The market / Global
*Monocle* asked three influential economists for their predictions for 2008: Christian Gattiker-Ericsson, head of equity and strategy research at Bank Julius Baer, sees more pressure for economies reliant on ageing workforces; Brian Redican of Macquarie Bank recommends working with China, rather than against it; and Lars Seier Christensen, co-CEO of Denmark’s Saxo Bank, believes SWFs will shift the world’s economic balance in favour of Asia.
01 - Christian Gattiker-Ericsson
Bank Julius Baer, Zürich
An age-old problem
Demographics means doing research in ultra slow-motion. Experts in this field have seen it all coming: the baby-boomers born in the 1950s are getting older and will be retired by 2020 at the latest. In contrast, younger nations in emerging markets are pushing into the global labour force. They will provide the growth in workers for the 21st century. Some of these nations, such as India or the Latin American countries, have plenty of time to do that. Others, such as China, are under increasing pressure: in 15 years’ time, given the effects of the one-child policy introduced in 1979, its age profile will increasingly look like that of the US.
How will they be under pressure? By saving for retirement. With mass retirement looming from 2030 onwards, China needs to “grow rich before it grows old”. Other emerging nations have more time. But ultimately they will also face these demographic pressures and will start saving. The question is: what has this got to do with an investor’s outlook for 2008? Aren’t key events such as the Chinese Olympics or the US presidential race going to have a marked impact, and therefore deserve greater focus? Arguably yes, but the longer term pressures stemming from demographics will be felt in the here and now, too.
Specifically, we believe that central banks in developed economies will keep interest rates low, as their stagnating or even shrinking labour forces threaten to be a drag on economic growth. In contrast, emerging economies are compelled to grow in order to generate the wealth they will need for their retirements.
To us, this is not as dismal a picture of the global economy as it may seem. On the contrary, the good news from this scenario could be at least two-fold. First of all, interest rates in developed countries should stay historically low. This is positive news for risky assets such as equities or corporate bonds, as their greatest enemy is high-yielding, risk-free money. Secondly, growth, while slowing somewhat, should be OK in 2008. Yes, there will be cyclical hiccups and the US consumer market may not be buoyant. But overall, the rest of the world should be able to step in and compensate for some of the sluggishness in US growth.
The flip side, of course, is the US dollar: it is unlikely to recover substantially from its current malaise. In 2008, however, we expect the dramatic fall of the greenback to subside. And in such an environment, investors should be less distracted from valuing dollar assets by the currency’s movements.
“So what is in it for me, financially?” you may ask yourself. We think there is the potential for solid returns in financial assets like equities or corporate bonds. Furthermore, commodity-oriented assets should be underpinned by solid demand and continuous bottlenecks in the production and distribution chain. And finally, emerging-market assets should continue to do well, given the structural forces at work. So in 2008, amid the cheers and tears of the Olympics and presidential contests, tectonic shifts courtesy of demographics are quietly at work in your portfolios.
02 - Brian Redican
MacQuarie Bank, Sydney
Eight of the 20 largest companies in the world are now Chinese, while only seven are American. China Mobile is now bigger than Microsoft. Over the past year, the number of Chinese billionaires (in terms of US dollars) increased from 15 to over 100. These facts highlight that China is no longer just emerging as an important player in the global financial markets – it has already arrived.
Of course, people have been waxing lyrical about China’s potential for hundreds of years. How many companies’ ingenious business plans have been based around the premise of “selling one sock to every Chinese”? Even Napoleon once famously remarked that “when China awakes, the world will tremble”.
And just as there was a lot of hand-wringing about Japanese companies taking over the world back in the 1980s, so there is a fair degree of trepidation and scepticism about the expansion of the Chinese economy now. But such attitudes miss the point of what the ascent of China really means in terms of the global economy. This is because China’s incredible growth is really a story about the ability of poorer countries to escape their poverty traps and join the ranks of rich industrialised economies.
In that light, China is important because it is so big and has been so enormously successful in jumping aboard the bullet train of high-speed development. However, exactly the same thing is now occurring in countries such as India, Brazil, Russia, Chile and the Czech Republic, and potentially even in Africa. And because this development has now reached a critical mass, it is this that is driving the global economy rather than what is happening in North America or western Europe.
Two common responses to this trend are fear and greed: fear of the threat posed by the competition from China (and the predictable call for protection), and greed as epitomised by the companies that are hoping to sell one sock to every Chinese.
Neither of these approaches, however, are particularly sensible. The companies – and countries – which will prosper are those that assist and facilitate the development of these so-called emerging nations, rather than those that attempt to stifle it.
