‘Yuan weakness is a positive for Chinese stocks’
Brendan Ahern, CIO of KraneShares, sits down with IGTV financial analyst @AngelineOng to discuss the trajectory of the Chinese economy, EV politics, the dollar and why yuan weakness is a positive for Chinese stocks.
China makes an incremental comeback
AO: Hello, I'm Angeline Ong and welcome to IG's Trading the Markets.
Here to discuss the outlook for the global economy and the Chinese economy is Brendan Ahern, chief investment officer (CIO) at KraneShares. Thank you so much for being with us.
I guess the first question is: as we've had this mixed ‘mood music’ out of China, mixed economic data, this rising tit for tat between the US and China, how do you see this dynamic developing?
BA: Well, post-zero-Covid, the elimination of that policy, China's economy is coming back. It's just coming back incrementally. And I think a lot of us in the West were used to strong stimulus, proverbial helicopter money, modern monetary theory, simply handing out free money to stimulate the economy.
The Chinese government is not doing that. They know it's an economic cycle. The economy is coming back, it's just coming back incrementally.
On Covid babies... and the divorces
On your second question, Angeline, it's really about this: you have zero-Covid, you have a period where the US and China diplomatically weren't traveling to see one another, they weren't communicating, and you take a relationship and you put it through the stress of zero-Covid.
Yes, you had ‘Covid babies’, you know, some relationships got better, but you also had ‘Covid divorces’. I think most importantly is, thus far this year, we've seen the Biden administration looking to stabilise the relationship: Secretary of State Blinken, Treasury Secretary Yellen, Commerce Secretary Gina Raimondo, John Kerry, Henry Kissinger.
So we've seen a flurry of activity thus far that could lead to a Biden-Xi summit this November at the AIPAC in San Francisco. So the path is improving, is stabilising.
AO: The other question, too, is China's production of electric vehicles (EVs). There is this growing concern that Western economies especially are going to go from this dependency on oil to a dependency on EV batteries. In fact, in Europe, there's going to be a summit quite soon to discuss this vulnerability that has been pinpointed.
Do you see this as in any way a block to lead production of EVs out of China and potentially used as a political sort of chess piece, if you like? And how will that impact companies that are related to this? And how do clients trade that?
China's EV investment is significant
BA: Well, China's invested very significantly in electric vehicles, both government subsidies, but also the companies themselves. And that's why they are the leader. And so they have an intellectual property that, you know, similar to Tesla, is unique among many automakers.
And so, it's a shame that that investment, you know, we're not able to buy those. You know, I was recently meeting with (Chinese multinational automobile manufacturer) Nio. And I can't buy a Nio in the United States, you know, heavily tariffed.
But I think what you're seeing from Chinese companies is from the West, you know, we've looked at what happened during zero-Covid as a supply-chain problem. But if you put yourselves in the shoes of a Chinese company, that was a revenue problem. They were unable to sell their wares to the West.
Manufacturers look to make goods near the markets
So, we're seeing a lot of geographical diversification from a manufacturing perspective from Chinese companies. So recently, Nio built a factory in Hungary. So I think you're going to see a movement for Chinese companies, Chinese automakers to want to manufacture where they're selling those goods. That sea change will happen.
Some markets will put up walls like we have in the US. You travel across the world, you see Chinese electric vehicles all over South and Latin America, in the Middle East, in parts of Asia. But you don't see it in certain markets that have protectionist tendencies to protect domestic producers.
This practice ultimately is inflationary and keeps a great product out of the hands of consumers.
AO: Now, other than China, the big topic that our clients are really keen on this year is artificial intelligence (AI). And I'm sure that you've heard this buzzword almost too much in that there's not much in the way of proof and proof of concepts and how we're going to use AI.
There seems to be all this hype and now everyone's starting to try and figure it out. What do you say to clients and investors who are keen on the space, but unsure of investing?
A last-gasp grasp at AI
AB: Well, one of my personal beliefs is that US equities are undervalued. The high technology weight of the S&P 500 has propelled a vast underperformance over the last 14 years.
