Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Joshua Crabb, Old Mutual Global Investors Head of Asia Equities.
Hello, Joshua.
Joshua Crabb: Good morning, Emma.
Wall: So, we've just head today that in about a month's time the President of China may well be visiting the President of the United States in the U.S. Now, this has been a concern for emerging market investors Trump being elected to the White House because he has been pretty inflammatory in some of his comments towards China. So, as an investor in Asia equities, do you think this is an opportunity or a headwind?
Crabb: I think it is an opportunity. There will be losers and winners out of these events, but I think there's a couple of things to consider. One, politicians' bark is often worse than their bite. So, we are – as was made clear during the debate with Hillary, Mr. Trump or President Trump as he is now known, has been quite happy to use Chinese steel and Latin American labour.
I think the second point to keep in mind is this still needs to get through a Republican senate and house. And if we consider even with very popular presidents like Obama the inability to get things through – it's quite difficult. And Republicans for hundreds of years have actually believed in open trade. So, I think, that will be less of a headwind than people sort of anticipate going forward.
Now, I think, the interesting thing on sort of protection element is really the impact that it's going to have. So, are there many people, for example, who sit in the U.S. who are going to want a $3 an hour job and I don't think there are many. And this is the interesting debate because people often look to China whereas where we've seen a place to be more concerned has actually been ironically a place like India and that's because there's some very expensive well-known sectors in pharmaceuticals and IT much higher paid, much more likely to come under attack from the U.S. and much more likely jobs that actually could move back. So, we think it's really about understanding where those risks sit and taking advantage of them.
Wall: Now, having a look at your portfolio and your top 10 holdings, I can see there are five Chinese banks and indeed, one Indian bank there. Now, Chinese banks are quite a contentious issue among investors. There are concerns about debt levels and indeed, the opacity of investing in the Chinese bank. So, why are you positive on them?
Crabb: This is a very long topic and we could go through the issues around state-directed investment and how that means, the government stands behind them, et cetera. But I want to just put this in simple terms for now, because rather than talk about the very long-term issues, let's just talk about what's immediately happening. So, the Chinese banks were cheap. They were very low in price to book, low to P/E and they were still paying dividends. We often find that when banking systems go under duress, the first thing they do is cut back on their dividends which makes sense and they've continued to pay those in China which means you're paid to wait quite handsomely.
So, the second aspect is around, so what are these projects they've lent to. So, in China, rather than government raising bonds and investing in public infrastructure, they get the banks to do it. Now, the thing about public goods is they don't make money. And as a result of this the government effectively stands behind some of these things. We've seen restructuring as these have moved from local government entities that can't raise money into the central government. So, that's one aspect.
The second aspect is around bad companies that they may have lent to. And one of the aspects that we think is very important is what's been happening with the PPI or the Producer Price Index. That has been negative for many years in China which has meant that companies despite the destocking, the deflationary environment have found it very tough. When the value or price of what you're selling is going down and there is not natural volume offset, it's very tough. If you're a bank that lends that, it's also very tough.
Over the last short period, we've seen that going from being many years of sharply negative to being very positive for the last print of 7.8. And what this means is that pricing power is starting to improve, which means that the system is getting better, the profitability is getting better and therefore, those banks loans are getting better. And in our view, they are just too cheap for this environment that we're going through now, because people are too busy looking backwards. In the same way in 2007, when people were paying things like five times price-to-book for China merchants banks and thought was a good idea and that were backwards not forward, we think they have been making the same mistake at the moment.
Wall: Now, both of those answers have been very positive. But bearing in mind the fact that we have had incredible rally in Asian equities, how positive are you looking forward as to what we can expect in terms of growth as a shareholder of Asian equities?
Crabb: Yeah. Look, absolutely, and the way I like putting this is into a framework. Everyone's got views. And the way I sort of look at that at the moment when we look at most investors is a couple of observations we can make. Most people are still underweight. Most people are still positioned very, very defensively in high-quality assets, in growth assets that are independent of the cycle.
So, in that backdrop, we now have the market on 1.6 times price-to-book. If we look at 20 years of history and look at your probability of making money over a 12-month period versus price-to-book, it's still very, very favorable at 1.6 times. Interestingly, February last year when everyone was panicking, it was at 1.2 times. History suggested 100 probability of making money.
Now, the framework that we're sort of loosely using at the moment is it feels a little bit like 2003, 2004. And if you remember back then the U.S. had come out of the tech bubble and crash, was starting to do okay, was pretty highly valued and the same way is it is now. People looked at Asia, they were very negative.
Back then it was because we had the bombings in the night clubs in Bali, coups in Thailand, we had had property prices in Hong Kong halve and we had SARS and people forget these issues, but it traded at massive discounts, similar valuations today.
The U.S. had come out. That growth had started to spread globally. The U.S., which I'll come back to, actually raised rates during this period and Asia massively outperformed as that global growth spread. When we look at the world today, we see a very similar environment. The U.S. is fine, but it's quite expensive, but it should be able to hold in there. Asia is still very cheap. The Fed is likely to raise rates. Everyone thinks that therefore the Fed raises rates, Dollar is strong, Asian equities underperform.
If you look at 2003/04 to 2007, the Fed hiked much more than people are anticipating now. The DXY or the dollar after initial rally then sold off. Why? Not because it didn't raise as people were anticipating but the rest of the world got better relative to expectations. And we see a very similar environment at the moment. So, we think on a range of sort of that 1.0 to sort of 3 times price-to-book over time sitting at 1.6 today, when earnings revision is turning positive, it's still quite a good outlook for Asia.
Wall: Joshua, thank you very much.
Crabb: My pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
