Asset Allocation Q3 2020

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First into the COVID-19 crisis, Asia is also first out and across the region, countries are reopening for business. The outlook is still tough and definitely not smooth, especially in countries for whom tourism is a substantial contributor to GDP, such as Thailand, but the manufacturing diaspora from China is continuing to pick up speed, with ASEAN and Taiwan reaping the most benefit. Asian companies have not cut their dividends as widely as those in the West and the dominance of tech in the region is providing support.

In every country which locked down, businesses in the hospitality and services industries were slaughtered and unemployment has jumped. Yet, because day and seasonal wage earners are relatively resilient in mental attitude and innovative at looking for the next opportunity we remain optimistic that those with very large informal employment sectors will recover rapidly. In this respect Thailand (whose unemployment rates remain amongst the lowest in Asia), India, Indonesia and the Philippines stand out. Some countries (China in particular) have been assiduous at directing support towards individuals and SME’s, so their bounce back is deeper and more convincing than elsewhere. Taiwan and Korea contained the virus so efficiently that their domestic landscape did not shut down – fortunate for the rest of the world, as they supply so much of the technology now powering your Zoom calls. In general, countries which faced China more than the West were hit in Q1, but less so in Q2, whilst the opposite was true for those, like Singapore, which felt the impact as the rest of the world locked down. Unemployment has leapt globally, but we expect it to have a much less lasting impact than similar economic shocks in the past, because those it has hit hardest have historically been the most flexible groups of workers.

In Asia, countries with large numbers of State-Owned Enterprises have been able to use them not only for policy (rents forgiven, insurance premia waived, bans on workforce reduction, etc), but also as conduits for non-fiscal debt. Bad loans have risen, but this is not a re-run of the Asian Crisis: Asia’s banks are well capitalised and prudently regulated (although India still has some work to do).

The size and breadth of stimulus unleashed globally has been without precedent and private investors sense that. A new frenzy of retail investor buying is appearing globally, chasing yield and seizing the opportunity. With governments selling the family silver to pay for the COVID-19 debt and index providers adding ever more domestic Chinese A Shares to their product, the weight of Asia in local and global indices is rising quickly. ETF’s must follow, so the rate of account openings and margin buying is soaring. Do you remember 1980’s Britain? The economy and stock market soared, even as the old economy and its workforce were left behind. With the pace of new offerings rising dramatically, we see this happening again in China and elsewhere. In the first six months of 2020, 848 issues have been announced to list in the greater China region, totalling US$104bn. There are literally hundreds more waiting in the wings.

Sino-US relations are deteriorating at speed. China has made little progress on meeting the quota of US imports it agreed to in January and the US is highly unlikely to give any leeway for the impact of COVID-19, so China is ramping up its relationships elsewhere. The importance of ASEAN in Beijing’s speeches and propaganda is rising (ASEAN has now overtaken the EU as a trading partner, as so many businesses have moved there from China recently) and ASEAN is pushing hard to get the giant RCEP trade treaty signed between it, China, Korea, Japan and Australasia.

China’s international activity has continued apace throughout lockdown, whilst the world’s media were only offering saturation coverage of COVID-19.
Naming islands in the South China Seas, finalising its new global alternative GPS network, which is embedded in the military equipment it is selling, and keeping up the pressure on Taiwan have all featured this quarter, but perhaps the most difficult to interpret has been the clash with Indian troops in the Himalayas – a sop to Pakistan, perhaps, as key debt renegotiation’s were taking place?

From Addis Ababa to Islamabad, debt is defaulting all along the Belt and Road Initiative new silk road. Collateral is based on commodities and revenue from tourism (not ideal in a quarter which saw oil at minus $40; locusts sweeping across Africa and India; and COVID-19). The holders of the debt are mostly China Exim Bank and SOE’s – already under pressure from their National Service. All the more reason to restructure and sell them fast.

COVID-19 is accelerating existing trends and so we expect tech to thrive in North Asia, manufacturing migration to ASEAN to continue and India to carry on bringing its vast domestic market into more modern standards of governance. Overall, with expanding stock markets, tech dominance and offering solid dividends, we find Asia well-placed to outperform global markets in future.

