Quarterly Review of Asia's Markets

China and Asia are once again at the forefront of many investors' minds. Investors have taken notice of a potential resolution to the trade dispute with the U.S., the pause in Federal Reserve tightening and the curtailing of the U.S. dollar's rally, along with headlines suggesting China is looking to stimulate growth. In meetings with clients across Europe, Latin America and the U.S., I sense a renewed interest in the region as sentiment and momentum in the markets start to improve.

This makes me both happy and, on the other hand, wary. I have never really profited from thinking of Asia and China in terms of near-term cycles. Nor does it sit very well with the way my colleagues on the investment team run their portfolios. We aim to take a longer-term view of the region's growth prospects. So, let me try to analyze the recent market moves in a longer-term context.

To understand last year, we have to go back to 2017. In mid-2017, we had extreme differences in valuations between fast-growing and slow-growing companies. China had loosened policy and earnings were accelerating for the first time in six or seven years. There was momentum and bullish sentiment in the markets and often prices seemed to be pushed higher on news flow rather than fundamentals. Last year, this came to a screeching halt. Many reasons have been offered, but often those garnering the most headlines were the least important. First, the trade dispute: the actual effect of tariffs was largely to raise prices for U.S. consumers on some goods. There may have been a marginal change in sourcing some goods, which may have had an infinitesimal impact on China's GDP. Otherwise, effects are likely to include an accelerating of investment in Southeast Asia and a reorganization of supply chains—all of which can be used to benefit corporate China as well as its Southeast Asian neighbors. Wild swings in sentiment as markets priced in risks of extreme events certainly dominated the headlines and influenced short-term markets moves but were always likely to be transient.

A bigger issue was tight money in the U.S. We argued it was overly tight. That seems to have been the case. Yield curve inversion tells us that the bond market is worried about growth. Economies across Asia, though not forced to be tight, felt they had to be. This tightness led much of the region to a disinflationary savings surplus, with consumers living well within their means. And while this may have underpinned currencies, it was harmful to equity markets and credit spreads. On top of this, tight Chinese money was the real driver of weak markets. In some respects, this was not a deliberate policy. I don't think the Chinese were overly concerned with core inflation at 2.5% but they did take acute action to clean up bad debts and to restructure the financing of local government investment vehicles. Their policies soaked up reserves and this tighter liquidity environment of tighter money hit profits, demand and sentiment—and core inflation fell to 1.7%.