Asset Allocation Q2 2020

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The centre of gravity shifts East

In order to tackle the rapid spread of the COVID 19 virus, governments in almost every country have taken unprecedented action, isolating the majority of their populations and almost halting the global economy.

It is these measures, rather than the disease itself, which now look certain to catalyse a long-lasting recession in almost every country, of a breadth and scale far in excess of that of any in living memory.

Asia, where the virus was first identified, looks better placed to deal with the impact. It has large domestic populations and its experience during the SARS and MERS outbreaks has left it well-prepared to cope with the disease itself, but the coming quarters are likely to see significant further downgrades to corporate prospects as the impact of Western lockdowns is quantified.

Initial estimates of 2020 GDP, which remain subject to daily downward revisions, show dramatic reversals in expectations for global growth. Asia’s calm control of its response to the virus has, in general, kept its economies functioning, leading to minimal expected GDP contraction in Korea and Taiwan, whilst the large, youthful populations and archipelagic geography of Indonesia and the Philippines should give them a three-fold natural protection against the spread of the virus itself.

In this respect, Asia appears substantially better placed than Europe, with its older demography and continental geography, or the US, whose preparations for the pandemic have been woeful.

Coming as it does at the end of a decade in which the world has taken on unprecedented quantities of debt and at a point when few central banks have much left in their armouries, the long-term consequences of the shutdowns look likely to be immense.

Initially, the lockdowns in China looked extreme, especially in the light of successful containment in other countries such as Taiwan, Korea and Japan without recourse to such measures and even now, 99.994% of the Chinese population have not been infected with the disease. However, as the virus coincided with the great migration which is Chinese New Year, the spread has been far faster than anyone envisaged. Given the exceptionally low infection rate across the wider population and the fact that four fifths of cases remain asymptomatic (BMJ 2020; 369 doi:, it is highly likely that the disease will reappear in waves over time, which may lead some countries to re-impose some form of social distancing. We suspect, though, that the aftermath of the current round may be so great that it is never again contemplated in this form.

The decision to lock down has had an immediate impact on unemployment, with the most notable data so far coming from the US, where 15 million people have registered as unemployed in the last three weeks alone.

Globally, the International Labour Organisation (ILO) estimates that 35% of the entire global workforce is at risk of job losses and pay cuts, with 2.7billion workers affected by lockdowns and 1.25bn people in “extremely vulnerable” sectors. Estimating the true scale of demand destruction globally is nigh on impossible, other than to say “unprecedented”.

US Initial Jobless Claims (data to April 4th)

Because of the lockdowns, over 99% of most populations have not yet had the virus. Therefore, when its next wave returns, countries will have to decide whether a) the Q1 2020 virus was not sufficiently severe to have warranted such extreme action; b) it was, and therefore the lockdowns should be repeated; or c) (most likely) victory over the Q1 2020 virus can be declared; all subsequent occurrences labelled “different” in some way; and countries will never repeat this exercise again. For authoritarian governments, this will be too good an opportunity to miss. For libertarian ones, it could cause immense existential problems. Asia already understands how to thrive in authoritarian regimes. The West – not so much. This event has sown the seeds which will topple governments in future.

As if the impact of the virus were not enough, in March, Saudi Arabia announced that it would increase its production by 12m barrels of oil per day (bopd), following a failure to reach agreement with Russia on constraining supply. On 9th April, after the dramatic falls in crude and the reduction in global oil capex shown below, Saudi tentatively agreed to cut back its production again by up to 10m bopd in each of June, July and Q1 2021. The astute chess move achieved a 39% drop in the number of active US oil rigs and an average 30% cut in capex at the global oil majors. It also successfully flexed OPEC’s muscles and demonstrated that Mohammed Bin Salman and Saudi Arabia are firmly in charge. As a result, we may have seen a bottom in oil prices, but with all global storage facilities full and demand destruction of cataclysmic proportions, a rebound to anything like previous levels looks highly unlikely.

For Asia, low oil prices are generally beneficial, but not for Malaysia, Asia’s principal oil-producing country. Their reference price on Brent for the annual budget for 2019-20 was set at $62. Malaysia is also one of the Asian countries most exposed to global trade, with gross exports of 131% of GDP and 13% of its GDP is also tourism related. Hampered by a complex political upheaval as well, it remains one of our least favoured markets, as is also true for Singapore, where oil revenue is a smaller, but significant, proportion of GDP. “Safe-haven” Singapore’s epithet is in danger. Although its property market has leapt this quarter, its reliance on imported food, water and labour, makes it especially vulnerable to the global lockdown and its stock market has been overwhelmed by dividend cuts. For Singapore, gross exports to a world now locked down represent an extraordinary 326% of GDP.

