My Three Big Investment Themes for the New Year

• 16-Jan-22
• admin

Twenty twenty-two.  The new year has started without a bang, a bust or bullets let loose.   That’s exactly the way I like it.   

 

In today’s commentary, I would like to talk about my three big investment themes for 2022.   

 

Before I do that, there are many new readers of this blog, and I thought that a bit of selfintroduction might be useful.   This blog is a labour of love, and perhaps reflect the frustrations of a wannabe writer.   Indeed, I have tried at hand at writing books.   That has been a misguided exercise, and I could have stuck to just managing money, which is far easier.  If this blog carries bad prose, my excuse is that writing is not my chosen profession.   It is only an amateurish avocation.   You, unfortunately, are a victim of my decision to let loose random thoughts that I have during the week on how the markets are likely to behave in the short term.  I am motivated by an interest to help friends unravel the arcane nature of financial markets. 

 

I am by background and current commitment, a professional fund manager as well as your co-investor in the FX trading system that drives the Spread company returns.    Many famous names in the investment profession get it into their heads that having money means they are qualified to proselytise, and so we have it – tomes of nonsense of how they think the world actually works.   Being rich does not make one wise, and I am not even rich…

 

At least I don’t claim to know how the world works.  But after 43 years in the investment markets (in which the ability to earn a meagre living for so long must testify to a modicum of expertise), I imagine that I have something to share.   I am also guided by the thought that having chased skirts around the hallowed halls of the NUS (top economics school in Asia) and the University of Chicago (top graduate finance school in the world) a long time ago, the pretence at being able to pontificate on international economics and finance may actually fool some people.  CFA training also channels all that academic mis-mash into a professional format, and so perhaps, I might have psyched myself in thinking that I have something to add to investment thinking in the Asian context.  Or so I hope…

 

The predominant thought however, is that there is a role, I believe, for bilingual professional investment thinkers/writers who can go to source in both English and Chinese, rather than through the filtered glasses of monolingual media.  When you read this blog, you should know that I have spent hours upon hours every week reviewing information in both languages and removing as much of the cultural bias that comes with single language writers.   In addition, I have personally lived in both the US and in China with deep social circles in both places, and can tell bullshit expressed in either language.  As such, I hope that the value add in this blog is that it is simply a weekly presentation of personal opinion drawing on original bilingual sources and that it would be meaningful in that context.

 

Now, on with the three big themes that I see in 2022.

 

Theme No 1 (the Long Term Economic Backdrop): The successful implementation of the RCEP (Regional Comprehensive Economic Partnership) which was launched on 1 Jan 2022 is the first.   

 

RCEP is a massive deal, negotiated over more than a decade, and now covering 30 percent of the world’s population and 25% of its GDP.  It is the second “mega-regional” trade conglomeration in the Western Pacific, exceeding in size the first, called the CPTPP (Comprehensive and Progressive Agreement for Trans-Pacific Partnership) started in Dec 2018.

 

It is the largest trade organization in the world as can be seen below.

 

 

Importantly, Japan will have an agreement with China and with South Korea for the first time ever – these 3 countries are notoriously protectionist isolating themselves through various kinds of domestic barriers to entry.  Now they will open up to each other.    This will boost GDP by 2.7% and create more than half a million jobs in that country, according to Japanese sources.  The others will benefit equally.

 

RCEP will eliminate tariffs on 90% of goods as well as introduce rules on investment and intellectual property to promote free trade.

 

It adds substance to the phrase, the Asian Century.  Simply put, it’s a trade deal that sets up trade in Asia, for Asia, and between Asian countries that are usually more interested in trading with the United States.

 

It covers 15 member countries, but there’s also some overlap with the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

 

Traditionally, trade in Asia has been according to the mantra that people make things in Asia to be sold to the richer countries of the West.   A lot of raw materials, parts and components move back and forth among Asian countries to facilitate that business model. Final assembly that happens in Asia ends up shipped to the US or Europe due to tariffs in place, non-tariff barriers and so on – so less trade within the region than we would expect given the size of populations and the origin of raw materials.  RCEP, while not perfect yet, will make it more likely for businesses to create supply chains in Asia, for Asian consumers.   It is a good start, and over time, the momentum will accelerate to build up intra-Asian trade.

 

The fact that China and Japan have already agreed to RCEP is a virtual miracle, and especially for Japan to have moved so quickly - it’s the first time that they have an agreement with South Korea (to start on 1 Feb 2022), and with China.   It’s actually virgin territory and that must mean something.

