Under The Macroscope

Christy Tan (Host): Hi, this is Christy Tan, Investment Strategist with Franklin Templeton Institute. Thank you for tuning in to this episode of Under the Macroscope. Today, we'll be delving into the ins and outs of multi-asset investing, and joining us as our special guest is Subash Pillai, the APAC Regional Head of Client Investment Solutions here at Franklin Templeton.

Welcome Subash, and let's get right to it. Now, you specialise in multi-asset portfolio solutions. With the interest rate environment now, how does multi-assets come into play in investor’s portfolio?

Subash Pillai (Guest): Christy, thanks so much for having me on.

So, you know, firstly I think multi-assets’ definitely in the area where investors are focused on. The income suite within multi asset is sought after because of you know higher interest rates, higher inflation. It’s a way to supplement your income. It’s a way to earn sufficiently if you’re a levered investor to support your borrowings against your investment portfolio.

I think this is an environment that’s likely to continue as well over the next decade.

Host: Speaking about the decade, we are certainly living in an exciting era, or rather complex environment now. How do you see a multi-asset portfolio set up to navigate this environment?

Guest: Yeah, it's been a very exciting time for us. I think there are two key dynamics going on in the market right now. So firstly, I think you've got a very complex macroeconomic environment. And what a multi asset portfolio gives an investor the opportunity to do is to basically have a dynamic manager. They can affect changes in their asset allocation a lot faster investing in a multi asset style portfolio, and in an environment like we've had with so much volatility, you know, I think they see the benefit in that.

Second, the second kind of key dynamic, as I see it, and this is more around the multi asset income space is you do have a challenge. Yes, I know inflation is moderating, but it is still much higher than most people have experienced in in the last couple of decades and equally importantly, interest rates remain very high. So that is an important impact on investors. So, if you're just investing your spare capital, well, it's good if you're actually earning an income on that, that can help you meet those higher bills. We all know inflation here in Singapore got to well above 5%, that's going to be useful.

So, what a multi asset income capability or strategy does is it typically delivers a level of distribution that is much greater than what you would get, say, as the just the normal dividend yield on an equity portfolio and this can help investors have the cash to basically satisfy those borrowing costs. So, I think those are the two key dynamics driving investor behaviour right now.

Host: That’s really interesting, and it ties in with what you mentioned at the start of our conversation that, investors who are leveraged need to consider this kind of income they want to be delivered from a multi-asset portfolio.

Now, let us pivot our conversation to diversification and correlation between asset classes. We know the static 60/40 allocation didn’t turn out well last year. So, how would that be different in a multi-asset portfolio?

Guest: Yeah, so within a diversified multi asset portfolio, what you're accessing is not just that simplistic diversification dynamic of: oh, well I have more equities and less fixed income or more fixed income and less equities. That's kind of the first stage of diversification. Now that's a very important stage of diversification. But it can let you down, as was the case in 2022.

There are other important methods of diversification if you want to be more 3 dimensional in your diversification. So, within your defensive assets, in an environment like we had in 2022 where you are seeing inflation surging, well, long-dated bonds are not so defensive anymore. You would be well placed to actually be allocating to the front end of the yield curve, where you are not going to suffer the same degree of capital erosion as you will when interest rates rise. So that's a way that you can diversify even within fixed income.

Similarly, if I think about equities as a, you know, a large part of the growth component of anybody's portfolio, there are going to be different sectors that show different interest rate sensitivity. There are going to be different sectors that show more or less pricing power in an inflationary environment. And you, really, in that inflationary environment, for example, you want to be more exposed to those companies with less interest rate sensitivity and stronger pricing power. And that's a way that you can diversify even within your growth assets. So really you know what a multi asset strategy allows investors to do is to get that multifaceted diversification.

Host: 3-dimensional diversification; actively managing the allocation within the asset class itself. That’s a good one! Well, in this volatile condition, it would make sense for unconventional approach to multi-asset investing.

On that note, thank you Subash for the great insights and advice. And to all our listeners, this is Under the Macroscope. I am Christy Tan, Investment Strategist, Franklin Templeton Institute.

 Christy Tan (Host): Hi, this is Christy Tan, Investment Strategist with Franklin Templeton Institute. Thank you for tuning in to the seventh episode of Under the Macroscope. In this episode, we will be talking about Japan – loved by tourists but not so much by investors! This time round, we have our fourth guest on this podcast – Hsung, Vice-President of the Global Equity Group and Portfolio Manager for our Japan Strategy.

To start off Hsung, what are the three most pertinent points you want our listeners to pay attention to today?