So far, the impact of this trend is most obvious in soaring commodity prices and the incredible boom taking place in mining activity. However, this is only the leading edge of the impact that this development will have on the global financial markets.
Next is the enormous growth of the financial assets of these economies. We estimate that China will accumulate $400 billion (€278 billion) of foreign exchange reserves in 2007 alone. So far, China has channelled this enormous bounty into the US bond market, which has kept global bond yields low and underpinned growth. However, as the development needs of the economies shift, so too will their investment strategies.
Already this has been reflected in the creation of sovereign wealth funds (SWFs). These funds are designed to adopt a more aggressive investment profile than simply parking money in government bond markets. The amount of money currently accumulating in SWFs is estimated to be over $2 trillion (€1.4 trillion), and is growing rapidly. China, South Korea and Russia have now set up their own SWFs following the lead of countries including Norway, Singapore and Abu Dhabi.
As long-term investors, these funds may inject more stability into the financial markets. Moreover, as the size of the funds keep growing, they could start to have a similar impact on the valuation of equity and property markets as the large foreign exchange reserves have had on bond prices.
Moreover, while there is still no indication that China will allow its currency to rise sharply any time soon, it is something that must happen at some stage. And when it does it will become a lot cheaper for Chinese companies to buy western assets – such as mines – or the companies that own them.
So what does all this mean for investors? Well, trying to fight this trend will be as useless as the mystical warrior who tried to wage war on the ocean. But this doesn’t mean that western firms are doomed to oblivion. A more intelligent response would be to ride the wave, rather than be inundated by it.
This may involve dealing directly with emerging markets – that is, selling them the coal that they need to industrialise, or catering to the rapidly growing Chinese tourist market. However, for many more firms it will involve capitalising on the changes wrought by this industrialisation process – whether it be the implications of a falling US dollar or the demand for quality assets by the sovereign wealth funds.
These are interesting times. Indeed, in some ways, what we are witnessing is not so much the rise of emerging markets but rather the end of emerging markets, as they finally join the ranks of developed nations.
03 - Lars Seier Christensen
Saxo Bank, Copenhagen
State of play
Economically, I see a paradigm shift taking place – away from the US and towards Asia. This is best illustrated by the new dominant force in the markets – the large governmental funds known as sovereign wealth funds (SWFs).
SWFs are state-run investment funds created by countries that have large current-account surpluses, often derived from a wealth of natural resources such as oil (or, in the case of countries like Singapore, from pure current- account surpluses). It is projected that SWFs will swallow up between 5 and 10 per cent of all equities within the next three to four years. The biggest SWFs come from Australia, Alaska, Brunei, China, Kuwait, Norway, Russia, Saudi Arabia, Singapore, South Korea and the UAE.
With Asia in the ascendant, the US is set to gradually lose much of its financial muscle due to decades of overspending. It will be burdened with higher funding costs, because the “surplus” world – Asia and the Middle East – will increasingly direct its money towards Asia and will, in the future, change the composition of assets from being mainly fixed income to a more balanced approach between equities and fixed income.
The combination of SWFs and the re-emergence of stocks as a bigger part of everyone’s portfolio will have a significant impact. Banks with no borders, such as Saxo, should be able to respond to these changes quickly by focusing on technology and keeping costs low, and will be better positioned than major investment banks that largely cater for the G12 and bigger EMG (Emerging Market Group) countries.
As we see the balance of power shifting from the US towards Asia (which, simple demographics dictate, will also be the continent that sees the largest future growth in population), banks will seek to position themselves accordingly. We have already opened a regional hub in Singapore to cover trading in that time zone, and are also considering other suitable locations across the Far East and Middle East.
Many will call for the liberalisation of the relatively inaccessible Asian stock markets – and Saxo intends to be at the forefront of any such developments, in line with our goal of being leaders in technology and our respect for the growing economic importance of Asia.
Access to closed Asian markets will probably come as part of a deal to allow SWFs to place their capital in such markets, which should act as a massive driver of volume in Asian and Middle Eastern stock markets.
As well as these major changes in the long-term economic balance of the world, we’ll also see increasing sophisticaion among investors, and a strong trend in favour of self-empowerment. The typical investor will demand more transparency and more influence on their investments and trading activities, which will lead to increasing use of derivatives. It will also result in more money finding its way into relatively new areas, such as foreign exchange.
These changes to the flow of capital and investment patterns will challenge the established market players and business models. At the same time, they will present exceptional opportunities for new, more flexible financial institutions that can meet these challenges without being shackled to traditional, more expensive business models.