Q3 2023 Market Updates: A Divided Market

From the moment Russia invaded Ukraine, the world has been split into two separate factions, the west and its allies and those who are not. Given the polarizing geopolitical environment, both governments and businesses are starting to shift their policies and business models in an attempt to de-risk the impact of future unforeseen political events.

As a result of this shift, three big trends have materialized which has resulted in a fundamental shift in the long-term contribution of the Asia region's and global economic growth.

1. “De-risking” from China, further forcing China’s progress up the value chain

2. Step up in the role of other emerging countries to fill the gap left behind by China

3. BRICS+ and reduce reliance on USD

I will briefly talk about each of these trends for this quarterly update and what this means for our portfolio moving forward.

1. "De-Risking" From China

From de-coupling to de-risking, Western politicians and their allies have now taken active measures and implemented protectionism and anti-competitive policies in an attempt to interfere and slow down China’s economic progress in the name of “national security”.

In particular, the western bloc has concentrated its efforts to reduce its reliance and exposure on China’s supply chain as well as to limit China’s ability to trade freely in the international market for semiconductors.

While the measures are questionable from the Western economic perspective, it is an easy win for the politicians to score political points and improve their ratings especially with the US presidential elections coming up in November 2024.

On China’s side, it has resulted in unwanted economic disruption and the government has recognized the need to shift its economic model which is what they are currently doing - while balancing an ongoing property crisis.

The de-risking efforts would now mean that China will have to pick up the gaps that are being limited and restricted by the Western bloc which essentially forced them to innovate and provide for themselves without relying on the international market.

Impact on our portfolio: While the Chinese government understood the weakness in their infrastructure-led economic model, the urgency and catalyst for change has never been present.

With the economic hostility from the West and the ongoing property crisis, it is a good time for the government to force a change in its current infrastructure-led economy to a consumer-led economic model while moving its global manufacturing capabilities up the value chain.

That being said, as an investor, while I am confident in the Chinese’s ability to overcome this obstacle, there will be a price to pay in the short run which I doubt the international investing community will be able to stomach (as we’ve seen from the price action). As such, I’ve decided to lower our portfolio allocation towards China to reduce the overall portfolio risk and volatility.

In the long term however, if China can develop itself to compete up the value chain while unlocking its consumer base, I have no doubts that the economy will continue to enjoy a more sustainable economic growth as compared to the ones they are experiencing today.

2. Increasing Importance Of Emerging Asia

Riding on the previous point on de-risking from China, ironically, for the West to be able to de-risk from China without incurring a high degree of inflation driven by cost pressures, they will still have to offshore their manufacturing capabilities to other low-cost countries.

As a result, emerging countries within Asia (I.e., Vietnam, India, Bangladesh and Thailand) and even emerging countries within North America (i.e., Mexico) are benefiting from the manufacturing that is shifted away from China. This will further accelerate the economic development of these countries as they get to enjoy higher economic growth from the businesses flowing out of China and into their countries.

That being said, shifting the supply chain away from China is easier said than done as these emerging countries will require more time to build up a similar level of supply chain capabilities, and develop the right talents and working culture. We’ve seen this with the recent manufacturing woes that companies such as Apple faced in an attempt to shift part of their production to another emerging Asia.

Implication on our portfolio: While the problem of de-risking still exists for businesses around the world, it is an inevitable trend and a new reality. That said, in the long run, I foresee that Emerging Asia will contribute a larger share of Asia’s economic growth while China’s contribution slows.

As such, as part of the de-risking trend and the increasing importance of Emerging Asia, I’ve decided to allocate part of China’s allocation to other countries that stand to benefit from the trend itself.

3. Formation of BRICS+

The third prominent trend that has materialised since 2022 is the formation of the BRICS+ and the move of de-risking from the United States Dollar among other emerging countries.

As of 1st January 2024, 6 countries will be joining the BRICS and they are Argentina, Egypt, Ethiopia, Iran, Saudi Arabia and the United Arab Emirates. Each of these countries brings to the table different competitive advantages ranging from natural resources, financial, infrastructure and manufacturing capabilities, which if played out well, will be a major plus for all players in the bloc itself.

That said, the key motivation for these countries - each with their fair share of problems and conflicts with one another - to come together lies in their collective desire to reduce their reliance on the United States Dollar and boost trade among each other with their currencies.

Since the start of the Russian-Ukraine war and the unwavering stance of the developed countries to raise interest rates and maintain them at a high level until inflation comes back down, the strength of the USD has become a blessing for the US markets and a curse to the other emerging markets.

With a newfound fear of being at the mercy of the United States government weaponizing their currency (as seen from Russia’s case) and the economic pain associated with being too reliant and exposed to the USD, these countries now have an economic incentive - one that is strong enough to look past their political differences - to come together and form the BRICS+ alliance in hopes of improving their situation.

Implication on our portfolio: If the BRCIS+ can set aside their differences and work together, it will be a major catalyst for change in the current world order from a US-led world order to one that is more balanced across the developed and developing countries.

That being said, it is unlikely that we will see the positive implication of the formation of BRICS+ in the short run as it is easier said than done to set aside the differences - especially on the world stage. In the long run, however, only time will tell.

Daniel is a Licensed Independent Financial Consultant with MAS and a Certified Financial Planner (CFP®).

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Disclaimer:

This article is meant to be the opinion of the author

This article is for information purposes only

This article should not be seen as financial advice

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