Hsung Khoo (Guest): Sure, thanks for having me on this podcast, Christy.

The three points are:

Number 1 – It is time to take Japanese equities seriously, after 30 years of neglect by global investors. Number 2 – Inflation is returning to Japan.

Number 3 – Corporate reforms have reached a tipping point.

Now, let me start with my first point, and that is Japanese equities has been a neglected asset class for the past three decades. Japan’s weight has fallen to around 5% of, on the MSCI World Index from 40% back in 1987. Japanese equities trade at a significant discount to developed market peers. This comes down to two reasons. Firstly, earnings growth outlook has been poor as Japan was in deflation. Secondly, corporate Japan lacks a focus on shareholders’ interests. For example, Japanese companies have notoriously low return on equity, or ROE.

Japanese equities can provide portfolio diversification in an era of geopolitical rivalry between U.S. and China. It is a large and liquid stock market with improving corporate governance.

Host: Now, let’s address your second and most important point – inflation. How does this benefit corporate earnings in Japan?

Guest: Well, inflation helps earnings in two ways. Price increases raises the revenue growth potential for businesses. Profit margins also tend to expand with higher revenue growth. Most businesses have a reasonable degree of fixed costs. So, revenue growth generally outpaces cost in an inflationary environment.

Host: Well, there have always been false dawns in the past, so how is it different this time? In your opinion, is this inflation sustainable?

Guest: That’s a great question, Christy. What is different this time is that an inflation cycle is in motion. Companies have regained confidence in raising prices and households are accepting higher prices. Most importantly, wages are rising at the fastest pace in thirty years. Rising wages is the key to sustainable inflation. Companies are no longer able to suppress wages as labour market is very tight. Japan has an ageing and shrinking population. It has also run out of slack labour.

Here's a pop quiz! What do you think is the female labour participation rate in Japan?

Host: A wild guess from me, around… 70%?

Guest: You got it! It’s close to 75%¹. That is higher than in the U.S!

Host: Wow, in that case, everyone can see how this will translate into sustainable inflation trend going forward. Your third point on corporate reforms is very interesting as well. Please unpack for our listeners, why and how is this a game changer?

Guest: The lack of focus on shareholder interests in Japan has been a key reason for the valuation discount to developed market peers. Half of the listed companies trade at below book value. Most of these companies are in a net cash position. The scale of potential value to be unlocked is game changing for Japanese equities.

Host: That is quite a number of listed companies trading below book value. I can see why you think Japan is at a tipping point of its corporate reforms journey, but please elaborate!

Guest: So, the journey began ten years ago with the introduction of the corporate governance code.

Since then, dividends and share buybacks have been steadily improving. Today, Japan is 2nd only to the US in the number of activist shareholder campaigns.

Sony and Hitachi are examples of successful corporate reforms. These companies have generated strong returns for their shareholders. They are returning excess capital to shareholders, exiting unattractive businesses, and deploying capital towards more profitable businesses.

The institutional pressure to focus on shareholder interests stepped up further this spring. The Tokyo Stock Exchange requested listed companies that trade below book value to provide an action plan aimed at improving their market valuation and return on equity.

As half of the listed Japanese companies trade at below book value, the corporate reform movement has now gone mainstream. Investors should seize the opportunity to engage with companies on the best way forward to unlock shareholder value.

Host: I think it’s really an exciting time for Japanese equities with these corporate reforms in the works.

To conclude, in your opinion, how should investors be positioning themselves to seize these attractive opportunities in Japan? (The information provided is not a recommendation to purchase, sell, or hold any particular security.)

Guest: Yes. I think the most attractive opportunities are likely to be under-represented in the index. Active management is a better way to capture the unique investment opportunities in Japan.

Host: On that constructive note, thank you Hsung for the great insights and advice. And to all our listeners, this is Under the Macroscope. I am Christy Tan, Investment Strategist, Franklin Templeton Institute.

¹Source: Ministry of Internal Affairs and Communications, Citi research, June 2023 

Christy Tan (Host) : Hi, this is Christy Tan, Investment Strategist with Franklin Templeton Institute. Thank you for tuning in to the sixth episode of Under the Macroscope. In this episode, China will be once again, under the macroscope. This time around, we have a special guest with us from Shanghai, Xu Lirong, the Chief Investment Officer of Franklin Templeton Sealand Fund Management who will give us his local insights about this vast country.