This quarter, we are reducing our underweight in China, staying overweight tech-heavy Taiwan and Korea and favouring the large domestic populations of Indonesia and India. Our economic spotlight this quarter is on Taiwan, where Chinese and US tech demands meet.

Taiwanese Economics

Taiwanese economic growth for the first quarter slowed to 1.59% yoy, as expected. This broad-based slowing is the slowest growth since March 2016 but stands in sharp positive contract to that of other countries globally. Government spending took up the strain and was the only segment that had faster growth versus the previous quarter.

Private consumption declined by 9.4% in the first quarter, in the sharpest decline on record (since 1981), despite the fact that Taiwan was one of the best prepared for COVID-19. Unemployment also picked up to 4.16% but this remains well below the 6.09% recorded in 2009. Employers hiring expectations have unsurprisingly been tightened, but still remain positive at +7% for the Q3 2020 outlook. Unsurprisingly, the weakest segment is services (which contributes more than 60% of GDP) and within it, Leisure/Hospitality.

Chinese tourists have all but disappeared since February. The decline began before COVID-19 set in, as the Mainland signalled its disapproval of the Taiwanese general election and Beijing tightened its citizens’ visas to Taiwan.

Tourist arrivals from other countries plummeted by 68% yoy between January and April as COVID-19 accelerated. For Taiwan, tourism is a substantially lower proportion of its economy than in the “beach economies”, standing at just 5% of GDP in 2018. Nevertheless, the government has moved swiftly to
support it.

As employment condition in services and leisure/hospitality continue to worsen, it is not surprising to see non-manufacturing PMI decline so sharply from beginning of this year. It is ticking up slightly in its latest reading but remains in contraction.

Industrial production was exceptionally strong at the start of this year but its growth slowed sharply in May (albeit still recording an increase) to 1.51% yoy after peaking in February at 20.7% yoy. Taiwan IP growth remains notably positive versus the severe declines seen elsewhere globally and is being driven by the very strong influx of manufacturing business relocating from China. Taiwan’s industrial economy is dominated by technology companies and COVID-19 has created a boom in demand for many of its products. In May, manufacturing PMI recorded 41.9 vs 42.2 in April vs 50.4 in March. We would expect this to be the low point, given the influx of new investment and tech focus.

Foreign Direct Investment (FDI) continues to boom in Taiwan, driven by the shift from China and the rise in demand for tech products globally. Taiwan is also a significant beneficiary of the Sino-US trade wars, as both sides consider it their own and seek to place orders there in preference to purely in the US or China. As of 21st May this year, 189 companies YTD had applied for government incentives to invest over NT$761.4bn ($25.7bn) in Taiwan. These investments should boost construction activities, materials demand and ultimately create employment.

Both exports and imports declined but at much slower rate than other Asian peers. Export growth declined by just 2% in May. Import growth declined by 3.5% and the trade balance picked up strongly, helping to keep the TWD stable. Exports to the US picked up by a strong 9% in May, driven by China’s desire to localise its tech production and by the trade war.

Inflation reflected the global COVID-related slowdown in H1 at both headline and underlying levels and wholesale prices fell even more sharply. This, along with the general weakness in global trade, should allow the central bank to keep rates low for some time to come, having already cut once to cushion the blow of COVID-19.

We find that Taiwan remains exceptionally well placed to thrive in the current environment. The effective measures implemented by the government has also sheltered Taiwan from both COVID-19 and its severe economic disruption. Taiwan does remain somewhat vulnerable, given its reliance on external demand, but its technology industry will provide a much more substantial cushion than is available to other economies.

We find that Taiwan remains exceptionally well placed to thrive in the current environment. The effective measures implemented by the government has also sheltered Taiwan from both COVID-19 and its severe economic disruption. Taiwan does remain somewhat vulnerable, given its reliance on external demand, but its technology industry will provide a much more substantial cushion than is available to other economies.

Risk warnings

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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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