Thailand has been one of our favourite markets for some time. After three years of exogenous shocks, its economy and national psyche were recovering and in Q4 2019, it showed widespread signs of sustainable recovery and has been a major beneficiary of the diaspora of Chinese manufacturing. Then came Covid 19. With a third of GDP coming from tourism, retail and autos, Thailand is one of the countries most exposed to the impact of the virus. It remains one of our least-preferred countries, because tourism may take a long time to recover from the current crisis, but the strong currency which dragged on exporters and dissuaded tourists in 2019 has reversed sharply. The country also has low government debt to GDP and after having launched stimuli in 2019, its manufacturing economy may kick-start sooner than others.

Indonesia recorded 54,592 cases of dengue fever (an illness which starts with fever and aching limbs), which resulted in 348 deaths in February and March alone, so its reluctance to lock down the country is understandable. This compares to the 2,273 cases and 198 deaths from Covid 19 identified so far. With moderate gross trade to GDP (43%), a very young population (average age 28) and an archipelagic geography, Indonesia’s physical vulnerability to the disease is low. However, the global economic collapse due to the lockdowns is hurting demand for its exports of coal and palm oil, which had already been under pressure from the trend to ESG. Foreigners have been so fast to sell government bonds that the currency has been sold down to a level touching its lows in the Asian crisis of 1998. President Jokowi is popular and if his Omnibus bill to reform the economy passes the legislature, the heavily oversold equity market could rebound at speed. It is therefore one of our most favoured markets.

In the Philippines – another large (100m), young (average age 25), archipelagic nation with almost no infections – the global lockdown has proved an excuse to increase authoritarianism, yet President Duterte is popular and economic growth remains positive. Inward remittances remain strong at c 12% of GDP, but they look vulnerable to the drop in Western economies, as also might its substantial call-centre industry. The country has a high exposure to trade, with gross exports at 76% of GDP, but it also has an equity market standing at over 3 standard deviations below its long term mean price to book valuations. The opportunity to pick up stock selectively here looks appealing, which places it amongst our more preferred markets.

In North Asia, where populations are more densely concentrated and much older on average, the situations is very different. Taiwan and Korea stand out as beacons of calm efficiency. Both have shown exemplary control of the virus; rigorously testing and isolating, whilst keeping their economies functioning to support the cost of controlling it. Their heavily tech-focused economies are beneficiaries of the global shift to working online and have seen both volumes and prices rising as demand for 5G-related equipment accelerates. The accelerating diaspora of businesses from China is boosting FDI and industrial production in both countries and Korea is also seeing a regulation-led recovery in shipyards, but both economies are very open to global trade, with gross exports totalling 62% and 83% respectively for Taiwan and Korea. In the coming quarter – usually a low season for the tech industry anyway – we expect to see wholesale cancellations of orders from the West, particularly for consumer goods. Therefore, although both countries are in our most preferred section of the allocation this quarter, we remain cautious.

China, where the virus started, was first into the crisis and is first to emerge from it. Our discussions with many companies in a multitude of sectors make us comfortable that the declaration that 95+% of the workforce have returned is true. Social distancing is taking its toll on utilisation rates and efficiency of production. This may accelerate the trend towards automation longer term, although this machinery is costly and labour is likely to be very available and very cheap in future). The reckoning for the years of debt build-up comes next and China is at its epicentre, so we remain very wary of its impact on the economy of not only China, but also all of its partners. Fortunately, China possesses the largest stock of State-Owned Enterprises globally and its move to “mixed-ownership” – a euphemism for part-privatisation – looks likely to accelerate. This will expand the relative size of the Chinese stock markets within the region and ensure a steady flow of monies from ETF’s. The imminent release of long-subdued economic data may reveal the true cost of China’s dramatic lockdowns. This could keep volatility high and give us further opportunities to increase our long term weightings. Consequently, China is in our list of more preferred countries this quarter.

