Investment Theme: Developing Asia ex-China

In my early 2019 posts on China I was relatively early in recognising this as a historical reframing of the democratic West’s engagement with the emerging autocratic power. As the talking heads on television – selling flows in share/stock purchases – implored investors to position for an expedient solution to the trade spat, I remained sceptical and sold out of all of my Chinese stocks (that I accumulated end of 2018 at low prices) as well as emerging market funds.

As I explained in those posts, I had personally witnessed and experienced (in a very minor way) the actions of the Chinese Communist Party during a month-long workshop in China shortly before it joined the World Trade Organisation, and I long had concerns that it was not abiding by the implicit “arrangement” that it would open its economy and greater freedoms would flow to its people in return for the opportunity to develop its economy. 

Nonetheless, I have to admit that I had been lulled into thinking nothing would change by the almost 2 decades of increasing enmeshment of Chinese businesses in the global economy, even if I had little time for the elites arguing that rising out of poverty of its people was an achievement of global businesses. After all, the West is at the same time very quick to talk about liberty and freedom, and espouses an ethic that it is better to die on one’s feet than live on one’s knees.

And in reality President Trump and other Western leaders are not so much concerned for the freedoms of Chinese people, but of having domestic businesses handicapped when seeking to extract benefits from dealing in and with China and the loss of technological superiority. 

The one-sided arrangement which had developed was suggestive of an emerging power in a hurry to develop and assert its influence on the Global community.

While I would be relieved to see the end of the Trump era of erratic and dumbed-down crass diplomacy, if it should happen I will be alert to his successor continuing this critical adjustment. I am unsure whether anybody else would have had the “front” to do what President Trump did on engagement with China so abruptly, at the same time standing up to powerful US business interests, and it will undoubtedly be his biggest achievement in office. 

It was especially important for us Australians where our economy had become so beholden and vulnerable to China and the interests of the Chinese Communist Party, and thus were experiencing a dangerous political drift towards this authoritarian influence. 

The investments in Chinese companies that I made in late 2018 were mostly in technology and especially in automotive technologies due to their relative value compared with US companies. One of my investments was in BAIC which is one of their largest electric car manufacturers. After purchasing the shares, as I dug around its website I came to realise that BAIC is a major supplier to the Chinese military. This did not sit well with me because of its authoritarian system of Government (and how that is expressed within its own borders), because of its militarisation of disputed islands and seaways, and its increasingly conspicuous agenda to increase its international influence through infrastructure projects.

I decided decisively that I do not want my family’s capital to be used to strengthen an authoritarian regime’s influence in the world. 

Not surprisingly, given just how enmeshed Chinese companies had become in the global economy, this realignment is producing all sorts of adjustments many of which represent an opportunity to the alert investor. 

Firstly, however, I should say that I consider it to be an error to simplistically put this adjustment down to anti-globalisation. Certainly the politics in President Trump’s heartland, and throughout the xenophobic heartlands of the populists, suggests that these politicians are responding to this base. 

I see it the other way around, however. The politicians have created a background where they have a supporter base to implement the policies they want – lest the powerful business elites would be able to mount a successful campaign to protect their interests.

Obviously I agree with the need for the readjustment. However, it is disappointing that a genuine leader did not come to the fore and manage it more openly and inclusively as the side-effects of President Trump’s methods are unfortunate and dangerous, especially when it comes to social cohesion and climate change (see Themes 2 and 3 below).

So this is not evidence of anti-globalisation in my view. Rather it is a specific response to a very specific threat. 

No matter how much populists talk about bringing jobs back home, that is going to be a very long process and even when manufacturing is brought back onshore it will often accompany significant investment in automation and it will involve significantly fewer human work hours (see Themes 2 and 6).

The offshoring trend for labour is unlikely to reverse, in fact it may even ramp up. Let’s take the example of a manufacturer that has continued to produce in a developed country while the majority of its competition has offshored to China. They have resisted because they did not want to disrupt the way in which they do business even if they have been realising that they were fighting a losing battle with those producing in China at much lower cost, and the retailers were providing feedback that the struggling consumer was not in a position to pay a higher price for the locally-produced good even if superior in quality. 

