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You recently attended the Bank Credit Analyst conference in New York. What did you take from it?
Firstly, the US economy is growing well – very few disagreed with that.
Secondly, numerous leading analysts affirmed that Europe is on the road to recovery with plenty of ammunition in terms of quantitative easing to stimulate the economy.
Thirdly, there was huge disagreement on China’s influence on the global economy.
Any interesting comments about the US economy?
The predominant view was that no inflation is coming through the system.
One prominent analyst argued, in fact, that there is considerably more deflationary risk than inflationary risk and that the 10-year Treasury rate could well decline to 1.5% from the current level of 2.2%.
There was broad consensus that there was little reason for the Fed to raise interest rates.
Others were scathing that few on Capitol Hill, including the president, are serious about co-ordinating fiscal and monetary policy; a major obstacle to the normalisation of monetary policy, getting interest rates back up, and underpinning further economic growth.
How big is the China issue?
Huge. Firstly because of its extreme importance in the global economy; and secondly because it is widely felt that growth is considerably lower than the official figure.
In 2001 China’s contribution to the global economy was 7%; today it is 17% and bigger than the US, adjusted for purchasing power.
But there’s a broad view that current growth is around 4% compared with the official figure of 6.6%.
Do you buy that?
Yes, we have suspected it for three or four years. I was initially influenced by Michael Pettis, professor at Peking University.
Many in the market thought that Pettis’ view at the time was rather radical.
It became apparent to me then that China’s transition was going to be negative for commodity prices.
Simply, the bubble in commodity prices was going to burst and the high level of real prices had a long way to fall in the context of mean reversion.
This was one of the major reasons behind my selling down the Investors’ Fund’s mining exposure a few years ago.
On what basis have you adopted this view?
Most immediate perhaps is the transformation of the Chinese economy from an investment-led economy to a consumer-led economy.
The same occurred in Japan. It is a difficult process and a lot of the debate now is whether China is going to be able to manage this in an orderly way or worse.
What are the chances of China muddling through?
I think reasonable and I still see a lot of potential in China, but the growth drivers over the next few years will be different.
Graham Bell, our strategist, recently spent some time in China and this has provided an interesting and personal perspective for us.
For instance, the generation of intellectual capital in the high growth city areas is impressive, but the educational spend in the rural areas still lags.
Intellectual capital stock per capita is much lower than in, say, Japan, South Korea, Taiwan and Singapore.
There has been no effective freeing up of banking. It’s said that non-performing loans run at about 1.5%, but the reality is that it’s probably closer to 8%.
Borrowers have limited access to equity or bond finance, unlike in developed economies.
Bankers are very cautious to lend and act in fear of contravening the spirit of the anti-corruption drive and this is holding back investment.
Small- and medium-sized enterprises in particular have limited access to credit at above-market interest rates.
Is the 4% economic growth priced into other emerging markets, including SA?
That’s the million dollar question. There is considerable disparity by sector.
There are people who think that aggregate growth is 6% or higher; there are others who consider it to be a lot lower.
I would argue that the services sector is probably growing around 8% and the manufacturing sector at a negative 5% or so.
The data we look at just does not back up the official data and we see overall growth closer to 4%.
How would you translate this in terms of commodities?
The Chinese challenges, the global growth rate below 3.5%, and excess supply does not provide much upside support to commodity prices in the short term.
We are seeing a few improvements on the supply side, with some capacity closures in copper and zinc, but overall not enough to materially swing the balance yet.
We still have a low exposure to mining through BHP Billiton, which has attractive margins in iron ore and is the best-positioned of the miners to pay an attractive dividend.
This article originally appeared in the 10 December 2015 edition of finweek. Buy and download the magazine here.