Morning, Lirong, thank you for joining me today! Now, I've recently argued in my article, “China’s Consumption Triangle”, that its domestic consumption is the biggest upside opportunity in the next 6 to 12 months. Now I know that many people may disagree with me because the recent macro data has been disappointing, but I think a large part of it is because of patchy consumer confidence. But I'm confident as well that signs are pointing to more stimulus measures underway with government agencies working together to support some of the key sectors in order to boost domestic confidence and consumption. Compared to six months ago, I think that, now, the government has put in place more supportive measures. I also believe that the recent market movements have been due to a mismatch in investors’ expectations – they are getting impatient about China’s recovery post-COVID reopening.

So, let’s start with a couple of  pertinent points you want our listeners to pay attention to in China’s investment landscape.

Xu Lirong (Guest) : Yeah, I think first, you're right that in the mid to long-term, consumption will be the key driver of the Chinese economic recovery. But before that, people have to wait more patiently for consumption to recover.

And the second thing is, I do think the Chinese government will deliver some kind of policy to support the economy, but the key word here is to “support”, not a stimulus. As a stock picker who observes things from a bottom-up approach, I do think this recovery – although it is slow – will be more consistent and more stable. This means that it's not just for one or two years, but possibly the next three to five years. These are all good things for China’s economy as a whole, as well as the capital markets. In short, in the mid to long-term, I'm still quite bullish about the China economy and also the stock markets, for both A-Shares and H-Shares.

Host : Thank you, and I think you brought up some very interesting points as a bottom-up stock picker. You do have that assurance that the Chinese economy, in the medium to long-term will be consistent and stable, so with these growth prospects I think consumers and investors have to display a little bit of patience. What are the sectors that you think will be constructive?

Guest : As we are bottom-up investors, we don't pick the sectors, we pick the companies. But generally speaking, I would see the manufacturing sector as kind of undervalued by the investors, in general. And the reason is, firstly, most industrial companies or manufacturing companies, most leading companies in different sectors, are listed in the China A-Shares market and not in H-Shares or in New York. So, this means that foreign investors are less familiar with them.

And the second thing is, I think China’s economy right now is entering into a new stage, which is the most favourable for those sector leaders, because the concentration ratio in almost every sectors are beginning to increase. So that means as a sector leader, you can still maintain your ROE (return on equity), or even increase your ROE (return on equity), while enlarging your market share.

Host : Right, and going forward, let's say we are looking at the recovery in China. You've traveled across Asia. In your recent experience within this region, how do you think investors are positioning for Chinese financial markets or Chinese A-Shares and how do you think they should position themselves with regards to Chinese A-Shares?

Guest : So, my point is, when I talk to clients in the Asia area, I get a few impressions (made a few observations). Firstly, right now all over the world in almost every country or area outside the US, they want to bet on both sides. This means that they don't only want to invest in China. Most of them are more reliant on, or invest heavily in the US, partly because of the traditional patterns, the strong U.S. dollar and the strong US stock market. But right now, I think there is increasing interest in investing in China, even though people are still watching. They are very interested, but many of them are still waiting because of what we discussed earlier – they are kind of frustrated that their expectations haven’t been met. I would suggest first, looking at the next decade or the next 15 years – China will still be one of the faster growth areas. In addition, Chinese markets including A-Shares and H-Shares will be the best place to chase alpha. The best part is, the Chinese stock market, especially the A-Share market, has quite a low correlation with the world's equity market. This means that even from an asset allocation perspective, global investors should have some kind of allocation to China.

When we talk about China, many people look at China as some kind of remote area, especially after what happened in the last three years. However, you need time to research and find out what really happened, such as on-the-ground research and the visiting and, you know, studying all the things. I think if you have done that, you will find that many of the investors outside China are kind of misguided because of the information they receive. So, I strongly encourage any investors who are interested in investing in China, to visit China’s different areas, such as the middle eastern area and the coastal area. You will then get (make) the conclusion by yourself.

Host : When we talk about opportunities, we cannot avoid talking about risks. What do you think are the biggest risks or headwinds for Chinese equities, and at the same time, how do you think you will advise investors to manage it?

Guest : I think from my perspective, if we think a little bit mid to longer term when investing in the Chinese market, I do think the key risk is still the geopolitical risk. But having said that, we have to face the reality that the next decade or next two decades is a different world compared to the last two decades. So that's just the reality.

So, I think to manage that kind of risk from an investors’ perspective, I would think or suggest an asset allocation, where you allocate some position to Greater China or to China. This is so that your position is counted in your overall risk evaluation of your whole investment (portfolio). So, from that perspective you may not need to worry too much about that.

And other risks, I think from the foreign investor perspective, I imagine many of them think about policy risks, for example what happened in last three years.  But for next decade or maybe next two decades, Chinese GDP will be relatively stable.

