Global Outlook: Value emerging in the renminbi

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on July 30, 2018 - August 05, 2018.
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The renminbi is expected to outperform in the longer term due to factors such as the gradual liberalisation of the currency, according to Reema Desai, head of multi-asset investment specialists at Amundi Asset Management in London.

Desai, who is in charge of the firm’s balanced, income and real return portfolio, finds value in the Chinese currency after it fell against the US dollar. That is despite the renminbi’s vulnerability to capital outflows if it were to weaken further. The value of the onshore and offshore renminbi had weakened about 4% against the US dollar year to date (as at July 19).

The China government and its central bank have been loosening their grip on the renminbi by allowing market forces to determine its strength, says Desai. If this continues, the renminbi will be more attractive to international investors and be more widely adopted globally.

“The renminbi has weakened since the beginning of the year and we expected the Chinese government to intervene. But they have not done so,” she says.

The opening up of China’s financial markets could attract new inflows, and this would provide support to the renminbi. In March, Bloomberg announced that it would include China bonds in the

Bloomberg Barclays Global Aggregate Bond Index — a process that would start in April next year and take 20 months to complete.

Desai says China had shown its willingness to cooperate with the US and other countries when the trade war scenario unfolded over the past few years. “Some may think it is hard to be positive in China, but we are looking at what it has done right, particularly on reforms,” she adds.

Desai says the Chinese government is steering the economy in the right direction. One example is how the government and central bank have been tightening regulations in the country’s shadow banking sector.

The People’s Bank of China’s decision to cut the reserve requirement ratio (RRR) last month is expected to pump another US$108 billion into the market at a time when the country is embarking on its corporate deleveraging efforts. However, some market players see this as a negative sign, saying that the central bank has started easing its monetary policy again and the country’s deleveraging process will not go through.

Desai says the RRR cut is seen as a good move by China’s central bank to avoid a liquidity crunch in the market amid a US-China trade war and ongoing corporate deleveraging. “China’s credit growth has slowed recently as the government transitions to higher quality and sustainable growth. We note that the growth in the shadow banking sector has slowed considerably.

“Meanwhile, the Chinese government has several tools at its disposal to provide the required support [to small and medium enterprises] amid a trade war and corporate deleveraging process. The recently implemented RRR cut is one such instance.”

Desai says the ringgit also appears attractive. But the political uncertainties have made investors cautious about it. “Malaysia is a good investment opportunity as the country has a current account surplus. It is also supported by oil prices, which have stabilised at higher levels without many negative catalysts to pull prices down. However, the uncertainty over the new government’s policies has resulted in us taking a cautious position.”


Finding value while turning defensive

Desai advises investors to be more defensive and conservative going forward. She says economic activity globally, as measured by the Purchasing Managers’ Index, is still expanding, but the growth has slowed in some of the world’s biggest economies, including China, the eurozone and the US. This is also happening in some emerging markets. “Fundamentally speaking, while global growth remains in expansion territory, growth may have peaked,” she says.

There is also a US-China trade war currently playing out in the market. The US slapped a 25% tariff worth US$34 billion on Chinese high-technology goods this month and China retaliated by imposing tariffs on 545 US goods that are of the same value.

Desai says the trade war could crimp global growth and cause a higher-than-expected inflation rate. If the US Federal Reserve hikes interest rates faster than expected, the markets could be disrupted.

“Already, the US market is close to full employment and this is expected to result in upward pressure on wages. Moreover, a trade war could eventually make things more expensive in the country,” says Desai.

She adds that the US inflation rate could rise drastically if President Donald Trump followed through on his announcement of a 25% tariff on all imported cars. “The tariff, in general, could be inflationary as it may be hard to find substitutes in the near term.”

There are already news reports pointing out that the imposition of tariffs on imported cars will cost US taxpayers US$45 billion, wiping out all the benefits provided by the recent tax cut to the low and middle-income groups in the country. It could also cause countries that export a large number of cars to the US to retaliate, exacerbating the rising inflation and interest rates.

There are other repercussions when the Fed is forced to raise interest rates faster. Countries that have a high level of US dollar debt will also be forced to increase their interest rates. This could hurt the economic growth and corporate earnings of these countries as borrowing costs increase. Indonesia and the Philippines are two examples of this, says Desai.

She says these are the reasons the Amundi team in London, which is in charge of the balanced investment portfolio, is moving its investments away from cyclical sectors to defensive ones. “We have increased our exposure to utility companies, for instance. We are trying to be more defensive and build a less cyclical investment portfolio,” she adds.

“Some of the cyclical sectors that are exposed to global trade have not been performing well amid speculation of protectionist policies. It is time for us to be more wary of such sectors.”

However, there are stocks that are worth buying from a bottom-up perspective. These companies have strong fundamentals and are relatively cheap.

Desai says some building material companies are poised to benefit from the expanding global economy. The price of commodities linked to these materials have also been stable, providing these companies with steady cash flows and enabling them to pay out dividends consistently.

She also favours some banks in China, which are benefiting from the country’s deleveraging process. The quality of the banks’ books has improved and valuations are relatively attractive.

“We see compelling investment opportunities within the banking sector in other Asian countries as well. Their balance sheets are healthier after provisioning for poor quality loans to underperforming sectors,” says Desai.

However, the automotive and consumer discretionary sectors are deemed unfavourable due to the US-China trade war that is still playing out. The earnings and share prices of some companies would undoubtedly be impacted.

The US high-yield bond market is another space investors should beware of, says Desai. “We have been wary of certain sectors within the market, such as the energy sector, where there have been significant releveraging activities since the 2008 global financial crisis.”


Long-short play on expectations of steepening yield curve

Amundi is deploying several long-short plays to benefit from the yield curve movement and rising inflation rate in the US going forward, says Desai. These plays involve the use of derivatives and can only be executed by professional fund managers with the necessary knowledge and fund houses that have sufficient capital and access to such derivative contracts.

One example is to long the two-year US Treasuries and short the 10-year US Treasuries as the yield curve between the two securities is expected to steepen on the back of robust economic growth. “We know the yield curve has been remarkably flat even though the US economy is growing above its potential. Economically, it is a bit hard to understand why, especially when the labour markets are tight,” says Desai.

“We believe that as inflationary expectations get priced in, the yield curve should steepen with long-term yields moving higher than short-term ones. As bond prices are inversely proportional to yields, we maintain a relative value trade with a long position on the two-year Treasuries and a short position on the 10-year Treasuries to take advantage of the steepening yield curve,” she adds.