Reversing order? A nearly year end review

We now find ourselves in a world that is almost unrecognisable from the one we started off with in 2016 and for global investors looking for even an ounce of certainty and security there are fewer options for placing their capital. In this short article I would like to briefly examine where the world stands today and extend a rationale for why investors will further their interests in the USA and the UK.

With the presidential election over in the US, investors can now focus on what is going on in the world economy and what future investment opportunities are lurking out there. Donald Trump is the president elect, and, contrary to expectations, the outlook is not as uncertain as his campaign rhetoric and maverick ideas on both domestic and foreign policy suggested. He has now gone hot and cold on many of his earlier promises to his electoral supporters. What is clear is that Donald Trump has made it an imperative that the US will not be the shoulder that the world once relied on. The president elect will focus on “Making America Great Again”, prioritising domestic US companies, building infrastructure and supporting the fossil fuel industry. If supported by the Republican-held House of Representatives, this will mean a near-medium term period of growth within the USA. The adjustment in US foreign policy priorities also commits trade agreements (such as the TPP) and long-standing international security treaties and organisations (such as NATO) to an unclear future, leading to higher geo-political risks and an opportunity for another country to step in and fill the position.

We are also entering a world where the concept of the European Union is growing more fragile. Established by the Inner Six countries after World War II as a pillar of much-needed stability, which encouraged political and economic joint cooperation through a single market and free-movement of people and capital between previously hostile nations. The future of the European Union is now clouded by growing populism from within its founding countries. Donald Trump’s ascension to Presidency has given legitimacy to populist ideas, exarcebating the uncertain future of Italy’s and France’s membership in the European Union should Renzi resign over losing his constitutional referendum on the 5th of December and Le Pen to gain further ground in the race to Presidency against Fillon. Chancellor Merkel, who announced that she would run for a fourth term, has lost political capital at home and with other members of the European Union over the immigration issues. Germany will struggle to stand strong in the midst of a brewing storm in her neighbouring countries. Regardless of the outcome in the upcoming elections in Europe, the result will be the same as the USA. There will be a clearly polarised divide with little or no middle ground.

The “Leave” outcome has set back growth in Britain, in Europe and around the world at a time when economies had already been struggling. At present, Europeans seem resigned to a prolonged period of slow growth. They are puzzled by the negative interest rates in Germany and Japan but believe there is a significant risk aversion among investors who are looking for a place to store their money in Europe until they develop more conviction about where they can find capital appreciation opportunities, and some are even willing to pay the banks a storage fee to do it.

In addition, there isn’t much of an appetite from Europeans for investing in China or the emerging markets. European investors recognize the appeal of countries with a growing middle class but the short-term political problems and volatile commodity prices have kept them on the sidelines. Although there were opportunities in Africa, many companies have been reluctant to make investments there either.

The UK, on the other hand, has been a hot-bed for foreign investment since the referendum results in late June, initially from Asian investors and, more recently, North American and Latin American. It has been driven primarily by the dramatic fall in the GBP to Dollar rate (stabilising around the 1.25 mark at the point of writing in early December 2016, for how long I am not sure) but there other important factors to consider. President elect Donald Trump has pledged his support to the UK in the form of US trade and investment, and similar to the red-carpet welcome the UK gave to President Xi Jingping in 2015, Theresa May has welcomed Donald Trump and the age old UK-USA alliance with open arms.

In China and South-East Asia, the year-long volatility in the commodities market – years of overdevelopment in infrastructure and overcapacity in real estate, as well as global and domestic political uncertainty catalysed by emerging market leaders such as Malaysia’s Najib and the Philippine’s Duterte – have resulted in a significant drop in Asian yields and flight of capital. The Chaebols, the Titans of South Korean business and enterprise, are now facing increasing scrutiny from the public with the likes of Lotte and Samsung currently under investigation by the South Korean state for malpractice, while the first female president Park Geun-hye has agreed to step down amidst a series of corruption scandals and threat of impeachment.