So that means, to make money or to find growth opportunities is not that easy as compared to the last decade. So that means you need to do more homework, not just study the industry policies and all that. And even if you can do that well, you can still miss the good opportunities. And so that's the reason I suggested my earlier point of on-the-ground research.

The last thing I want to mention is the volatility. The volatility of the Chinese market, A-Share market, and H-Share market, especially during last two years is relatively higher. The China A-Share market is a little bit momentum-driven and a retail-driven market, so that makes volatility a little bit higher as well. So, to manage that risk, I would suggest the investor to remain relatively mid to long-term. In that perspective, these volatilities may be friends of yours.

Host : So, spending time in the market rather than timing the market, as well as to ride out the volatility to get the returns and the rewards that are, you know, important, right? OK, perhaps just one last point. For investors who are not familiar with China, what should they equip themselves with when investing in China?

Guest : I would think firstly, it would be common sense.

And secondly, keep an open mind. I mean, we are living in a very diversified world, right? There are many different kinds of people and different kinds of culture. So, if some people or some areas or some countries, do things is a different way than yours, that doesn't mean they're wrong, right? So, try to be open-minded and not be biased.

For the last thing, I'm a stock-picker. So, when I pick the companies, I do think that one of the most important things is to meet the company on the ground: to visit the people, talk to them and get a full picture of the company. So, regarding China, if you invest in China as a relatively longer-term investor and are serious about it, you should visit the companies on-the-ground more frequently. Then, you can come to a conclusion by yourself.

Host : Thank you. So, I gather that the three points are, having some common sense when investing, to remove any biases, as well as being on-the-ground.

Guest : Yes.

Host : With that conclusion, thank you Lirong for the great insights and advice. And to all our listeners, this is Under the Macroscope. I am Christy Tan, Investment Strategist, Franklin Templeton Institute.

Christy Tan (Host): Hi, this is Christy Tan, Investment Strategist with Franklin Templeton Institute. Thank you for tuning in to the fifth episode of Under the Macroscope. In this episode, we’ll be discussing the U.S. Fixed Income markets.

Joining me today in Singapore is my second guest for Under the Macroscope podcast series, Sonal, who is Chief Investment Officer of Franklin Templeton Fixed Income.

Welcome, Sonal! Let’s start with the 3 most pertinent points you want our listeners to pay attention to in the U.S. fixed income complex.

Sonal Desai (Guest):  The first one is, the growth outlook is not as poor as markets seem to be pricing.

So, if I look at the US labour market, if I look at the US consumer, I look at US retail sales, all of this point to strength in the labour market, strength of the US economy.

I don't want to sound as if there is never going to be a recession, I just don't think it's going to be as sharp a recession as markets have recently been pricing.

The second point would be that, inflation is sticky. I think people need to just recognize it's sticky. And if you got the type of rate cuts, which the market is pricing, real interest rates would simply not be high enough to maintain lower inflation.

And the third point, I think which people need to recognize is, perhaps over the last decade-and-a-half, people have become very used to a very dovish US Fed. But, there's a big difference right now in that inflation is high. Since the Global Financial Crisis, anytime markets got a little nervous, the Fed would throw a lot of money at the problem.

This time around, I don't think it can. So, that would be the third point.

Host: Great points! During our recent conversations I’ve noted down some important points you made, and this encompasses your prediction that the Fed won’t lower interest rates this year, and the ECB (European Central Bank) and BoJ (Bank of Japan) will maintain their approach of tightening monetary policy.

These predictions are based on your belief that the U.S. and Euro area will experience a mild economic downturn. However, it appears that the current point of contention lies in the market’s differing opinion on this matter.

Guest: But the markets are counting on the idea, to some extent, that Fed rate cuts are going to be needed or the economy is going to have a very steep recession.

However, if the economy does not have that recession, the Fed rate cuts are not needed, and the Fed is going to remain focused on inflation. This is a big change in paradigm relative to the last 15 years.

Host: A big change indeed, and understandably, you are urging investors to place greater focus on security selection in portfolio construction, considering the mismatch between current corporate spread levels and the slowing economic conditions, as well as interest rate volatility.

In your view then, for fixed income investors, what does 2024 bring about, in terms of yield, duration and fixed income opportunities?

Guest: So, if I look ahead to 2024 by then, I do think the Fed hiking cycle is finished. We definitely are, in my mind, set for a very good period for fixed income. I think you have extended duration by then, by 2024, we will have extended our duration. But I think it's also a mistake to think that when duration is extended, this is an anticipation of 300, 400 basis points of rate cuts.

