When the going gets tough, the tough get perspective (Asia ex Japan)

Key takeaways:

• For the US administration, tariffs are ideological; the US is taking steps to redefine global terms of trade.
• As a policy step that can be reversed at any time, this makes portfolio construction problematic – we are mostly sitting on our hands, waiting for a clearer sense of asymmetry before being more active.
• Investors need to stay focused on their “North Stars” – we are maintaining discipline around constructing a portfolio of intentional, non-correlated company-specific investment opportunities.
• In Asia, the additional economic uncertainty and market turbulence is taking place at a time when we think a number of interesting potential investment opportunities already exist, notably in Hong Kong, Indonesia and technology stocks.

Welcome to the new world order

Historians have argued in recent years that the US has been returning to its pre-World War II role in global markets. In fact, in his “Liberation Day” speech on 2 April, US President Donald Trump even cited his country’s historical tariff use from the 1700s to the early 1900s, claiming that the Great Depression might not have happened if the policy hadn’t been abandoned. We’ll let the historians argue that one out.

The Liberation Day tariff announcements sent global markets into turmoil as Trump introduced baseline tariffs of 10% on all imports followed by additional “reciprocal” tariffs on 60 countries he dubbed the “worst offenders”. These included China, Japan and India. Financial market stress became so acute that the White House was forced to pause these for 90 days, opening the door to negotiation with a notable exception, of course: China.

“As far as financial markets are concerned, this is an iceberg moment.”

As far as financial markets are concerned, this is an iceberg moment. Unusually, it’s not an economic iceberg but an ideological one. Being self-imposed, it can be walked back at any time making it entirely different from the type of shocks that underlie most living investment muscle-memory reactions.

Attempt to reset global trade

Markets seemingly underestimated the ideological resolve of the new US administration. It appears that tariffs are not just about getting a better trade deal; the White House tariff rhetoric is increasingly sounding like the trade ideology espoused by Sir James Goldsmith some 30 years ago¹.

The argument is that global free trade – as practised – has become a race to the bottom with goods produced in countries where labour is cheapest, regulation weakest, and human dignity most negotiable, then shipped back to nations who have forfeited their productive capacity and undermined their social cohesion.

The argument further holds that trade policy should not solely be about maximising efficiency or profits, but about ensuring economic activity serves the broader interests of society. It seems that the White House is attempting a reset to the world that unfolded with The General Agreement on Tariffs and Trade (GATT), established in 1948, and its successor the World Trade Organization (WTO), which was founded in 1995.

We think it’s fair to say that this is a bigger deal that most were expecting. Whether we accept the straw man presented above, whether we agree with it or not, whether we think that the White House might be fighting a battle that moved on 40 years ago, the US is now, in fact, taking steps to redefine global terms of trade. There can be little debate that the magnitude and the speed of the changes being sought are almost as shocking as the bluntness of the tools being deployed.

This feels very much like a US Brexit moment; whether one is in favour or against reforming our global free-trade model, it seems unlikely that abrupt, blunt, volatile, unilateral measures mired in antagonistic narrative will smoothly deliver the White House’s desired results.

On the other hand, reckless policy behaviour does carry a significant probability of unleashing wild, unintended consequences in the global economy.

Systemic uncertainty

Understandably, markets are rattled and companies are already hitting the brakes. On 9 April, financial markets were perilously close to a major, widespread malfunction before the “90-day pause” was announced. Unleashing this level of systemic uncertainty is needless and irresponsible, in our view. In the best-case scenario, it imposes a tax on growth and with that comes, almost certainly, recession-type outcomes.

“Investors will need clarity, one way or another, on the global trade and tariff debate, before they can move forward”

However, this is not just a growth scare; it’s a question mark over the nature of the regime we operate in. Investors will need clarity, one way or another, on the global trade and tariff debate, before they can move forward, sustainably, in a pro-risk manner.

As mentioned above, one thing that is distinct about this economic and financial market episode is that it is manufactured. This is not an economic iceberg that causes instant damage. This is a policy step that can be reversed at any time. This makes portfolio construction problematic.

