Conventional wisdom is always right—until it isn't. The question is: When is it right to disagree? The investment herd is thinking: Trade wars, tight money, fractious politics and a falling stock market in the U.S. Banking systems in distress in Europe and the splitting of the EU. A weak credit and profit cycle in Asia, slow earnings growth, and a Chinese state determined to assert political control. Roll on 2019, it is likely to be a doozy!
It is easy to get pessimistic at times like this, or overly short term and overly emotional. But it has been an emotional time! As we entered 2018, we were optimistic about Asia's markets. We were right for only a few weeks. Our concerns were more about monetary policy in the U.S. and high U.S. valuations. Asia seemed to be earlier in the monetary cycle (except Japan) and much more reasonably priced. But we got off to a crazy start and soon we worried about Asia's valuations, particularly in some of the high-growth areas of the markets. As 2018 progressed, Asia's markets were battered, beginning with Indonesia, then China and finally even Japan. For a while, the S&P 500 Index remained unperturbed and the Nasdaq marched upward, buoyed by the “last squeeze of the lemon,” from U.S. tax cuts. This divergence became extreme and eventually the U.S. market cracked, too, taking Asia down again. In the short run, a one-for-one fall is about what you should expect from Asia. This is what happened, adding misery upon misery and driving Asian valuations as low as 11.3X forward earnings for the MSCI Asia ex Japan Index, a 30% discount to the U.S. That is quite extreme.
What is your greatest risk in markets right now? Well, it might sound trite, but it is probably you. Can you continue to be impartial and thoughtful amid falling equity prices and depressing headlines? Trading is an emotional game; investment is a thoughtful analysis of contradictory evidence. At times like this, the two can conflict. As prices have fallen, my view has become increasingly optimistic. Headlines, sentiment and short-term momentum are overshadowing some important long-term considerations. 2018 is almost gone and thank goodness. While year-end is a somewhat arbitrary time to stop and think about the future, it nevertheless provides an opportunity to pause and reflect on the structural drivers of long-term growth in Asia.
Trade Conflicts Have Been the Headline Writers' Friends
Trade conflicts have taken a severe toll on sentiment, but fears of additional equity market declines stemming from trade impacts have been driven more by sentiment than calculus. I was surprised (and frustrated) by the inability of the U.S. and China to resolve their trade issues. Maybe it is time to jettison my belief that these two administrations can resolve things quickly. I think Chinese policymakers would like to, but the U.S. side remains intransigent. In my view, the U.S. is wrong on the theory and the practical implications of trade with China. What might give the U.S. pause is if the current rumblings of tariffs (both from the U.S. administration themselves and retaliatory ones from China) hit corporate profits and hurt U.S. financial markets. If these rumblings continue to amplify, then the impetus to make a deal will be greater. The irony is trade protectionism, if it ever makes sense in the short run, it is only really useful during times of depressed demand. Today, protectionism is unequivocally damaging, but not to the extent that breathless headlines would have us believe.