The US market has outperformed every market by two to three times. So, I think we're ending this period of low interest rates, which have supported long duration assets, including technology, and you have this last gasp of grasping onto AI.
This is what's going to justify these massive valuations in the magnificent seven, this small number of mega-cap US tech names that are supporting the market. If that comes to an end, maybe this period, this decade-long period of US outperformance comes to an end.
And I think you can prove that by looking at, look at a company like Badoo, a very, very early investor in AI with autonomous vehicles. There's no valuation premium given to Badoo. Why? Because it's not a US technology stock. So, you just have to step back and say, okay, the US market is simply overvalued and what's going to stop that?
Well, high US interest rates. Personally, I've been buying CDs, first time in my life I've ever bought a CD. I can lock in 5%. It's a great deal. That money would have gone into US stocks in the past. And I think my behaviour is probably like many US investors.
So, for one, I think you have the potential baton for US stock equity outperformance to be handed to non-US equities. And it's been a long 14 years.
AO: What would you also say to those investors out there looking at fund flows, which have showed more interest in the second half in money markets, cash, you know, that caution creeping in. Where would you and where are you seeing your clients redistribute that money?
BA: Yeah, it's a great, great question, because I think you have to think about individual markets that asset classes compete with one another, stocks versus bonds versus bank deposits, money market funds.
And in the US, you'd say there's been a tremendous shift from zero interest rates to real yields available, which is a big threat competing asset class for US dollars.
If you think about other markets, in the case of China, interest rates have come down and bank deposit rates continue to fall. So, it makes stocks look more appealing, that the dividend yield in China is around the dividend yield of a 10-year treasury. The dividend yield on the S&P 500 is less than half of a two-year treasury.
So, I think you're going to see you have to put yourself in the shoes of different markets. And does that incentivise an investor to put money into stocks, bonds, money market funds? And I think particularly in our focus on China, you'd say equities is where that money should be going just from competing asset classes.
It’s very different across the world. In Mexico, you get like 12% in a bank account, right? Very similar in parts of Latin America. So that's a potential headwind to equities in those markets.
AO: And finally, back to China. Many investors were hoping for this reopening, post-Covid rally. Everyone was looking to China to kind of boost the world economy just when it was faltering under this burden of high inflation. It hasn't really come through.
And because you spend so much time looking at that market, you think potentially it could be an understanding issue. Perhaps China never intended to have this huge reopening. Maybe it was always going to be a really small step recovery. Would you say that's true?
BA: From the October lows, the Chinese market from October of last year through January of this year actually went up in terms of our flagship strategy focused on China internet: that went up 100% over that time period. And then we have pulled back.
It has come off. So, it ended up being a little bit of a trade because I think a lot of investors thought we'd have this revenge spending, this see policies that we saw in the West…
AO: … the revenge travel?
Tourism market starts to stabilise
BA: One hundred percent. It's been much slower. The Chinese government, much more conservative versus its Western counterparts, running a small fiscal deficit that's left inflation very tame in China. In some ways, you could argue what China has been somewhat smart versus policies in the US high inflation, big budget deficits, creating problems around government spending.
And I think that's why we're more optimistic on this. Basically, the end of this year, 2023, going into 2024, where we think investors will recognise a few of the things we've seen and it does look like the market is starting to stabilise as we see incremental domestic spending increase, domestic travel increase, as well as international travel.
Here in Europe, I'm seeing a lot more Chinese tourists versus a year ago when there was no travel. Now we're seeing Asian tourists coming to the United Kingdom, coming to Europe. And you're going to have a bit of that revenge spending happening outside.
But, certainly, a lot of policies to support domestic consumption in China going forward, which makes us a little more constructive on the Chinese equity market than the consensus.
AO: Right. We have to end there. Thank you very much, Brendan Ahern, CIO at KraneShares. This is IG’s Trading the Markets. I'm Angeline Ong.
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