Equities (Asia)
Peter Sartori, Nikko Asset Management
The MSCI Asia ex Japan rose by 2.7% in USD terms in June, outperforming global equities by 3.8%. The Brexit shock proved short-lived for Asian markets as investors started to price in greater monetary and fiscal stimulus across G7 economies. The majority of Asia ex Japan currencies appreciated against the USD, with the only exceptions being the Philippine peso and Indian rupee.
Meanwhile, Indonesia, Philippines and Malaysia were buoyed by political developments. The passage of the tax amnesty law lifted Indonesian equities, currencies and bonds higher. The central bank cut policy rate by another 25bps in June helping boost demand for property and yield-sensitive stocks. Philippine equities surged to fresh year-to-date highs on the back of an optimistic outlook on the newly inaugurated Duterte administration, with high hopes set on his ability to execute, particularly on infrastructure. The Malaysian ringgit appreciated by 3% versus the US dollar. The ruling alliance Barisan Nasional’s (BN) resounding two by election wins prompted market speculation of earlier elections.
The MSCI China rose 1.1% in June in USD terms. Investors fear that economic stabilisation was achieved via a temporary stimulus, however, resulting in a decline in cyclicals from mid-April. MSCI’s decision to further delay the inclusion of A shares into its indices did not help matters.
In India, the government further liberalised foreign direct investment (FDI) across nine sectors including defence, pharmaceuticals, civil aviation, and single brand retail. The reforms included increasing the FDI cap in some sectors, moving from governmental approval to automatic routes in others, and easing preconditions in others. MSCI India modestly underperformed during the month returning 1.3% in USD terms.
Equities (Asia)
By Mark Mobius, Franklin Templeton
The Chinese economy expanded 6.7% year on year in the first quarter of 2016, slightly slower than the 6.8% year on year increase recorded in the fourth quarter of 2015. The consumer price index eased to 2.0% in May, from 2.3% in April, largely due to lower food price inflation, while producer prices declined 2.8% in May, compared with a 3.4% decrease in March.
Industrial output grew 6% in May on a year on year basis, unchanged from April, while retail sales growth edged down to 10% in May, from 10.1% in April. Growth in fixed asset investment, however, declined to 9.6% in the first five months of 2016, from 10.5% in the four-month period ended April.
Foreign exchange reserves declined by US $27.9 billion to US $3.2 trillion in May, after increasing in March and April, largely due to strength in the US dollar. German Chancellor Angela Merkel met President Xi Jinping in China, where both leaders agreed to strengthen bilateral co-operation. Moreover, Chinese companies signed agreements valued at US$15 billion with German companies and deals worth US$4.1 billion with American companies during the quarter.
In South Korea, GDP growth eased to a revised 2.8% in the first quarter of the year compared to the same period a year earlier. Weaker growth in private consumption and exports and a decline in corporate investment were among the key reasons for the slowdown. Growth in government expenditure, however, accelerated in the first three months of the year. Concerns about weakening domestic consumption coupled with continued weakness in exports led the Bank of Korea (BOK) to reduce the benchmark interest rate by 25 basis points (bps) to a record low of 1.25%.
This was the BOK’s first rate cut since June 2015. The government announced a US $17 billion fiscal stimulus package to support the domestic economy and reduced its 2016 GDP growth forecast to 2.8% from 3.1%.
Finance Minister Yoo Il-ho announced plans to inject US$9.3 billion into state-run banks to support the restructuring of the shipping industry. After unexpectedly losing its majority in the National Assembly in parliamentary elections held in April, the conservative Saenuri
Party regained a majority in June with the rejoining of seven members, giving the party 126 seats compared with the 122 seats held by the main opposition Minjoo Party.
Equities (Asia)
By Louise Dudley, Hermes Investment Management
Wide-ranging reform is set to continue in Japan following Prime Minister Shinzo Abe’s ruling coalition’s victory in the nation’s upper house. The majority mandate should contribute positively to the outlook for the Japanese equity market and GDP in general.
For Japan’s corporates, we believe the result signals further progress in the area of corporate governance.
The once staid and conservative boardrooms of Japanese companies have already embraced large-scale reform on governance issues following the implementation of an official corporate governance code last June. However, Japan remains a conservative society and companies will need the support of government to push through further effective reform. Progress is slow but should move incrementally forward.
There are some doubts about the strength of the commitment to change. A year after the introduction of the governance code, it is feared that some corporates are just paying lip service to greater accountability. Cross shareholdings between companies continue to be significant. Long-tenured directors still clog the boardrooms. Companies are looking to improve their behaviours ‘when the environment is right’, but with markets as they are, this may take longer than we originally thought at the beginning of the year.
The objective for all Japanese companies must now be to thoroughly comply with the code, as clearly some firms are failing to evolve their corporate governance standards. For example, Toshiba recently came under grave criticism after an investigation revealed a corporate culture where employees were afraid to question superiors. This was seen as a major contributing factor to the accounting scandal of epic proportions within the Tokyo-based conglomerate.
At Board level, there have been improvements. The percentage of independent directors is slowly increasing. We have also have seen many companies completing board evaluations, including mapping skills, strengths and weakness. This increasingly objective analysis is encouraging.
