A clash of opinions took place in Melbourne this week at AsianInvestor’s conference for superannuation funds.
Investor Marc Faber opened up by proclaiming the end to US Treasuries and cash, and the need for investors to be in risk assets such as emerging-market equities, real estate and commodities.
But the day concluded with Diana Choyleva, economist at Lombard Street Research, painting a very different picture in which she sees commodity prices weakening over the next few years.
It will be up to the superannuation fund CIOs in the audience to sift through the ideas and take their own view, although the overall mood was ebullient, thanks to Australia’s economic links to China at a time when the US is struggling to recover from its 2008 financial crisis.
Faber argues that US politics make it near-impossible for the Federal Reserve ever to return to positive real interest rates. He says the country is bankrupt and US Treasuries are no better than junk bonds. It’s only available option is to keep printing money in the hope it generates enough growth one day to crawl out of its fiscal hole.
For investors, this makes US and European sovereign bonds undesirable, and cash dangerous.
Although everyone accepts that yields on US Treasuries must go up at some point (the 10-year rising nearly 100 basis points n December to 3.4%), few believe this process will be quick.
But Faber disagrees with consensus and believes yields on Treasuries can rise sharply and soon. “Even if there’s a short-term rally, government bonds will be a disaster over the next 10 years.”
Where he diverges from other doomsayers is in his belief that this Western failure is not bad for shares. Public-sector credit continues to expand more than private-sector credit has contracted, leading to massive volatility in risk assets, from currencies to stocks to commodities. Because bonds are so scary looking, Faber says investors must stick to risk assets.
He favours emerging-market stocks because of the growth stories in those markets. That growth, in turn, augurs good tidings for commodity prices.
Although he acknowledges that China has also entered a realm of negative real interest rates and a property bubble, which will burst, he doesn’t put this in the same category as the US or Europe.
He cites Latin America’s economic bust in the 1980s, after gorging on excessive borrowing (via petrodollars). Latin America’s ‘lost decade’ may have involved a credit crunch and weak currencies but equity markets held their own, in local and US dollar terms. It was in local bonds where investors really suffered.
“At least you preserved your capital by being in stocks,” Faber says. The trick was to shift tactically among equities, commodities and real estate as their uneven progress and currency swings buffeted risk assets. But careful investors could prosper in Latin America this way.
Likewise, today, “The more bearish you are, the more you should own risk assets and avoid government bonds,” says Faber.
Done and dusted? Not quite.
Diana Choyleva argues that commodity prices are in danger of a prolonged decline because she believes the China story is not so sanguine. “Our long-term forecast for China’s growth is bearish versus the consensus, and therefore for commodities, too.”
She believes China growth will not fall to a benign 7-8%, as predicted by another speaker, Hu Yifan, chief economist at Citic Securities, but will average 5% over the coming decade.
Hu describes China’s economy as headed for the sunny uplands of what she calls “well-being growth”, which echoes the Communist Party’s own assertion that it accepts lower rates of economic growth in turn for higher-quality growth – in other words, more ecologically sound and designed to boost living standards.
Key to this shift is to boost the activity of small and medium-size companies, which until now have been discriminated against by the big state-owned banks in favour of SOEs. This is meant to go hand-in-hand with tax cuts, wage hikes, diversifying the industrial base, and getting people to spend more on leisure and culture.
Choyleva, in contrast, describes how national savings can be transformed from helpful to malignant, if income savings becomes structurally greater than efficient investment and spending needs. Her forecast is at odds with Hu’s, and therefore her view on risk assets is more cautious than Faber’s.
Today China’s savings amount to 54% of its GDP, far more than makes sense for a country that still has mass poverty. Moreover, the majority of savings are held in deposits among the four biggest state-owned banks.
These institutions are often required to make non-commercial lending decisions, and served as the key conduit during the government’s 2009 stimulus programme, providing cheap financing to state-owned enterprises or government-linked investment trusts.
Capital controls mean depositors have few alternatives to bank deposits (mainly just real estate and A shares), and allow the banks to roll over dud loans without penalty. But, says Choyleva, this penalises households, forcing them to save ever more if they want to buy a new car or apartment, and depressing consumption.
Although anecdotally China is a consumer powerhouse – buying more cars than Americans last year, for example – consumption continues to decline as a percentage of GDP, now down to 35%.
Indeed, the government’s capital controls and use of banks as conduits for splashing credit around is making its citizens poorer, not richer, Choyleva argues. The economy is more reliant than ever on fixed investments and exports, but the financial crisis means the West will no longer be so accommodating towards China’s need to grow market share to boost SOE profits.
What this amounts to is not a collapse but a significant headwind to GDP expansion, which is why Lombard Street reckons growth will slow to half the levels it experienced in the 2000s.
She does not believe the ongoing round of credit tightening is meaningful when adjusted for rising inflation. Instead, the policy will lead to growth slowing down measurably by 2013. “And therefore, commodity investments are at risk,” she concludes.