisation. The Washington Post article said the Trump administration could learn a lot from Australia on this.