THERE has been substantial media and analyst commentary around the changing political and regulatory environment in China.
Important as this is, we think it is at risk of overshadowing what economic data releases in July and August have shown about the Chinese economy: genuine economic weakness across the board.
Almost every Chinese economic release in those months was weaker than the previous data point, and below expectations.
A selection of this month’s data would include:
More ominously, the datapoints that we believe lead the real economy were also soft.
M2 money supply growth in July declined to 8.3% year-on-year and growth in claims on the financial system declined to 7.4%.
These together reflect monetary policy as tight as that in the 2018/2019 period.
Bond yields are also suggesting a slowdown. Chinese government 10-year yields are lower by 0.3% year-to-date. This is during a period when most countries’ sovereign bond yields have risen.
Despite this, commodity prices have not reacted as might have been expected.
Copper has remained around US$9400/t, having started the year at about US$7700/t.
Iron ore has come back to US$145/t from its US$235/t peak in May, but is only slightly lower than its US$156/t start of 2020.
From an equity investor’s viewpoint, MSCI EM Materials has performed well year-to-date and in the past two months.
We cannot see this lasting and we remain zero-weight industrial metals producers in the portfolio.
Brazil and South Africa upcycle
We continue to hold overweight positions in Brazil and South Africa, both of which are major commodity producers.
Why are we less concerned about these markets, given our view on the direction of the Chinese economy?
Emerging economies can generally be thought of as having a trend rate of economic (or earnings) growth, and then a business cycle around that trend.
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Even if the medium-term trend is less attractive, markets undergoing a strong business up-cycle can offer compelling opportunities for investors.
This is what we believe is the situation in Brazil and South Africa.
In the eight years that followed the 2002-2011 commodity boom, Brazilian GDP growth averaged just 0.5% year-on-year. Unemployment climbed from 5.2% to 11.3%.
This period saw a significant slowdown in credit growth and a strong increase in the trade balance (reflecting weak domestic demand).
Domestic demand had begun to recover towards the end of this period (for example, car sales bottomed in 2016 and unemployment bottomed in 2017). But the impact of Covid delayed the recovery.
Risks remain, including the timing of the peak in inflation and interest rates and political risk from the October 2022 election.
But we continue to see Brazil as an economy with the economic and financial conditions to stage a near-term recovery in domestic demand — towards what we fully recognise is a mediocre trend rate of growth.
A slowdown in China, with lower commodity prices, may further reduce that trend growth rate. But it will not, we believe, prevent the recovery.
South Africa finds itself in a similar position.
In the 2012-19 period, South Africa experienced average GDP growth of 1.4% with weak credit growth and a deleveraging of the private sector and rising unemployment.
South Africa had not even begun to recover before Covid hit — yet the improvement in the trade balance was much stronger than in Brazil.
We feel South Africa will also stage a recovery back towards trend growth levels in the quarters ahead. We expect opportunities in domestic demand, while recognising urban unrest and new Covid variants are risks that must be monitored.
We do not see a 2021 slowdown in China preventing that recovery.
Some emerging markets are commodity exporters. But neither the economies of those countries nor their equity markets have mechanical linkages to commodity prices — and there will be periods of opportunity in the face of softening export prices.
We believe the second half of 2021 will be such an opportunity.
James Syme and Paul Wimborne are senior portfolio managers and co-managers of Pendal’s Global Emerging Markets Opportunities Fund.
The fund aims to add value through a combination of country allocation and individual stock selection.
The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.
The stock selection process focuses on buying quality growth stocks at attractive valuations.
Find out more about Pendal Global Emerging Markets Opportunities Fund here.
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