Newton fears China recession, Japan outflows
There are warning signs that China is headed for a recession, while Asian equities could be set to benefit from a huge capital inflow from Japanese investors, says Newton Investment Management.
Newton, a London-based boutique owned by BNY Mellon, has around $83 billion in assets under management, of which its Asia Pacific equity strategy accounts for $10 billion.
Jason Pidcock, head of Asia Pacific ex-Japan equities, says he has become far more cautious on the outlook for China’s economy. In the third week of May the firm increased cash levels in its core Asian equity fund – Newton Oriental – from 1% to 7%, their highest since 2008. It has not reinvested this yet, on the grounds that China may be about to unravel.
Pidcock argues that profit growth on a lot of listed Chinese firms is paltry, while the point at which the Shanghai interbank offered rate (Shibor) spiked up last month sounded a stark warning, reminiscent of the situation the US faced in 2007.
“I guess for a long time we were aware of the imbalances in China, the overinvestment and overcapacity in many industries,” he tells AsianInvestor from the firm’s London office.
“It has been very easy to access credit, so a lot of companies are not very profitable. If companies do not have the incentive to invest because they are not very profitable, at some point they won’t.
“They were only doing so because credit was easy, but at some point that does not get rolled over. When Shibor rates spiked, it felt to us as a similar moment for China as the US faced in the summer of 2007. That was a warning that things had gone as far as they could.
“Even though Shibor rates have come down a bit since, the cat is out of the bag. Obtaining credit won’t be as easy going forward and the mid-tier banks will probably struggle to roll things over to get access to credit themselves.”
Pidcock points to overdevelopment in China’s property sector – including residential, shopping malls and office blocks – which he says has been a large driver of growth hitherto but which he expects to struggle for funding from now on.
While he concedes earnings for property developers in China have been strong, he notes that demand could evaporate quickly. “Because of capital controls a lot of Chinese people have put money they have earned into properties that no one lives in,” he notes. “They think it is a store of value. That is why you see so much vacant property in China. But that kind of speculation can disappear overnight.”
As a result he does not like either the property or banking sectors, on the grounds that even a modest pick-up in non-performing loans could see equity in banks wiped out. “We don’t know if the banks are worth anything more than zero,” he says.
Based on the view that China is vulnerable, Pidcock is cautious on other countries in Asia, even though he acknowledges that some are in good shape economically.
“The Philippines does look terrific, and Malaysia and Thailand look pretty good too, while Indonesia looks ok,” he says. “The next tier of Korea, India and Taiwan do not look as good. But there will be this sentiment effect if China is seen to be undergoing a bit of a crunch.”
All of Newton’s exposure to Chinese equities is through the H-share market, and Pidcock confirms it is selling at the margins while selectively adding stocks in Southeast Asia, particularly in telecoms.
Sounding a further warning, he also voices concern about monetary debasement in Japan, which he says could get out of hand quickly if Japanese investors lose confidence in the currency.
“I think central bankers around the world need to fulfil the promise that was explained, as emergency measures cannot last indefinitely," he says. "Otherwise the distortions they create will sap their credibility.
“There is now scope for a huge capital flow from Japan. I imagine a fair chunk would go to US Treasuries, but I would also expect a slice of it at least to go into high-yielding equities elsewhere in Asia.”