I can't believe I am putting my fingers to the keyboard again to write about U.S. Federal Reserve rate rises. Again!! You must be thoroughly bored with the whole tedious topic; I am certainly starting to tire of it. But it is an important topic for a couple of reasons: first, because December saw the first rate rise in the U.S. in almost a decade; second, because people seem to have serious misunderstandings about what it means for Asia. I intend to take on the second of these issues—the misunderstandings—and then examine more important matters concerning Asia's domestic growth.
Fortunately, I have a lot of help in this regard. The definitive answer to what happens to Asian portfolios when rates rise has already been written by my colleague Gerald Hwang. Of course, Jerry may hate me for using “definitive,” because really there is no definitive answer as to what Asian securities will do in the face of Fed hikes. It all depends.... It’s dependent upon what’s happening to U.S. growth and wages; Asia's growth and wages; price inflation for goods; money supply growth; investors’ expectations of all these factors; supply-side reforms; risk tolerances; and the list goes on and on.
The only thing I can say for (almost) certain is that, despite expectations of rate rises in the beginning of the year, the Fed did not move until the very end of 2015. Growth was not as strong as some expected and despite the never-ending mantra from bankers and some financiers that "zero rates are unnatural,” the Fed held its nerve and held rates, too. The financiers' talk was enough to move the markets' expectations toward tighter money, and inflation expectations weakened. This has been a big drag on Asia's economies. It created an environment of vulnerability. And all it needed was an acute reaction to China's renminbi re-pegging to make the markets swoon to a level at which they appeared cheap. A more sanguine view on rates allowed the market to recover and “cheapness” has dissipated from many Asian markets, but the sluggish pace of growth continues. I had been pretty convinced all along that raising rates any time in 2015 would have been a bad move. Even now, I think that the Fed was premature in raising rates. We will see if they got it right or not—but growth has hardly been strong.
Now things are changing in Asia. After years of disinflationary growth, Asian central banks are "leaning against the Fed" and loosening policy—Japan, India and China included. That shift in policy is good for the region. U.S. wages finally appear to be on the rise, but that is also just one data point and we shouldn't cheer the arrival of the cavalry just yet. So, despite the fact that it seems possible we will see further rate hikes before mid-year, I am much less fearful of such hikes if Asia is reflating and U.S. wages are rising. As Jerry says, the common wisdom that rates go up and Asian securities go down is based on an all-else-being-equal analysis. "But all else is never equal." What is more crucial now is that the pace of growth in global demand is sustained. There seems to have been some improvement in the eurozone—though are they ever really far from another political economic crisis? In the U.S., too, the economy has been resilient, but not exactly growing gangbusters—and recent liquidity problems in marginal parts of the high-yield bond market have cast some doubt on this resilience. So, whilst we should be wary of saying things like China can save global growth or that it is the new engine of the world economy, much of what matters for Asia's stock markets and certainly what matters for most of the companies in your portfolios, is the growth in Asia's domestic demand.
High savings rates, governments open to new ideas, citizens trying to better their lives and learn new skills, along with some pretty ambitious reform programs all bode well for long-term growth. But the markets are having a hard time seeing past dollar strength and rising rates. So much so, that any commodity-related currency has been hit hard. And the whole region has suffered at the hands of a rising dollar, even if Asia has current account surpluses and domestic economies that are nowhere near overheating. Because of this, the market has favored any country that seems to be more resilient to these forces—South Korea with its high current account surplus, low valuations and thriving technology business on the one hand; Japan with its aggressive stimulus and corporate governance changes on the other. And it has certainly favored companies that are more focused domestically and have strong secular growth: so, many of our holdings in the consumer-facing sectors, health care, and online businesses have fared well, even as areas where the Matthews Asia Funds have always been less exposed—traditional manufacturing, state banks and materials sectors—have been extremely weak. So, our strategies have benefited from the focus on these kinds of businesses and from some good relative performance from mid-cap stocks. This has been pleasing in a relative sense, across many of the portfolios, even as the absolute performance for the year has been disappointing.
These sectors remain our focus for the long term, as we look toward 2016 in the hope that more policy activity to stimulate economies will raise nominal growth rates, improve margins and see Asia’s EPS (earning per share) potentially grow faster than the developed world. This would help sentiment and bring valuations down from what can best be described as average levels relative to history, even though they trade at a discount to the U.S. I remain wary, however, that in such a scenario—a more reflationary Asia—we may at times lag the performance of the indices. So be it—a rising tide, if that is what we get, might raise all boats. But I would expect, ultimately, secular growth to show through. And we have to stick to our convictions about the long-term path for Asia’s economies.
There are, therefore, a few glimmers of hope for the New Year—but let us not count our chickens just yet.
Robert Horrocks, PhD
Chief Investment Officer