 

Further to RCEP, the other trade grouping, TPP or CPTPP had come into force earlier than ever thought possible after Trump torpedoed it on his first day in office in 2016.   The TPP was proposed by the Obama Administration as the “pivot to Asia”, to lock a group of countries into a win-win trade organisation that would treat non-members as outsiders.   For whatever wisdom that made them forgo their original plan to create a sort of ‘bamboo curtain’ isolating China, America has now put itself on the other side of the curtain that they created.  This is a strange turn of events. 

 

What are the differences between RCEP and the CPTPP?  In CPTPP, countries joined voluntarily, and they aspire to high ambition, high quality arrangements, and they are gungho. In RCEP, proposed by ASEAN, members were dragged into it because they had to join, because they were in ASEAN or they had an existing agreement with ASEAN. The diversity among the members in RCEP is impressive: population size, wealth, landlocked versus archipelago countries, services versus trading goods, imports versus exports.   RCEP variety is truly breath-taking.   Consequently, there is a big gap in quality, in coverage, in depth and breadth and a lot of that is attributable to the members’ background as analysed above.

 

What does RCEP cover?  For intellectual property (IP) rights coverage, RCEP is very progressive. Asia is not known for creating good IP rules. What they have already agreed to in RCEP is way beyond expectations. On the other hand, the countries have not agreed on simpler matters - rules for labour, worker or human rights or on environmental protection. That will happen in other international forums.  None of those as at this time are regarded as important as tariffs.  As such, tariff reduction remains the focus of RCEP.

 

Will the world become split into different trading areas because of RCEP?

 

Because trading zones are preferential and there are benefits for being in and penalties for being out, they are naturally divisive. Large regional trade agreements will force companies to align their supply chains in goods, services, or investment within the zone.  When that happens, they are difficult to unravel. There will also be business trends emerging as a result of RCEP, even among companies that are not tariff driven.  CEOs, top managers and entrepreneurs will start ‘thinking Asia’, as it stimulates strategic planning in the direction of chasing growth.  This will be self-reinforcing. The more you have businessmen who think Asia First, the more the world will see Asian growth.  

 

This cannot be good for US leadership in the Asia Pacific economy going forward.   Now that China is in cooperation with Japan, S Korea and ASEAN in one common economic platform, with China’s domestic market replacing the US market as the beef in the deal, these countries will be getting closer.   When that economic integration progresses, the one-third of the world’s population would be dependent on each other to grow the regional economy, and everybody else outside will lose leverage with the members inside.  Where would a Chinacontainment policy fit in all this?   It would lead to, instead, a diminution of American economic power in the Western Pacific, wrought upon themselves.   And it would also give both Japan and Australia the excuse to focus on economic cooperation with China within the RCEP (and later the CPTPP when China joins) while giving the Americans the lame support it craves in the military alliances of Quad and AUKUS that will eventually have no teeth.          

 

However it turns out, there is no question that 2022 will see a big boost to the long held concept of an Asian century where China is at the center of the universe.    It will also complement that other major Chinese economic effort, the Belt and Road Initiative, to economically unite the Central Asian countries by road and rail, and bind them to the countries in the RCEP membership, by maritime expansion of a massive Chinese merchant fleet.   

 

Indonesia will realise its ambitions to sell its mineral wealth to its neighbours; the Philippines

(after ratification) will be able to deploy its population in intra-Asia services; and all of SEAsia will soon be linked to Mainland China via fast rail that will stretch from Kunming in Yunnan Province all the way to Singapore, and perhaps over bridges or tunnels to Indonesia.   War becomes unthinkable once countries are linked inextricably in this manner.   All the efforts by the Americans to have the countries of SEAsia take sides with them to contain China is already falling on deaf ears, when the prospect of the alternative is so much more enticing.

 

How can this not be exciting?   An economic region which is connected not just by naval chokepoints as in British imperial strategy, but by actual continuous road, rail and shipping lanes from Seoul to South Africa, Singapore to Spain and traversing the Hindu Kush, Iran and Iraq (all now apparently buying in to a Chinese economic plan for peaceful trade and investment) is being formed.   This is economic integration on the grandest scale in the history of the world.  It creates what the geopolitical analysts called the World-Island, with 50 percent of the world’s population and its resources in it.  It may take another 50 years to see it finalized, but it is coming and it will be irreversible.   

 

This is the biggest of investment themes for me, starting immediately.   RCEP – 1 Jan 2022.   The continents of Africa, Europe and Asia economically integrating progressively over time, with military conflict minimised by strong trading relations, in this version of Mackinder’s World-Island theory fleshed out in another half century.   This is a mega-trend in global economics.   The winds are shifting from west to east.   

 

Theme No 2 (the short-term financial trends) : Watching Inflation.

 

From the perspective of all Asia-based businesses, RCEP is largely positive, with long term growth potential.   China will become the centre of their world.