It will be interesting to see whether small and mid-caps follow the lead of the large companies and go beyond the minimum ‘comply or explain’ level requirement to make real changes. The declining population of Japan is a real concern in the long run, but in the nearer term this could well be offset by increased workforce participation by women, something which remains much lower than in the West.
Equities (Emerging markets)
By Craig Botham, Schroders
It is hard to see the failed coup in Turkey on 15 July as anything other than negative for the Turkish economy. The extent of the pain will depend on the political and policy response.
Should President Recep Erdogan achieve his goal of an executive presidency, erosion of institutional quality will accelerate and investment would likely weaken, reducing both short-term and trend growth.
A pro-growth, inflationary bias is likely to take hold in both monetary and fiscal policy, which could provide a short-term boost at the cost of long-term pain, exacerbated by lira weakness as policy credibility falls and dollarisation (when people use the US dollar in parallel or instead of the domestic currency) rises.
Perhaps the best that can be hoped for is a negative reaction to any attempt to exploit the coup for political gain, manifesting as electoral disappointment for Erdogan’s AKP party (i.e. falling short of the seats needed to amend the constitution), though we think this would still result in a steady tightening of Erdogan’s grip.
From a global perspective, while it is a positive that the coup failed insomuch as a Turkey in the grip of civil war would be a true disaster, managing both the conflict in Syria and the refugee problem for Europe will be much harder with Turkey distracted, if not hostile.
Monetary policy has been one casualty of Erdogan’s unique school of economic thought, even before April’s appointment of Murat Cetinkaya as head of the central bank.
For some time, Erdogan has railed against what he calls the “interest rate lobby”; essentially any economist who suggests that Turkey should hike rates to fight inflation. In the eyes of Erdogan, these are self-serving comments designed to generate profits for foreign banks. This has piled pressure on the central bank to keep rates low and cut them if possible, despite high inflation.
A more inflationary environment then lies ahead for Turkey, and this is even before we consider the impact of the currency. The Turkish lira weakened markedly on the back of the coup and will deliver a strong inflationary impulse if not brought under control.
Commodities
By Shane Oliver, AMP Capital
Since around 2008 (for energy) and 2011 (for metals) the commodity super cycle has been in decline as the supply of commodities rose in response to last decade’s commodity price boom combined with somewhat slower growth in China.
However, after 50 to 80% peak to trough price declines and with supply starting to adjust for some commodities (eg oil) it’s quite likely that we have seen the worst (in the absence of a 1930s style recession). This doesn’t mean the next super cycle commodity upswing is near – rather a long period of base building is likely as we saw in the 1980s and 90s.
Implications - Low commodity prices will act as a constraint on inflation and interest rates but the likelihood that we have seen the worst may also mean that the deflationary threat will start to recede. In other words it adds to the case for a bottom in global inflation. A range bound environment less clearly favours commodity user countries over producers.
FX
By Luke Goldsmith, Macquarie Investment Management
Despite the weight of expectation that the UK would vote to remain a member of the European Union (EU) the pollsters got it wrong. Financial markets got it wrong. The bookmakers saw the weight of money price in an 80% chance of remaining and got it wrong. And as the dust settled after the vote, a Prime Minister had been left with no option but to resign and Britain stood alone.
The world still waits with baited breath as to what the action plan is now. We have detailed Brexit from an FX perspective and provided some thoughts on our base case on politics in Europe into 2017.
June 23rd marked the day that the UK voted to leave the EU. As the vote neared, GBP price action was dictated by the daily polls which appeared to predict a victory for the ‘Remain Campaigners’. GBP had rallied from 1.40 to 1.49 against the USD in-line with the polls during the week ahead of the vote and spiked above 1.50 as the first exit poll predicted a remain win. As the results came in, it soon became apparent the exit campaign would prevail. GBP dropped 18c to 1.32 and equity markets sold off around the world. This was the largest one day fall on record for the GBP, eclipsing Black Wednesday in 1992 when the UK left the European Exchange Rate Mechanism. Predictions from sell side strategists had ranged from 1.25-1.38 on how far the GBP would fall on this outcome. Therefore, while an 18c move is very significant, it was within the expected range.
Since the referendum, the Bank of England (BOE) has announced it did not intervene to hold the currency up. Instead GBP has found a natural range between 1.27 and 1.35 for now, a low not seen since 1984.
The general expectation is for GBP to find new lows this year. These predictions depend on how quickly the new leader of the Tory party – Theresa May - invokes Article 50 of the Treaty of Lisbon. From this point, the UK and EU will have two years to negotiate the separation. May has indicated she is unlikely to trigger Article 50 before the end of the year. It is important to note that the EU has as much to lose from these negotiations as the UK.
One of the first reactions to Brexit was to analyse the political landscape in the EU. Now one country had left, who would be the next domino to fall? A lot has been made of the reasons behind Brexit.
Two of the main rationales was the general feeling against the freedom of movement of people around Europe and the other was that this was a vote against the political elite. These feelings are common around the world and have been cited as drivers behind the likes of Donald Trump in the US, Pedemos in Spain and Marine Le Pen in France. But now Brexit has occurred, would other countries follow?
It seems possible political contagion may flow through to the mainland Europe, especially if the UK only suffers a mild recession. In a situation where a second country leaves, EUR is expected to depreciate much like the GBP (though not as quickly). Though such an event would require a catalyst in the home nation to drive it in that direction.