I think fixed income once again takes its place in a portfolio to deliver nice returns, but not equity-nice returns. So it's going to be lower volatility, lower total return than we've become used to (because we've become used to, again in the last 10, 15 years, getting equity-like returns from fixed income). And I think that is not going to happen.

And look at yields you know; I think we might go through an extended period of time where you get decent yields from fixed income. You get decent income from fixed income, which again, we haven't had for a long time.

So, outlook is good, I would say, for especially for my asset class.

Host: With that constructive conclusion, thank you Sonal for the great insights as always. And to all listeners, this is Under the Macroscope. I’m Christy Tan, Franklin Templeton Institute.

Note: This interview was recorded on 23 May 2023, before the US Fed FOMC meeting in mid-June 2023. Barring the reference to the market’s expectation of rate cut, the rest of the opinion expressed by Dr. Sonal Desai in this recording remains valid as of the publication date, 14 July 2023.

Christy Tan (Host): Hi, this is Christy Tan, Investment Strategist with the Franklin Templeton Institute.

Thank you for tuning in to the 4th episode of Under the Macroscope where we will be discussing the global sukuk market and the Gulf Cooperation Council (GCC).

Joining me today in Singapore is my first guest for Under the Macroscope series, Dino, who is Chief Investment Officer of Global Sukuk, and the MENA fixed income based in Dubai, welcome Dino!

I would like to take a different tact today by starting with, what are the three most pertinent points you want our listeners to pay attention to in the global sukuk space.

Mohieddine Kronfol (Guest): Hi, good morning, it’s a privilege to be your first guest.

Given that the global sukuk market is also very much exposed to the GCC, I think that’s the 3 recommendations – trust the numbers, check the growth of the GCC and have some confidence in its future.

Host: Short and to the point, I will get back to you on those three points in a couple of minutes.

But first, you've made this bold statement that the global sukuk market will rise to USD 2.3 trillion by 2030¹. Could you elaborate on that, please?

Guest: Yeah, we have an optimistic outlook for the global sukuk market because there are a few really important drivers that are really supporting that growth.

On one hand, you have the growth of the GCC or Gulf Cooperation Council which are issuing a significant amount of bonds and today represent over 20% of the emerging market bond index and many investors continue to be underweight and as that grows, there’s going to be a certain percentage of these issues that are in sukuk format – historically they’ve been about 25%.

Also, the sukuk market has become increasingly mainstream and most investors today are fairly comfortable investing in a sukuk instrument vs a conventional bond.

But honestly, the reason we are most optimistic is because the global sukuk market over the past 10 years has delivered some of the best risk adjusted returns. We’re talking about the highest Sharpe ratio, and we’re talking about the lowest volatility of any major asset class over the past 10 years. And so, we think investors are going to continue to allocate money to those risk factors that deliver the best risk adjusted returns, and so our growth projections to grow from 800b today to about 2.3-2.5 trillion by 2030 implies a 15% annual growth rate.

Host: Thank you. And in this current environment where volatility is elevated and we have a lot of uncertainties surrounding the global growth issues and the US banking sector stress as well as the uncertainties involving China's reopening, I think it's very interesting to see that the sukuk market is still on the growth path.

So how do you see the sukuk markets can actually help to provide optimal risk return profile for investors?

Guest: So yeah, I mean I agree with you. Risk is top of mind today, there are a lot of uncertainties that we have to navigate and we’re probably going to have some elevated volatility. But the thing about the sukuk market that I think is so attractive are its defensive characteristics which we expect to persist. We touched on the lower volatility and that is to a certain extent, a function of the relatively liquid and dedicated investor base. The Islamic financial institutions that continue to support the market. And also, we’re talking about a relatively high-quality market and a relatively lower duration. So, in that context, when you think about lower volatility, you think about important diversification benefits, and you look at a history of smaller drawdowns. These defensive characteristics are going to deliver the type of diversification and portfolio protection that investors should be seeking in this relatively uncertain environment.

Host: So, diving into the different sectors within the sukuk market, do you foresee that the high yield sukuks or the investment grade sukuks that are getting more attractive?