 

This must mean that, on the risk side, all of Asia will be locked in to that centre, to the flip- flops of economic performance and policy making in Beijing.   It used to be said, when Wall Street sneezes, the world gets a cold.   The global economy has already evolved to the point in which everybody now has to watch what is happening in both the US and in China.  

 

For example, in the final months of 2021, the impending collapse of Evergrande and several other highly leveraged Chinese property giants led to a fear that another Lehman collapse would be coming.   While that potential outcome is overhyped, as western media is contemptuous of the Chinese system and cannot be objective or accurate, there are nevertheless issues in the way Beijing runs things that impact negatively on the world.   The housing market in China is indeed on the decline, and some deleveraging will have to occur. Growth will take a small hit.   

 

The private tuition crackdown, the tech crackdown, and the pursuit of common prosperity all occurred in a very short time period, and crashed the Chinese stock market.  I personally think that all the measures by the CCP to reduce income and wealth inequality were well intentioned and necessary, but they could have been given more time to roll out.   This is therefore a sign of things to come – that Beijing will act with lightning speed once it makes a decision.   Whether the world is ready or not, does not matter.   Asia will have to get used to that.     The Asian trade blocs that involve China contain pluses and minuses, ratcheting along an upwards trend.    There are new rules to follow in this game.

 

The American economy, while no longer the sole and overwhelming power it once was, is still a very important force in the world.   We need to keep track of what’s going on there.

 

The last year has been good for the US economy with job growth exceeding expectations; but it also had its fair share of problems – supply chain breakdowns, energy crunches and inflation.   If inflation moderates, then the net result would be commendable.   And without forgetting that Covid Omicron is now raging in the US, we cannot really say the American economy is completely out of the woods.

 

Nevertheless, the mood of the markets is that inflation has reached the point when the Fed has to tackle it head-on.   There has been nearly one year, well at least 9 months, when the financial markets have pushed the American central bank to stop the massive money printing and raise interest rates so that inflation can be arrested.   For the longest time, the Fed took the position that inflation was transitory, and that there was time to change interest rate policy to arrest inflationary pressures.   The Fed is not wrong.  Not about inflation being transitory, but that inflation, unlike depression, can be addressed when they want to.   They are holding the reins on the horse and would not let it run away.   When they previously talked about a raising of interest rates in early 2023, this has now changed to a possibility of rate hikes in April 2022.  Nine months ahead of schedule.   The Fed is demonstrating it is in control.

 

Yet in view of the fact that zero interest rates will soon be a thing of the past, the US stock market is totally Teflon in its response.   Yes, in the last six months, there were a couple of down drafts but none of the major indices dropped more than 5 percent.   Instead, after the socalled Christmas rally, the DJIA and the S&P500, the most popular indices, are still near record levels.  Even the most affected of the three big indices, the Nasdaq, is less than 10 percent off record highs.     

 

But this does not mean that the US stock market is totally impervious to declines.  Not at all.  

There are a wide range of stocks, especially in the tech sector, that have been pummelled in 2021 by sell downs of up to 50 percent.  That’s a crash of major proportions.   This is best summarised in the performance of Cathie Woods, a top momentum/growth fund manager during 2020, who has seen her funds battered by market sell offs.   Her fund, ARK Innovation, is off 48 percent from its highs, just last Thursday.   The Fund was up 70 plus percent in 2020-2021, but that was off a low base.  The drop of 48 percent is from a high number.   The fund is being crushed, ending worse off than from where it began.   This is serious as it spells the same scenario for all the top tech plays that benefited from the pandemic’s WFH trends.  Worse still, it is not over.   We have not seen the worst yet.

 

It is also a reversal of the fortunes for some of the top tech billionaires in the world, who captured astronomical gains out of the blues during the pandemic that led many to believe that wealth inequality has ushered in a new gilded edge.  Between the crashes of the tech titans by government action in China and the reversion back to a more sustainable normal by interest rate worries in the US, the richest among the rich in the world have given some of their windfall back.  It may turn out to be less unfair than we had all thought.

 

In 2022, we will also see the end of unfettered optimism on bitcoin as the technology to replace fiat currencies.   It had everything going for it at the start of the last year, when every technical analyst had a chart to proclaim that bitcoin had the potential to reach $200,000, or even that mystical $1,000,000, by Dec 2021, thus driving an insane rush to buy ETFs based on that speculation.  And no sooner has every one of those fools jumped into all the bitcoin exposure they wanted to get in the new regulated market of bitcoin ETFs, the clever ones dumped their holdings onto the greatest fools, and the bitcoin price has gone in a straight line down.   It has again lost 40 percent of its second peak, and the story of the chart leading to the moon is forever gone.   Bitcoin has proven to be just another speculative commodity, one that does not have, or will ever have, an actual purpose.  It’s basically over.   