And so to India, where the handling of the epidemic has been unlike that of any other country. Announcing a lockdown at just four hours’ notice, forced an estimated 40m migrant workers to try to return home, which caused lethal stampedes. As the government also shut down all transport, grocery and pharmacy stores, it left people attempting to walk back – some for journeys of up to 100Km – without access to food and water, or essential medication. With an average age of 28, the Indian population is at low risk from the virus itself, but the lockdown has delayed crop planting into months when the weather will limit or stunt germination. As India has a history of mis-managed agricultural flows, shortages of food and significant inflation in the coming months are a real possibility. The stock market has plunged in response and is now the most oversold against the region on trailing price to book valuations, yet downgrades have barely started and India’s worst coronavirus months lie ahead of it, not behind it. Therefore, it represents our least favoured country this quarter.

The numbers being cited now are without precedent, with governments around the world adding from 10% (US, Japan) to 15% of GDP in a mixture of fiscal and monetary stimulus: the US is adding $2trillion in stimulus; Germany¬ – has pledged to provide a “limitless” credit programme for small businesses, guaranteeing 100% of their loans up to Euro 800,000 at an interest rate of 3%. The US Fed has cut rates to zero for the foreseeable future. Mopping up the mess in the global economy will take decades.

With almost no growth in parts of the first and second quarters, statistical rates of rebound in the second half could be immense, as base effects come into play. The virus is likely to return, most probably in the winter 2020 (November to January). When it does, there is a possibility that governments choose to lock populations down again, but, given the economic damage being done now, and the growing clamour of eminent virologists questioning the scientific and statistical justification for current policy, we feel this is unlikely.

The decades ahead will be focused on servicing the debt which is being taken on now. Government divestments are likely to accelerate everywhere, with China and India in the lead, but in general, Asia starts this race in pole position, with smaller debt to GDP (China aside).

Globalisation looks likely to unravel, too. The hoarding of Covid-19 PPE and ventilators has shown that some countries cannot be relied upon to fulfil long-standing clients’ orders when the chips are down, so we expect to see a mass-localisation of production over the coming years. It is also becoming apparent that there has been a critical over-concentration of production in some locations. The two trends together should drive demand for factory automation machinery, to the benefit of Asian manufacturers in Korea and Taiwan. Demand from a large hinterland of domestic population therefore becomes essential. In this respect, Asia (the city states aside) is also well-placed.

Financial life looks as if it will be very difficult in future, but Asia looks well positioned to benefit and when Governments have to show that the actions they took were proportionate to the risk. In this scenario, Asia’s more measured approach is likely to offer investors greater stability and its large, youthful populations the growth that the West has traditionally craved.

In these trickiest of markets, we feel that retaining a high cash position is essential to smoothing the volatility of the portfolio. The table below, therefore, expresses our preferences for each country, rather than an indication of over- or under-weight positions.

As our summary this quarter is necessarily long, we highlight the Taiwanese economy in the following section in a shortened version of our usual format.

Taiwanese Economics

After almost a year of pause over the time of the election and its aftermath, the Indonesian economy is showing signs of reaccelerating again. The infrastructure stimulus packages put in place by President Jokowi in his first term in office are starting to pay off and, with a focus on outside Jakarta and Java generally, that growth is strongest in the regions and outlying islands. This has left the Indonesian consumer with confidence accelerating to levels only slightly below all-time highs.

Internationally, Taiwan has been acclaimed by the WHO as the country best prepared to deal with the impact of COVID 19. Shocked by Sars in 2003, Taiwan put together a programme under the auspices of Professor Su Ih-jen which built over 1000 negative pressure rooms in hospitals and labs to host viral testing, stockpiled 40m masks, reinforced its Center for Disease Control (CDC) with hundreds of doctors, and enlisted labs at medical centres on a contractual basis. A new cross-party political structure was put in place to allow the Chair of the Central Epidemic Command Center to rank equal to Ministers. It then tested and refined these measures during subsequent flu outbreaks. Consequently, Taiwan started to screen passengers from Hubei as early as December 2019, suspended flights from Wuhan early in January and began daily monitoring for everyone with respiratory symptoms who had arrived from anywhere in China. Immigration and Health departments have linked databases. Its testing protocols are also revolutionary – by testing patients with respiratory diseases who tested negative for influenza, Taiwan uncovered local transmission and halted it before it could spread.

