The EPFR Exchange Podcast

Episode 100: Headwinds in the economy

August 23, 2022 Kirsten Longbottom & Cameron Brandt
The EPFR Exchange Podcast
Episode 100: Headwinds in the economy
Show Notes Transcript

This week, we discuss a week where investors have begun to discount the short-term problems and focus on a better climate for asset prices down the line. Cam and Kirsten highlight issues facing Europe Equity, the perpetual state of headwinds for Brazil's economy, China's slower growth and aggressive stance towards Taiwan,  and sweet spots in the investment landscape for 2H22. 

Kirsten Longbottom 00:21
Hello everyone and welcome to the EPFR Exchange Podcast! My name is Kirsten Longbottom and we are joined by EPFR's Resident Economist Cameron Brandt. We'll walk you through what our teams were monitoring in the data last week and what we look forward in the upcoming weeks as well. Cam, settling back in how is your week this week?

Cameron Brandt 00:42
Well, it was a definite contrast to the week in Iceland, where the Icelandic weather gave us a pounding but we didn't lose anyone down a volcano and I was able to lure a large sea trout out of one of their rivers. So it was a successful round.

Kirsten Longbottom 01:02
Yeah, squeezing in fishing as always. Good, good... as ever. So in the Global Navigator this week you highlighted a few headwinds in the market that are currently continuing. They've been going on for a while, so one that was most remarkable is that we hit the 150-day mark with the Russia-Ukraine conflict and how do you think sanctions are still playing a role in the way that investors are moving their money? Or are they?

Cameron Brandt 01:33
What's probably more interesting about the headwinds is that most of them, investors certainly the ones that we track through mutual funds are really sort of discounting the short-term problems. And translating them into a better climate for asset prices anyway down the line. You know the the broad thinking being that the headwinds that you've mentioned and others add up to slowed or even stalled economic growth which in turn is going to force the hand of central banks currently in tightening mode. Inflation will start to come back down and the needs of growth and job markets will begin to move higher up the list of priorities for those major central banks like the Federal Reserve. The Ukraine continues-- The Russia's attack on the Ukraine and the fact it keeps grinding along, there's no doubt it's having a big impact in a number of areas. But you know what we've seen here at EPFR is that investors have kind of assigned the vast majority of the bad outcomes to Europe. So while Europe- The Europe Equity Funds that we track are now- well their outflow streak is up to 27 weeks and $83 billion we've seen less, markedly less, impact outside of that. It's not that other fund groups aren't having their issues and flows have certainly been bumpy in most cases over the past several months but US Equity Funds, US Bond Funds more often than not in recent weeks been seeing inflows, same for most of the major emerging Asian fund groups, interestingly Japan has begun to peel away a bit from that happy state of affairs, mixed sentiment towards Latin America but this past week we saw over $200 million go into Brazil Equity Funds. Investors really seem to be giving Africa a wide birth during this particular period, down period, which was triggered by the covid pandemic. Historically when Developed Markets and the bigger Emerging Markets are running rough, we have tended to see a bit more interest in Africa and the Frontier Markets as an uncorrelated asset class but we really haven't been seeing that this time around.

Kirsten Longbottom 04:44
So this week you mentioned how flows into Emerging Market Equity Funds were helped by solid flows into Latin America which was from Brazil Equity. What's going on in Brazil's economy?

Cameron Brandt 04:59
Brazil's economy basically operates in a per perpetual state of headwinds, to put it otherwise. Taxes are high, structural inefficiencies mean that the kind of lowest you can take- seem to be able to take interest rates without triggering inflation is about 5%, there's great inequality, the economy is still very dependent on commodity demand and prices. But people learn to adapt and Brazilians are so particularly good at adapting. So their economy even though interest rates, the key Selic rate at the moment is up over 13%, the economy is doing better than people expected. And is likely to get a boost going into the election they're going to hold in October. It's a feature of Brazilian elections that there's largesse from the incumbent and promises of largesse from the main challenger. Unlike many recent Latin American elections in key markets, this one for investors anyway on the surface of it offers a less painful choice. You've got the erratic, but certainly business-friendly, Bolsanaro in office being challenged by a man Lula da Silva who has a track record of responsible stewardship of the Brazilian economy even though his politics overall are markedly to the left of Bolsanaro's. Mexico continues to have its pretty bad policy environment significantly offset by the assumption that as the reconfiguration of supply chains plays out over the next few years that it's going to be a popular alternative to China in terms of accessing the major north American markets.