Theme No 3 (the Volalitity) :  Geopolitics

I would like to think that 2022 will proceed through the year like it did on its first day - without any wars.  The war on terror has run its course, military action in the Ukraine and now Kazakhstan will not become geopolitical affairs because the US will not get involved in wars in Russia’s backyard, and the war that America most want to see happen will not be fought by the two likely combatants – China and Taiwan, because the former has no reason to start a war when the latter is already in its grasp for all intents and purposes other than in name.   Over the new year, the nuclear powers reaffirm that they will never go nuclear, and with that declaration, military logistics in both Central Asia and the Western Pacific will make a major contest between the US and the new alliance of China/Russia impossible to even contemplate.  There will be no hot war in 2022.   Or ever, in these regions.

 

But that will not stop countries from talking trash to each other.   As a matter of fact, the way I see it, if everybody’s hands are tied behind their backs and they all know it, all the more will people start shouting at the top of their voices that they don’t like someone else on the planet and will move ships, planes and tanks around to seem like they are willing to back words with action.    But it will all be just talk.

 

There will no doubt be lots of excitement.   The cold war will seem at times in the new year like hell would freeze over, but nothing worrisome will come out of it.   What has happened in the last six months, is that the US - in gathering a coalition of its allies to “name and shame” China - has on the contrary created a powerful economic and military alliance between China and Russia which reinforces the evolution of Eurasia towards the formation of Mackinder’s World-Island.    As we watch the End of History, the evangelism of liberal democracy and capitalism as a system of governance everywhere, unravel to a wimpy end in the halls of Congress on Jan 6 2021, its most furious proponent, America, needs to see that even as it tries to rekindle a Summit of Democracy in Dec 2021, nobody really cares.   But there will be dying gasps in that evangelism, and there will be some military adventurism to go with it.   At those times, we will see volatility in markets.  

 

Conclusions?

 

Forecasting is for the fool-hardy.   But it can be fun, if one does not take oneself too seriously.   Here are some thoughts:

1. The economic trends are clear.   We are headed for a multipolar world with strong economic blocs in the NAFTA countries, the EC and Asia’s RCEP overlapping TPCPP.  Inter-regional trade will increase, and the “Sino-American” trade problem will become less important.   Trump’s trade war, which has not ended, will become increasingly irrelevant to the Chinese, who now have greener fields to play in.
2. The trend towards a China economy that will be twice or even three times as big as the American one in another decade will be inexorable.    And since military conflict is off the table, everybody must learn to live in the new multipolar world with mutual respect in order to prosper or risk losing their mandate to rule.   Trade rules will in future be set multilaterally.
3. The dollar will remain strong, because nobody else wants to be a reserve currency.  It’s as simple as that.  The US needs to be the world’s reserve currency to finance its humongous debt, and will get to keep that role.   The rise in US interest rates will also bolster the desire of everybody else to hold it.    The rest of the world want to be exporters and generally don’t want their currencies to strengthen against the dollar.
4. There is no reason for stock markets to crash but a continued upward drift of indices will be interrupted by sectoral shifts and rotation, with tech losing ground relative to the other sectors, including banking, energy and probably hospitality/travel as Covid winds down.   This will be true of the American, Chinese, European and Japanese stock markets.   ETF investing in the major indices is as good an idea today as when I first proposed it in this blog two years (for that matter since five years) ago.   
5. Gold will remain boring because unlike what most people think, it is not an inflation hedge.  It is a negative yield asset in an environment of rising yields. 
6. Bonds, especially in the government sector, will be lacklustre due to inflation.   Corporate bond investing, which is better, will become as difficult as picking stocks because at the end of the day, it is the same thing.  Portfolios of corporate bonds is the way to go if bonds must be part of a mandate.
7. The libertarian fervour that got overly enthusiastic on decentralized finance will be disappointed and even as crypto currencies will continue to attract its adherents, there will not be an eureka moment when its fans will declare victory over fiat currencies.   As a matter of fact, in the context of 1 and 2 above, the emergence of a digital RMB seems likely to see fiat, not replaced by crypto, but reinforced by government-backed digital currencies.
8. The best asset class in the world will be real estate.  In the center of mega-cities.     Inflation.

 

Happy Investing in 2022!  

 

 

Wai Cheong

Investment Committee

The writer has been in financial services for more than forty years. He graduated with First Class Honours in Economics and Statistics, winning a prize in 1976 for being top student for the whole university in his year. He also holds an MBA with Honors from the University of Chicago. He is a Chartered Financial Analyst.