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Diary of a fund manager - Bicentennial - 11.06.18

David Miller, Investment Director, Quilter Cheviot

Although this is the 200th Diary I have resisted the temptation to write a retrospective, commenting on what has changed over the last four years, what themes have emerged and which issues that appeared important at the time, are now forgotten. Instead the focus is on the future and, in particular, the growing influence of China, both economically and politically.

It was a pinhead week for financial markets, where significant events failed to move the averages. For the record equities were mixed with the US better for choice, and bonds down as the need for an immediate refuge from an Italian-provoked EU crisis diminished. The list of matters on which to keep an eye on lengthened. President Trump seems determined to escalate the simmering trade war, much to the bemusement of the other members of the G7. Cause and effect is hard to determine and generally counter-productive when searching for insight, but evidence is emerging that the first quarter contraction of the German manufacturing sector continues. Central banks from the emerging economies are responding to US monetary and fiscal policy, which in summary is a combination of higher interest rates, the reversal of QE, lower taxes and domestic investment, by raising interest rates. Countries and companies that have borrowed dollars are concerned. The evaporation of the UK retail sector continues with the closure of a large number of House of Fraser stores. The use of CVAs (Company Voluntary Arrangements), designed for companies in insolvency, to reduce rents for those still in business, is having a knock on effect through the property sector. It’s much the same in the US where Sears is also closing stores, having lost $10 billion over the last 7 years. Consumers are spending, but using new channels. Despite all of this uncertainty the ECB, which has a track record of doing the wrong thing at the wrong time, is kite-flying the idea that it might start reducing QE as a prelude to raising interest rates next year. It’s going to be an interesting summer.

The US has been the centre of gravity both economically and politically for several generations and continues to ‘make the weather’. Just as was the case for the UK in the 19th Century, the US has the largest economy, the biggest companies, controls the reserve currency and the global payments system, and has the most powerful military. Despite all of this, the future is looking less American with China acting as the catalyst for change. The numbers tell the story. China is the second largest economy in the world, larger than Japan, Germany and India combined. Growth may have slowed from 10% per annum to only 7%, but this is the equivalent of a new Switzerland every year. The population of 1.4 billion may no longer be the fastest growing or youngest, but is increasingly literate, interconnected and prosperous. Since 1980 average income has risen from $300 to $17,000, but this still ranks China only 79th, way behind all the members of the EU. The five largest cities in China are larger than New York and London combined with Guangzhou top of the pile with 44 million inhabitants, which is 8 million more than the entire population of Canada. The companies are also on the move. The global top 100 remains US dominated with 55, but China is now second with 11. Tencent and Alibaba are in the top 10. Unlike the US top 5 of Apple, Alphabet (Google), Amazon, Facebook and Microsoft, they operate in an environment of government support rather than suspicion and continue to invest for growth.

China’s coordination of diplomatic, strategic and economic initiatives is very powerful. The rest of us, and in particular, the US, can only look at this in awe. The Belt and Road infrastructure project designed to connect China to the rest of Asia, Africa and Europe is a hugely ambitious multi-decade plan. Countries along the route are spending their own money to make this happen, and if they haven’t enough in reserve the Chinese are providing credit. Even the Russians are joining in by building a $55 billion gas pipeline from Siberia to the Chinese border.

Infrastructure is not just roads, railways and ports, but also communication and electricity transmission. When 3G and 4G came along there wasn’t a global standard which meant that local solutions were self-contained. In contrast, 5G will be the same for all. China is right in the vanguard in terms of setting global standards, equipment manufacture and ownership of intellectual property. Interestingly, Softbank, the Japanese company that bought Arm, the Cambridge start-up, has just sold a controlling stake in its Chinese subsidiary to a Chinese private equity consortium. Arm chip designs dominate the mobile market. Electricity transmission is a domestic priority, not only because electricity is needed for growth but also because power generation in China is a long way from the end users. Over a distance of 2,000 kilometres, the Chinese have reduced energy loss to only 7%. In the US, the equivalent loss happens over 200 kilometres. Cost per kwh is between 2 and 3 cents whereas in the EU it is 23 cents. Robotics, AI, solar power and battery technology are also priorities. The list goes on.

All of this suggests that over the next few decades China will become even more important to the rest of us than it is already. Direct investment remains tricky because of concerns about ownership, but there are solutions. Investing in technology and infrastructure makes good business sense, but economic power has many uses. Lest we are tempted to cast the first stone, the British used superior military technology to defeat China in the Opium Wars of the mid-19th Century. In 1961 President Eisenhower spoke about the importance and challenges of the military-industrial complex. It is well worth reading his final speech as president as we grapple with the implications of 21st century change. History repeats, resonates or rhymes – take your pick.

Investors should remember that the value of investments, and the income from them, can go down as well as up. You may not recover what you invest. This commentary has been produced for information purposes only and isn’t intended to constitute financial advice; investments referred to may not be suitable for all recipients. Any mention of a specific security should not be interpreted as a solicitation to buy or sell a specific security.


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