Considering the constant onslaught of scary headlines out of Europe, the fear of a hard landing in China and the stubbornly low yields offered by the markets, now would seem as good a time as any for investors to start panicking.
But according to Michael Hasenstab, co-head of global fixed income at Franklin Templeton and manager of $160 billion in assets including the Templeton Global Bond fund (rated Silver by Morningstar OBSR analysts), this view would be too short-sighted. Hasenstab, who Morningstar named fixed income manager of the year in the United States in 2010, believes we really need to look further out and see the whole situation.
In his keynote speech to open the Morningstar Investment Conference on June 20 in Chicago, Hasenstab said there are two potential "global game-changers" that would spell disaster for investors. The first would be a sudden drop in China's growth rate, while the second, which is much more complex, would be an explosion of the eurozone. How likely you believe these scenarios are should go a long way toward determining whether or not it's time to panic.
Don't Panic: Europe Won't Collapse
"Greece is fiscally terminal," Hasenstab told the 1,850 delegates present at the conference. "Its debt is so big, it would take a miracle to turn it around." He pointed out that the austerity measures implemented in Greece since the start of the financial crisis only managed to bring its debt-to-GDP ratio down from 180% to 150%. Hasenstab believes that to be effective, the measures should have aimed for around 30%.
But as gloomy as the picture seems in Greece, Hasenstab doesn't think it will bring down the rest of Europe. He highlighted some of the steps taken by two other countries that are also in the eye of the financial storm: Italy and Spain. The issues in Italy, he said, were more social in nature, particularly when it came to inefficiencies in the labour structure, but the Italian government is taking "fundamental steps" toward labour reform. Hasenstab also pointed out that throughout the financial crisis, Italy's debt-to-GDP hasn't increased, remaining at around the 100% mark, in stark contrast to Spain and Greece which have seen their debt levels skyrocket. This, Hasenstab said, demonstrates Italy's fiscal responsibility.
Similarly, Hasenstab said that Spain has taken steps toward fixing its problem-ridden banking industry through recapitalisation. "Yes, it was three years too late, but better late than never," he said.
Hasenstab said the crisis in Europe may have been "a blessing in disguise" because it forced the governments of these countries to clean house. "We have seen the EU start to come together and talk about a fiscal union plan, which ultimately is the necessary prerequisite for the survival of the euro. Structural inefficiencies are being addressed," he said, "and that may not have happened if their hand hadn't been forced." He pointed out that the United States, which didn't face a crisis of the same magnitude, is not taking similar steps to fix its own ailing finances.
Don't Panic: China Won't Suffer a Hard Landing
Turning to China, Hasenstab said that two possible scenarios could lead to a hard landing: a major policy error by the government, or a banking crisis. However, he doesn't believe either one is likely. On the policy front, he noted that China has taken several steps toward easing monetary restrictions and encouraging economic growth. Regarding a possible banking crisis, he noted that if that were to happen, the country can use its $3 trillion in reserves to recapitalize banks, which gives it "a very large insurance policy to deal with nonperforming loans."
China is in the midst of a massive demographic change, Hasenstab said, as the country's "single child" policy is starting to affect the work force, leading to a shortage of young, skilled workers. This causes upward pressure on wages, which may seem like it would hurt China's competitiveness on the global market. But higher wages also have the benefit of leading to an increase in domestic consumption, which will counter the effects of the higher labour costs.
Hasenstab also noted that China isn't likely to be replaced as the world's low-cost manufacturer as a result of the increased work costs, since no other country has the capacity to absorb the sheer volume that is being produced in China.
Don't Panic: Look to Emerging Markets
Given that Hasenstab believes that the glide path for the eurozone will be “messy but not Armageddon” and that China will comfortably transition to a slower growth rate in the region of 6%-7% rather than 10%, i.e. a soft landing, now is not the time to panic.
So if we’re not to panic, what should we be doing? Look to the emerging markets, Hasenstab said. Some of the best and safest credit investments are now to be found in the developing world. Whereas one used to look to US Treasuries or UK Gilts as means to reduce portfolio risk, and consider emerging markets debt as a riskier investment, the tables have turned. In 2012, emerging and developing economies’ debt-to-GDP ratios are less than 40% on average, while advanced and developed economies’ ratios are above 100%, Hasenstab explained.
Furthermore, policy progress—economic growth, monetary policy and fiscal policy—is poor in the US, Europe and Japan, whereas the rest of the world is showing healthy promise. Examples of countries where Hasenstab sees promise include Malaysia, Indonesia and Singapore, within Asia; nations that are “low debt, high growth and not printing money”.
In addition to revaluating how one thinks about credit risk and the developing economies, the key to not panicking is having long-term vision. “Easier said than done,” Hasenstab conceded.