The result is a population who remain calm in the face of global panic of epic proportions elsewhere. Businesses remain open and factory utilisation remains normal, little impacted by the virus. The trade wars of 2018-19 had already prompted Taiwanese companies to diversify their supply chains and China’s increasing aggression towards Taiwan in 2019 further accelerated that. As a result, Taiwan has been gaining orders and seeing production shifted from China and trade has remained strong, with exports to the US, in particular, robust at +18% yoy in February and with companies in multiple sectors still recording strong hiring intentions.

The extent of new factory construction and extension is also visible in the Fixed Capital Formation component of GDP shown below:

Confidence does remain fragile, with February PMI data hovering around the neutral level. However, although export orders were strong in February, our concern now is that as lockdowns proliferate across the Western world, order cancellations will accelerate. However, Taiwan’s companies are typically highly conservative and generally hold heavy net cash positions, which should protect them to some degree.

Taiwan has one of a high proportions of GDP exposed to gross trade at 62% (Korea is 83% and China 38%), within which gross exports are 33% of GDP (source: WTO), leaving it looking more exposed in the next phase of this crisis.

Recognising the relative strength of the economy and the upcoming onslaught, the stimulus package announced by the government so far has been modest at just NT$60bn (0.3% of GDP). Within this, $50bn has been earmarked for tourism and transport of which $14.2bn will be for existing hard-hit companies, and the rest to upgrade future tourism in Taiwan. The remaining $10bn will be handed out in vouchers for consumer spending at places such as night markets.

Tourism has, of course, been devastated by the virus everywhere, but Chinese visitor arrivals to Taiwan had already been dropping dramatically ahead of the Taiwanese elections this year. That has given Taiwan a small window to increase visitor numbers from other countries, which has led to slightly better confidence in its hospitality labour outlook than the rest of the world at this time, with 11% of businesses even looking to hire this quarter.

The central bank has stepped in to loosen monetary policy again, as elsewhere, cutting its reference rate by 25bps. Reserves on demand deposit rates have also been cut to 0.068% from 0.146% and on time deposits from 0.82% to 0.56% and foreign entities’ demand deposits will no longer pay any interest.

Before this package has been disbursed, the government is proposing another, additional package to take the total to NT$100bn. The second stimulus package of NT$40bn now being proposed is designed to provide credit loans to businesses and their employees.

Taiwan is somewhat cushioned in the hit to GDP it may receive, because it had strong exports to the rest of the world when China was slowing and should see decent order recovery from China as the West locks down. Therefore, we expect to see the most significant hit to its GDP in Q2 and Q3, rather than Q1 (although that is expected to be weak, too).

Prices in Taiwan remain deflationary at present. However, as supply chain interruption and lockdowns halt the growth of inventory in the chain, we expect to see global inflation start to firm later this year, especially as some items (not only loo roll!) are already starting to rise sharply. As Taiwan remains orderly, we do not expect to see any need for rationing, but its island status means that it will not be immune to higher imported prices.

The calm functioning of the Taiwanese economy and cool response to COVID 19 has led to the Taiwan Dollar firming steadily against the Renminbi recently, continuing a trend which has been ongoing since 2015 and which has been underpinned by factory relocations. The rate against the USD has remained steady.

Overall, although the following quarters may prove more challenging, Taiwan has had the most supportive economic backdrop in the region this quarter, aided by its calm handling of the virus and conservative financial approach and giving a solid backdrop to its stock market.

Risk warnings
Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. Tax treatment depends on individual circumstances and may change in the future. The fund will be exposed to stock markets. Stock market prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The fund will invest in shares in emerging markets which can be more volatile than more developed markets. Changes in exchange rates may affect the value of your investment. In certain market conditions some assets in the fund may be less liquid and therefore more difficult to sell at their true value or in a timely manner.

Regulatory Information
This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. It’s provided for general information purposes only and is not personal advice to anyone to invest in any fund or product. The Key Investor Information Documents and the Prospectuses for all funds are available, in English, free of charge and can be obtained directly using the contact details in this document. They can also be downloaded from An investor must always read these before investing. Information taken from trade and other sources is believed to be reliable, although we don’t represent this as accurate or complete and it shouldn’t be relied upon as such. Calls may be recorded for training and monitoring purposes. Issued by Marlborough Fund Managers Ltd, authorised and regulated by the Financial Conduct Authority (reference number 141660). Registered office: Marlborough House, 59 Chorley New Road, Bolton, BL1 4QP. Registered in England No. 02061177.
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