Guest: That’s a great question. When we think about the markets, it is 80% investment grade. It’s high quality and till today, the largest issuers tend to be banks and sovereigns/governments. The bulk of which are investment grade and that is a source of comfort in a way. The way we look at the market right now we think that governments, banks, because there could be instruments of policy and many of the policymakers today want to see their Islamic or shariah compliant business grow, we think they’ll continue to be very important issuers. But, as governments today are making very bold commitments to net zero initiatives and the transition to low carbon, we’re beginning to see energy and utilities companies and some industrials participate in the market. And so, the outlook for the investment grade space is pretty positive. The high yield space is also very attractive, growing quickly, but I think the valuations today and the fact that we are defensive in general when it comes to credit, makes us very selective in that space, and I think we’ll continue to be selective over the coming few quarters.

Host: So, it's interesting that some of the new entrants are probably the contributing factors to the growth in the overall markets and it brings to mind that an even greater active management approach will be the way to go, would you agree?

Guest: Yeah, I mean it’s always been the case. Because historically we’ve had to deal with fairly significant concentrations in the market that we had to try and work around to try and diversify our portfolios as much as possible. Having a global remit, having risk management tools, having a very research-intensive process have all been important contributors. And I think as we go forward, we need to be very selective particularly with respect to high yield because if we look at the broad index, it does look pretty expensive, but within the market there are always opportunities and we continue to hold some high yield exposure but we are making very sure that were getting compensated for the risk, the valuations or the pricing is attractive, but also that they can manage to do relatively well in what we feel are very tight financial conditions and potentially a harder landing in the US as we go forward.

Host: So tying back to what you said in the initial part of our conversation, the three things that you would like our listeners to pay attention to, could you elaborate on that?

Guest: So the first thing I would say is that I would say look at the numbers; trust the numbers. If people were to control their biases and just look at the evidence that adding an allocation to global sukuk really helps reduce the risk of a multi-asset or a global fixed income portfolio, they would make those allocations. That would be the first thing.

The second thing would be to really look at or study what is happening in the GCC right now. This is a part of the world that is really being underpinned by some quite exciting structural reform story. It’s also a defensive allocation and it has managed the pandemic and the reopening a lot better than many parts of the world, at a fraction of the cost. It’s also a very significant and higher quality part of emerging markets that most investors tend to be under allocated to. That would be another recommendation.

The third, possibly tied to both, would really be to have a more balanced outlook on this whole transition to low carbon. I’ve heard recently that people are worried about the future of the GCC because as the world wanes its way away from oil, its future is less bright than other parts of the world, but in our assessment, that’s not true. The GCC is going to be very instrumental in the world’s transition to low carbon, they do have the most efficient production. They are investing in their energy mix, and they are going to be very much part of the story. I think it’s actually a very exciting place to invest in today – given that the global sukuk market is also very much exposed to the GCC, I think that’s an important component.

Host: Thank you, Dino, for your wonderful insights on the global sukuk market and the GCC, it was a pleasure to have you as our first guest today.

Guest: Thank you very much, it’s a pleasure to be here.

Host: And thank you all for tuning into this episode of Under the Macroscope.

This is Christy Tan, Franklin Templeton Institute.

¹Source: Franklin Templeton Fixed Income research as of May 2023

Hi this is Christy Tan, Investment Strategist with Franklin Templeton Institute.

Thank you for tuning in to the third episode of “Under the Macroscope”. Today, I will share my thoughts on China’s economy on the back of my recent research meetings in Beijing.

3 years of isolation: The first country to be hit by Covid-19 pandemic, and the last country to get out of it

For the first time in more than three years, foreign investors can get a true pulse on-the-ground about China from within China; and I am fortunate enough to be one of them. Here are three observations that formed the consumption triangle:

1. China’s domestic consumption is the biggest upside risk
2. China’s new administration may focus on consumption-led growth model
3. Watch out for a greater alignment between government spending and consumer spending

First Observation: The mood on the ground is optimistic, with a tinge of caution

The confidence that China will attain more than 5% GDP growth and that PMI (Purchasing Managers' Index) will stay above 50 this year are strong. However, the caution part comes from the observation that, post-pandemic, while domestic consumption is firmly in the driver’s seat, the foot is not on the accelerator. To put domestic consumption into high gear, policymakers should address a few speedbumps, namely:

• a 20-year high in propensity to save,
• encourage policies that raise household income, and
• support a steady expansion of middle-income groups

China’s gross savings rate is one of the highest in the world (45.5% ¹) and household savings surged by over USD 2.5 trillion in 2022. These are precautionary savings during unprecedented times of “dynamic Zero-covid” policy that forced millions to stay indoors, sometimes for months at a time. Precautionary savings were accumulated by delaying home purchases and withdrawing from the financial markets. I believe that this form of savings will be reduced when savers feel more assured about income and job prospects ahead.