Latin America has also had its share of recent hardship, with the Mexican Peso dropping as much as 18% against the Dollar since Trump, the momentum of Chilean populism culminating in a backlash against the government triggered by a privatisation of pension funds in a country hard hit by the recent commodity fluctuations and at the top of the income inequality distribution table in 2016, not to mention the seemingly never ending impeachments of Brazilian presidents with no clear leadership or the dire and widespread unavailability of basic food and sanitation in Venezuela. All these issues, compounded with the fact that most Latin American debt is priced in US Dollars with all the indicators pointing towards a Fed hike, does not leave the resource rich continent in a comfortable position.

Let’s turn our attention to China. With the slowdown in growth in China and the struggle to squeeze any form of value creation left in the economy, China will be forced to shift towards a more consumer driven economy that inevitably coincides with strong inflationary pressures. Furthermore, in its current position as a global trade leader, China has all the intentions of maintaining it and continuing down the path of a progressive movement in detaching from a ‘soft-peg’ to the USD. The recent efforts of the PBOC and SAFE to control the RMB have been in an attempt at restricting Chinese companies from FDI and M&A over £1bn and outside of their formal lines of business. However, such measures taken by Beijing to control the outflow of capital are only short term bottle-neck for investors as China is already part of an integrated global economy with established international banking relationships. The flow of capital cannot be completely controlled.

From the CIRC (China Insurance Regulatory Commission) mission in early November, I spoke to the heads of several of the top insurance companies and discussed their investment strategy in the UK and USA. I found that they shared similar strategies with the conglomerates in seeking secure income and capital growth-driven assets. I also learned that, fuelled by the domestic Chinese consumer growth, they were looking to acquire strategic assets that could provide value add and synergies into their existing platforms.

The insurers were also closely aligned with Beijing’s thematic policy and promotion of investing into large-scale nuclear, wind, tidal, and high-speed rail projects, with supporting finance coming from Chinese state banks. Infrastructure and transport logistic assets that are already generating income have been on the investment horizon but with the more experienced private equity and sovereign funds already active in the UK market, these prized assets may prove too hard to capture for Chinese newcomers. This has resulted in many Chinese companies often overpaying for unsought assets in lesser-known locations. The infrastructure projects will be decided on a government-to-government basis under the standard EPC in addition to a financing model that China has utilised to dominate most of ASEAN, African, and Latin America infrastructure creation in the last 30 years.

We will continue to see UHNW, institutional investors and large Chinese conglomerates via Hong Kong (and in some cases Macau) make the most of the opportunistic Brexit conditions and capture as much as they can in this favourable FX window, and all with the support of eager Chinese banks in the UK who will lend at sub-market rates to Chinese companies. We have seen seven of the last ten investments over £200m mark in real estate coming from Hong Kong based funds, which are almost all fully funded by mainland Chinese money. The prime commercial London real estate market has reacted accordingly and we have seen a recent fall in yields paid for by investors and, in some cases, landlords withdrawing their assets completely from the market. There will also be continued asset-building by Chinese companies in finding TMT targets which can be integrated and distributed across their already huge and ever-expanding platforms and companies in China.

As a final note, another area that we should consider keeping an eye on is clean energy and storage. Unlike the US, which will see a rise in the fossil fuel sectors under Donald Trump, China has maintained its position and policy on creating a ‘Clean Energy World’. It is accordingly focusing much of its resources and money into the advancement of such technologies and projects in emerging markets and on expanding capacity to satisfy the growing demand.

If we have learned anything in the last 12 months, it is that anything can and will happen. We are in the middle of a global macro storm. Much of the instability and new geopolitical risk have wiped off significant wealth in the world. Although there are always those who are willing to take greater risks in acquiring distressed assets, the majority of investors from both the emerging markets and western world are prioritising long-term safety and steady growth over immediate income. Traditional havens that offer respite from the tumultuous times will be in high demand… which will be reflected in the price to be paid.

We cannot go back on the world events that have happened. The new situation is what it is and investors will not simply rest on their laurels. Money will move and investments will be made only once the anchor has been set for the rough seas ahead.