Kirsten Longbottom 07:33
Well, speaking of China, that country from what I've read is experiencing slower growth and still has a pretty aggressive stance towards Taiwan which is worrying to investors. Do you think there could be even more fear or maybe less given that the US and Taiwan agreed to start talks on trade and how does Japan play a role in that dynamic?

Cameron Brandt 08:03
Well, you're right to sort of phrase it like that because it is all interrelated. The Keystone honestly is the Chinese economy. It's not doing as well as it has been for a variety of reasons. I mean as you get to a certain size, 7% growth year-on-year-out gets much harder to achieve and the recent crackdown on the private sector is I don't think going to be a net plus for overall productivity. And it's not terribly surprising to me that when economics isn't going as well and that's been sort of a key plank of the ruling communist party's legitimacy that they're being more aggressive in the foreign policy sphere. I still think it's unlikely they'll actually move directly against Taiwan. Events in Ukraine have certainly highlighted the difficulty of and risks surrounding offensive operations and those are multiplied when you conduct an amphibious operation. But it poses security and economic issues for economies throughout the region. I think we may be seeing a bit of that in the downturn flows to Japan Equity Funds. Which given the weekend's impact on- the positive impact on the pricing power, the exporter's revenue streams, their building and shipping products, using cheap yen and getting paid in harder currencies when they repatriate, plus a marked uptick for Japan in domestic consumption, these should be fairly good times for funds dedicated to Japan. But the fact that the market in China, which absorbs a fifth of Japan's exports these days, is slowing and getting more aggressive, and that tensions are rising between China and Taiwan, and Taiwan absorbs another 7-8% of Japanese exports, I think there is something of a reassessment going on about the longer-term prospects for Japan. It's businesses at the moment, especially the export-oriented ones.

Kirsten Longbottom 10:56
So in a recent forward-looking piece and maybe we'll end it on this one. But, you detailed that Infrastructure, Switzerland and Government were the key themes for the second half of 2022, why did you pick those three? where does that come from?

Cameron Brandt 11:14
Key themes, I think might be a little strong. I did identify those as likely sweet spots in the investment landscape but during the second half of the year and certainly infrastructure continues to deliver on that. Not that I deserve any great credit for highlighting that because between the demand, the stimulus packages that are once again popping up, and the sudden and urgent demands to improve energy, especially green energy infrastructure and military infrastructure in Europe. Quality infrastructure companies and businesses are going to be turning away business I think in the coming months and years. 
Switzerland I highlighted because A) it's a traditional haven when things in Europe are not going very well and it is reasonably well insulated from some of the worst things that could happen if energy supplies get really pinched. Insulated but not immune, but it has a very diverse supplier base, it does have reasonable hydroelectric capacity, transportation- internal transportation is over shorter distances in say is the case if you're running a business in France or got help though Germany with the rhine down to its bones. So that was the logic for those two.

Kirsten Longbottom 13:10
Good and government I think that one we kind of covered throughout this podcast for sure. So great. Well, thank you for your insight as always!

Cameron Brandt 13:23
Great, you enjoy your weekend you have company visiting I believe.

Kirsten Longbottom 13:29
Yep, going to a concert tonight. So it'll be very fun!

Cameron Brandt 13:36
Oh, so you're not taking them bareback bull riding?

Kirsten Longbottom 13:40
Not this one. haha