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climbing the great wall of worry

july 2020

It may come as a surprise to some readers that the world’s top performing major stock market this year is China. Per the chart below, MSCI China is up 24.7% year-to-date in Canadian dollar terms; versus -5.5% and 1.0% for MSCI EAFE and MSCI Emerging Markets respectively. With a global pandemic originating in Wuhan, the US taking aim at Chinese capital markets and the heavy-handed implementation of national security laws in Hong Kong drawing international condemnation, one could be forgiven for being slightly puzzled.

Just about every facet of China’s response to the COVID-19 outbreak has faced skepticism and criticism. Chinese authorities have been accused of attempting to cover up the discovery of the virus and then significantly understating the infection and death tallies thereafter. In February, China’s rigid lockdown measures were deemed “draconian” by Western news media. Irrespective of the legitimacy of the data, China did a remarkable job stopping the spread of the virus, especially considering the sheer size and density of the population. From a timing perspective, China was able to re-start economic activity as the rest of the world went into lockdown. This has provided the nation with a significant head start despite the ongoing hit to export demand.

Any inkling of positive momentum in the relationship between the US and China emanating from the “phase one” trade deal signed in January has now vanished. The US has remained on the offensive from a number of different angles, including pressuring allies to abandon using Huawei for 5G development, placing export restrictions on critical US technology and components, taking steps towards delisting Chinese companies from US stock exchanges and demanding that major US pension plans liquidate or avoid Chinese assets. However, these aggressive actions have spurred constructive responses from Chinese companies and policymakers. State-owned funds are making significant investments in domestic semiconductor manufacturers such as SMIC, which is simultaneously planning the largest IPO on the Shanghai Stock Exchange in a decade. Bellwether Chinese companies currently listed in the US are proactively initiating listings in Hong Kong. Additionally, capital market reform has accelerated, with regulators streamlining equity financing rules.

China has been widely condemned for its unilateral imposition of national security laws in Hong Kong, which effectively undercut the city’s autonomy and the “one country, two systems” doctrine. Already, the US is removing the city’s special trading status and fears are mounting in the financial community that Hong Kong will lose its status as Asia’s premier financial hub. Socio-political considerations aside, the economic risks to Hong Kong may be overstated. China has taken “ownership” of the instability in Hong Kong, which should ultimately lower geopolitical risk and ease mainland investors’ nerves. The city remains a critical financial gateway from and into mainland China, and the aforementioned flow of blue chip H-share listings should serve to reinforce that status.

As can be seen above, simply judging China by the headline risks frequently cited in financial news media leaves one well adrift of the big picture. As we have stated on numerous occasions, China is a policy-driven market (for a more comprehensive summary of our views on China, please see Special Report – Ask Forstrong: Postcard From China). And while monetary and fiscal stimulus has not been as forceful as other major economies, Chinese policymakers are nonetheless erring on the side of caution. We remain invested in the current Chinese bull market, but are closely watching for signs of froth to emerge.

GLOBAL STRATEGY OVERVIEW

Cash

Despite recovering some of their year-to-date losses, most emerging markets currencies remain oversold and offer attractive carry versus their developed market peers. We are overweight EM currencies in client portfolios.

Bonds

Yield curves in major economies around the world have flattened considerably as growth and inflation expectations have collapsed amidst COVID-19 economic shutdowns, putting considerable downwards pressure on longer-dated securities. In our view, long term bonds are not currently providing adequate compensation for their increased interest rate risk (duration) relative to shorter term bonds. Fixed income duration has been positioned well below benchmark in client portfolios.

Equities

We expect policymakers to continue to err on the side of caution as major economies gradually re-open and consumers and businesses attempt to find their respective footings. Significant monetary and fiscal stimulus should continue to support equity prices, but with deteriorating fundamentals and the likelihood of a bumpy road to recovery, we have elected to modestly scale back our overweight positioning.

Opportunities

Despite the US unemployment rate climbing into double-digits, there are numerous reasons to remain constructive on the health of the US consumer. A large number of terminated employees have informal agreements to be re-hired once activity resumes and many have enjoyed higher incomes while being kept off of payrolls. As a result, household savings rates have surged and consumer demand should be well-supported. With so much time at home and falling mortgage rates, we expect demand for new homes and renovations to flourish. We have taken exposure to US homebuilders to capitalize on these trends.

Gross-of-fees performance ($CAD) as of June 30, 2020. Returns for periods greater than 1 year are annualized.
Performance statistics for ETF Managed Portfolios are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Past performance is no indication of future results. A rate of return for one year or less is not annualized.

David Kletz

Vice President, Portfolio Manager

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