Speaker 0:
Welcome to this latest edition of market moves on Asset TV. I'm joined by Ed Smith, co chief investment officer at Raths Ed. Thanks for being here. You're welcome. Let's start with the reopening trade in Asia and China more broadly, do you think it's quite overstated? And do you think it will Peter out in the coming

Speaker 1:
months? The rebound so far has been strong, but there seems to be a reticent for the Chinese consumer to spend on really big ticket discretionary items and to engage in things like long distance

Speaker 1:
travel. We think that's the precursor to it. Peter out. We've seen consumer confidence still fairly weak. We've seen the proclivity to save continue to stay at 20 year highs even after they were let out of three years of effective lockdown. And perhaps that's not a surprise when we've had the first contraction in net household wealth last year in 20 years, as the housing market went bust and some of the wealth management products didn't

Speaker 1:
deliver, and so we think that will contribute to a softer growth than perhaps some of the China bulls are expecting in the second half of the year.

Speaker 0:
So looking at the the banking crisis and what we had with S V B recently, do you think investors that look at emerging market countries will start to look at that region with S V B tinted

Speaker 1:
glasses? Yeah, potentially. And actually, if you look at some of the frontier markets, you could argue that they're already doing so. So nine frontier economies are in official definitions of debt distress Sri Lanka and Pakistan, most obviously.

Speaker 1:
And then there are many, many more that are overburdened with debt and are going to have to refinance on interest rates they probably can't afford. And to give you some idea of the scale of that, 73 frontier economies were put in the interest rate, the sovereign debt payment moratoria that the G 20 arranged during the pandemic. And they were all highly

Speaker 1:
indebted. And this kind of reminds me of the 19 eighties, when you had the L DC debt crisis, the less developed country debt crisis

Speaker 1:
that was, uh, precipitate precipitation from the sharpest interest interest rate rise ever from the Fed. The Volcker fed. There's a clear parallel to today, and because there are so many more borrowers and so many more lenders and China is involved. Sorting it out in an elegant way like Brady Bonds in the eighties might be a lot more difficult.

Speaker 0:
But with quite stubborn inflation in China, Is there a case for it being quite a robust economy?

Speaker 1:
Yeah, I think, um,

Speaker 1:
there is. There's certainly a sort of best of a bad bunch angle, so we think the rest of the world will slow into a mild recession in the end of the year. We don't think China is going to go into recession even though we're not. We think growth will be a little weaker than perhaps some people expect. One thing that China is doing well at is keeping inflation relatively low. We had the consumer price and producer price inflation out this morning.

Speaker 1:
Producer prices are continued to be negative, in part because of lower energy and food prices, but also because after this lean in new year, you finally had migrant workers move around the country again, making sure that there weren't the labour supply problems that happened after the Western pandemics, for example, so low inflation is

Speaker 1:
definitely a plus for Chinese assets. You're unlikely to get a big surge in interest rates from the People's Bank of China. But we do think that the, uh, as as we started off by talking about that, the recovery will peter out.

Speaker 0:
It was only a year ago that China was deemed quite uninstall. Now,

Speaker 1:
yeah, I think so. It's easy how quickly people have ditched that word. Unable, isn't it? It's interesting. There are a few reasons why that, uh, moniker started to be attached to to China. In part, it was the, uh, as you say, the the trade policy, the protectionism, the economic cold war.

Speaker 1:
In part, it was also because of that regulatory onslaught that she embarked on in 2021 showing that he could obliterate the share prices of a sector overnight like private education, for example, just suddenly wasn't allowed to exist pretty much anymore. And the tech giants that Western investors

Speaker 1:
has liked for a long time again, he said that well, we're going to make it pretty hard for you to continue to grow at these exponential rates, and I think they're still there now. Those two things for us didn't actually make China uninvestigated. It just meant that as analysts. We had to apply a higher discount rate to tomorrow's earnings because there's more uncertainty. But there was a third reason why people started using that word uninvestigated. That is still around. And that's the growing consensus from the defence community

Speaker 1:
that, um, we may only be a few years away from where China could strategically win a war in Taiwan.

Speaker 1:
And that's, uh, for us is a tail risk at the moment, and we're putting together, we're we're putting the finishing touches to a plan to a playbook for what we should do if that risk moves out of the tail and becomes very material, Um, which it may do.

Speaker 1:
Um, it's not our base case at the moment, it's tail risk, but it may do that, and we would expect all asset managers to start start planning for that scenario. And

Speaker 0:
what about some more issues within China? The property sector had some issues last year and its banking sector, too. What's going on

Speaker 1:
there? Yeah, So the problems in the banking sector linked to the property sector again, Another reason why we think that recovery will peter out this year. Um,

Speaker 1:
essentially the um, the Chinese banks have a huge non performing loan problem. Now you can't see that, uh, at face value because they've hidden these non performing loans with accounting tricks and securitizations. But it's a real open secret, and you can see it in the profitability numbers, right? These banks used to have a return on assets of 1.5% 89 years ago, which was pretty decent. And now their return on assets is 0.5% which is pretty poor.

Speaker 1:
Um, and now this and a lot of that is related just to bad loans. Overextended in the property sector, the bottoms hall out of the property sector. Beijing will prop it up. But it's unlikely to recover enough that actually, all of those problems will just be forgotten about. And it will constrain credit creation

Speaker 1:
for some time to come. There won't be a banking crisis in China because most of the lending is from state owned banks to state owned enterprises, so it's just money moved from the left pocket to the right pocket. But it will constrain the extension of new credit to productive activities

Speaker 0:
going back to the covid policy because it was so inflexible it did throw China's economic cycle out of kilter with everyone else,

Speaker 0:
Do you think, therefore, that could be quite useful for investors? And if the China is the only economy that grows this year, it could be quite a good hedge, don't you

Speaker 1:
think? Yeah. So, um, if all global business cycles are synchronised, then investors would find it difficult to diversify their revenue streams. And if China If we thought China was going to enter recession this year, then our forecast for the rest of the world's recession would probably be materially worse than it is

Speaker 1:
than today, where we expect just a mild recession. So it is helpful, uh, to, uh, to to an extent. But to take advantage of that, then you're going to have to look for those parts of the Asia market the China onshore market that are less correlated with other assets. Because actually, if you look at the Greater China Index, and particularly those big companies

Speaker 1:
with American depository receipts or listed on the Hong Kong Exchange, they've got actually quite a high correlation with the rest of the world. Naught 0.7, for example, for the Greater China Index and the world index.

Speaker 1:
Uh, regardless of what the Chinese business cycle is doing, because it's just part of that sort of global risk appetite. So if you want to take advantage of that, you've got to look on shore. I think

Speaker 0:
that's a superb place to leave it. Thanks very much. You're

Speaker 1:
welcome.