China’s domestic consumption will be the biggest upside risk for overall growth performance in the next 6 to 12 months. Between almost a decade since 2010 (2010 and 2019),

• private consumption as a share of GDP went up to 39% (from 34%), even though household disposable income as a share of GDP barely budged during the same period
• household savings as a share of disposable income also declined from 42% in 2010 to less than 35% in 2019.

Part of this was driven by a strengthened social safety net – government spending on items like healthcare, retirement, and unemployment benefits – encouraging citizens to consume instead of saving for the future or for a medical emergency. We are starting to see some green shoots, based on the recent PBoC’s Urban Depositor Survey. While many Chinese residents are inclined towards more saving, the percentage has fallen, and those that prefer to invest has increased.

Second Observation: China’s new administration may focus on consumption-led growth model

There are signs that the new administration may renew their focus on consumption-led growth model, which will require expanding household disposable income and further strengthening of the social safety net.

China just announced it is reducing tax and fee burden for businesses (by USD 261.6 billion) this year, and the extension of existing tax and fee preferential policies, which are expected to reduce business costs by around USD 173 billion. With this, Beijing has extended tax cuts amounting to 1% of GDP through 2024, with the consumer portion making up almost half of the cuts (about 0.4% of GDP), and the policy room for further expansion is large.

Furthermore, the new private pension scheme that was launched last year (2022) is a major initiative that will provide attractive long-term growth opportunities for asset managers with an onshore presence in China. In addition, we expect Hong Kong’s stock market to benefit from potential South-bound asset flows through the Stock Connect. The growth opportunities are unmistakable, and the market projected to grow to USD 1.8 trillion by 2035. As the market grows, private pension products in China will increasingly invest in Hong Kong equities through the Shanghai-Shenzhen-Hong Kong Stock Connect.

For long-term investors, investment opportunities in businesses that drive automation will be attractive. Automation is the way to go to address higher wage costs and ageing population.

Third observation: Alignment between government spending & consumer spending

Finally, my third observation is alignment between government spending and consumer spending going ahead. Amidst the banking sector stresses in US and Europe, and the monetary policy straitjackets that central banks in developed economies, China stands out as a relative “safe haven”

• with a growth premium,
• minimal systemic risks within the domestic banking and real estate sectors, and
• a new leadership team led by Premier Li Qiang who should be pro-business.

As such, look out for pro-business, pro-private sector and pro-FDI policy initiatives in the coming months.

Thank you for tuning in to this episode of Under the Macroscope. This is Christy Tan, Franklin Templeton Institute.

1. As of end 2021, CEIC data

Read the in-depth article on China’s consumption triangle here.

Hi this is Christy Tan, Investment Strategist with Franklin Templeton Institute.

Thank you for tuning in to the 2^nd episode of “Under The Macroscope”. In this episode, we will look at the dissonance between the US Fed action versus the market, and where opportunities lie amidst the noise.

The tug of war between the Fed and markets

Post the FOMC (federal open market committee) meeting, Fed fund futures are pointing to at least 4 interest rate cuts by the end of 2023.

• If the Fed holds firm to the rope that the markets are tugging in the other way, there could be more swings and volatilities that lead to asset repricing at a lower band.
• However, if the markets have their way, we may see a revival in risk appetite.

Investors who are in the dovish camp tend to mention that the Fed has been known to cut rates within six months of the final hike. It is worth mentioning though that the lag between a hike and a cut can take as long as 18 months.

For a start, the Fed won’t cut rates in a Goldilocks environment

Taking a leaf from what the Fed Chairman Powell said back in 2018 that the Fed’s approach to raising rates is akin to walking in a dark room littered with furniture. Every rate hike seems to have darkened the room further and the banking sector has clearly bumped into some furniture recently.

However, as the situation simmers and investors shift from feeling panic to feeling assured after global authorities provided swift and effective backstops, the focus could return to the US economy and inflation. A goldilocks economy, where inflation and economic growth risks are balanced both on the downside and the upside, will probably not motivate the Fed to start easing.

Having said that, some may argue that the recent US banking sector stress could be disinflationary

US inflation has clearly peaked (headline Consumer Price Index at 9.1% in June 2022) and is expected to taper further from 6.0% currently. The impacts of the recent banking sector stress in the US will be felt in the coming weeks, in the form of reduced credit and higher funding costs. Beyond Wall Street, we may see reduced business activities and consumer spending, rise in unemployment, and fall in corporate earnings. The banking sector stress, like the COVID-19 pandemic, may catalyse a disinflationary trend in the US.