If the White House misjudges, markets could easily spin out of control. On the other hand, if it pulls back, significant price relief will likely ensue. For once, amidst turmoil, we are, for now, mostly sitting on our hands and a low tracking error, waiting for a clearer sense of asymmetry before being more active.

Maintaining discipline

In times like this, when exceptional volatility and regime-level uncertainty wreak havoc, we believe it’s important for investors to stay focused on their “North Stars” – whatever they may be.

For M&G’s Asia Pacific Equities team, that means maintaining discipline around our goal of outperforming our benchmarks through the construction of a portfolio where active risk is deliberately dominated by intentional, non-correlated, differentiated, asymmetric, company-specific investment opportunities.

We source these stock picks from a curated universe of companies we have developed over 20 years and match that with a pragmatic approach to portfolio construction that emphasises the avoidance of undue macro, sector or style risks.

Inevitably, the “God of markets” does not deliver a steady stream of single-stock alpha opportunities each month; alpha appears in a lumpy fashion. Sometimes we see and exploit the alpha, sometimes we miss it, but we are always vigilant and disciplined about what we definitely don’t know. 

“Market sell-offs can be amazing opportunities to add or destroy value.”

Market sell-offs can be amazing opportunities to add or destroy value, depending on the circumstances at play and the investor’s reaction function. For us, this was an unusual sell-off, as described above.

With correlations so high and with, so far, little obvious asymmetry being built into markets, it’s not obvious that we should keep our active risk anything other than modest. “Fatter pitches”, or more attractive opportunities, will come.

Whilst we exercise “aggressive patience”, we go back to our research, back to scenarios and simulations, to evidenced-based observation. We lean on our learned sense of the risk of ownership for our coverage companies and wait for opportunities where the odds are stacked in the favour of ownership, in the context of a portfolio sculpted to isolate other sources of return noise.

As we often admit, we will not forecast the future better than the market or our competitors. However, we do expect to identify, quantify and price the risk of ownership in a superior and consistent manner. In time, that superior perspective helps us to identify when to be aggressive and when to be patient.

Asia: volatility can offer bottom-up opportunities

Turning to Asia, the elephant in the room is obviously China. The initial impact of the very high China tariffs imposed by the US will likely be demand destruction and scarcity, as global supply chains and end consumers struggle to deal with much higher end pricing.

Critically, for some products, there is no competitive alternative to China and hence the initial adjustments will be painful for all involved. Like the Brexit analogy used above, it’s not obvious that too much of the current policy has been especially well thought through. 

“It is likely that China will seek to boost consumer spending to offset macro headwinds.”

In the absence of a negotiated agreement, it is likely that China will seek to boost consumer spending to offset macro headwinds, as the authorities seek to support consumer confidence. There is also the risk of further escalation as both sides jockey for leverage in negotiations.

Opportunities amid volatility

Importantly, from a bottom-up perspective, this additional economic uncertainty and market turbulence is taking place at a time when a number of very interesting potential investment opportunities already exist. This is certainly the case for a number of Hong Kong stocks, especially mid-cap names. 

A number of Indonesian stocks also look very attractive, in our view, with near-term economic and political concerns creating what appears to be excessive levels of risk premia. Finally, the tariff-related turbulence has built upon the ongoing correction in technology stocks across the region.

Our perspective has been that there are a number of technology stocks which had performed well last year as AI proxies, but this outperformance was likely not appropriate over the medium term, given they lacked a lasting “moat” for their businesses.

A number of these stocks have corrected sharply year to date, particularly in South Korea and Taiwan. More interestingly, there has now been substantial weakness in genuine regional AI leaders and this is creating an interesting set up for longer-term investors.

In summary, markets have been volatile year-to-date and geopolitical headlines continue to buffer sentiment. This environment is likely to persist. While unsettling on a day-to-day basis, this volatility can create an interesting opportunity set for disciplined bottom-up investors.