Now with tariffs on Chinese products retailers are suggesting that those manufacturers operating in China should relocate to other low cost countries to prevent price inflation.
So those that have resisted offshoring are faced with a brief moment in time when the playing field is level once again, where everyone – including those who offshored to China – is in a scramble to identify suitable manufacturing skills in other cheap areas. I suspect a lot of those who have resisted will see this as a lower risk time to embrace the “inevitable”.

At the same time that developed country businesses are looking to re-engineer supply chains – or base countries for goods manufacture – China still wants to develop its own sphere of influence and continue the progress that it has made. It is likely to intensify those efforts.

While China has been active in Africa and South America, I suspect that they will now place greater emphasis on defence and will concentrate more intently on their immediate neighbourhood. Western Governments, encouraged by the US, will want to counter China’s moves by showing more interest in these regions than they have in the recent era. 

This was on show earlier this year at The Pacific Forum in Tuvalu in August where Australian Prime Minister Morrison together with senior US bureaucrats worked to counteract the Chinese agenda, which prompted the Samoan Prime Minister Tuilaepa Malielegaoi to say that the island nations would not line up with Australia and the United States against China, stating “their enemies are not our enemies” and then suggested if countries “against China” objected to Beijing’s support for the region “they should come in and provide the assistance that China is providing”.  

There will be competition to win the hearts and minds of the leadership of other countries especially those in the Indo-Asia-Pacific. The Chinese will suggest that the West has not shown any interest in them and has developed a very perfunctory world based on Western dominance and exploitation of weaker nations, and will point to the far from altruistic motives in many of the post-WWII conflicts that the West has waged.

Already it is clear that China will use Anglosphere indifference to the climate change crisis as a point of differentiation which will appeal directly to Indo-Asia-Pacific nations.

The West will ask the leadership to think forward to what will be the world order with the hegemonic power an autocratic nation that has shown a willingness to mercilessly suppress its own peoples.

The leadership of these courted countries will mostly be guided by self-interest, so there will be a contest mostly in the form of direct and joint investment and other perks.

The West will most likely prove to be the most attractive suitor for it will be seen as the safer bet, but also because domestic politics may also prove easier since China is a fierce competitor to their own ambitions of producing low-cost goods for consumption by wealthy consumers.

All of this can be seen playing out especially in the two major multi-lateral trade pacts being negotiated at present, the Comprehensive Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the Regional Comprehensive Economic Partnership (RCEP).  I would suggest that a simple examination of which countries feature in both of these pacts will provide a good pointer to who are the most attractive countries who will receive the most attention, and inducements, from the suitors.

These courted countries will gain advantage from being courted by both sides. In many ways that is exactly the game Australia has been playing – where we rely on the US for its implied security but do not wish to offend China due to our increasingly close economic ties – until this point where President Trump has forced Australia to more overtly express its allegiance. 

One only needs to briefly consider the released transcript of the telephone discussion between newly installed President Trump and then Australian Prime Minister Turnbull where the latter was clearly subservient and expressing in the strongest of terms his desire to prove Australia’s loyalty. The smaller but more critically strategic countries, on account of their proximity to China, will be able to prolong the courtship almost indefinitely and with little repercussions when they run the gauntlet on important issues such as potentially allowing the subversion of US trade policies by allowing Chinese companies to divert exports via them for a price.

Companies will also likely want to establish manufacturing bases in these proximate countries where the Chinese manufacturers have already done some of the early work and have invested in infrastructure and in skilling up locals to work in factories.

I have been searching for the correct investment vehicle to position for this progression. Unfortunately I have not been able to find an ETF that is for Emerging Asia ex-China as most emerging market funds have a high weighting to China, and Asian funds ex-China typically include developed markets and thus have high weightings to Japan.

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© Copyright Brett Edgerton 2019

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