Accordingly, expectations for inflation to trend towards the Fed’s 2% target may gather steam. Furthermore, the loud calls for a shallow recession have softened. A soft landing or shallow recession was initially premised on strong household and corporate balance sheets as well as muted central bank support. Two (the latter two) out of these three rationales may no longer hold firm and the recession train may be picking up speed instead.

Window of Opportunity in Fixed Income Has Opened

All said, the three-pronged approach to investing in 2023 are diversification, quality, and active management. Franklin Templeton Institute’s Fixed Income Navigator¹is suggesting high conviction for fixed income investments, specifically in Treasuries, Investment Grade and municipals.

Inversion of the front-end of the yield curve is one of the first signals indicating that the window of opportunity for fixed income investments has opened. And the recent spectacular drop of 2-year UST (U.S. Treasury) yields has deepened the inversion further, as markets clearly expect the Fed to ease soon. It is fair to say that the current environment has complicated policymaking.

Nevertheless, even if rate cuts don’t materialize immediately, markets continuing to price-in such an event has driven bull steepening of the yield curve, where the front-end falls faster than the long-end of the curve. This environment has historically been very favourable for high quality bonds.

Finally, investors in Asia may also consider diversifying into Asian fixed income, where the region is more insulated from growth risks of the US banking stress and the additional growth support from China’s reopening is gaining momentum now.

I will give you more colours and on-the-ground pulse from China in the next episode of Under The Macroscope.

Thank you for tuning in to this episode of Under the Macroscope. This is Christy Tan, Franklin Templeton Institute.

Hi, this is Christy Tan, Investment Strategist with Franklin Templeton Institute.

Thank you for tuning in to this episode of “Under The Macroscope”, where we unpack capital markets insights for you.

FOMC’s Impact: Today’s Hawk Will be Tomorrow’s Dove

In the first FOMC meeting since the start of the banking stress, the US Federal Reserve (the Fed) unanimously greenlighted a 25bp hike. While this was broadly expected, markets went from expecting to suspecting that today’s hawk will be tomorrow’s dove. 2-year US Treasuries rose above 4% in response to the 25bp hike but settled below.

Step Back & Ask 3 Pertinent Questions

The initial strength in US equities disappeared after Yellen said regulators are not looking to provide “blanket” deposit insurance. In moments like these when events are rapidly unfolding and investors struggle to keep up with volatile markets, it is important to step back and ask three crucial questions:

1. Is a systemic financial crisis unfolding?
2. Will central banks stop hiking rates?
3. What actions can policymakers take to stabilise banks, financial markets, and the economy?

Here are our current thoughts:

Central Bank Tightening Could Be A Positive Signal

The European Central Bank (ECB) hiked rates 50 bps last week, sending a message to markets that policy makers do not think the situation is as bad as many have thought. Similarly, the Fed raised rates 25 bps this week, and also stated that it sees the US banking system as ‘sound and resilient’. By their actions and their words, the ECB and the Fed are trying to bolster confidence that the financial system and economy are stable enough for them to remain focused on their priority of bringing inflation down to more acceptable levels.

But, Rising Rates Pose Challenges To The Asset Side of Banks' Balance Sheets

That became plainly evident at Silicon Valley Bank (SVB), where losses on unhedged bond holdings blew a hole in the bank's earnings, leading to its collapse. Other banks may have managed interest rate risk better, but given the opacity of their holdings, hedging strategies and reporting, this lack of transparency is unsettling.

Depositors Must Be Reassured

Banking crises are pernicious because once depositors question the strength of banks, rapid withdrawals quickly follow, putting at risk both weak and strong banks. Longer term, bank regulators must expand their efforts to properly supervise banks, including via new stress tests. They must also merge or consolidate failing banks where necessary.

Central banks must not shy away from making clear statements about cyclical risk and how banks should view the quality of their loan portfolios. Those examinations must be made in advance of any cyclical deterioration in credit quality.

Response in Asia

In Asia, investors are nervous on several grounds. Concerns over contagion risks and the Fed’s policy path are on everyone’s mind. Asian regulators must hold the bottom line of financial stability.

The Monetary Authority of Singapore (MAS) issued a statement overnight that stipulates for Singapore banks, equity holders will absorb losses before holders of AT1 and T2 capital instruments, even in exceptional situation. We expect Asian central banks to be more inclined to bring monetary policy to a neutral stance, and that creates a more constructive environment for Asian fixed income in the future. 

We will be bringing more episodes of “Under The Macroscope” in the coming weeks as the situation evolves. Also, check out an article I produced this week on the impact of the banking stress in Asia. Stay tuned, and this is Christy Tan, Franklin Templeton Institute.