Investment Manager Report
I hope you are all well and dealing with the COVID-19 pandemic and associated lockdowns as smoothly as possible.
First, I should say a little about how we are dealing with the lockdown as an investment team. It has, obviously, limited the amount of travel that our analysts and portfolio managers can do to see companies. However, we do have some colleagues in China, Hong Kong, and Singapore, who are able to relay to us how people are dealing with the pandemic there and across the region. Having gone into the crisis and lockdowns earlier than the U.S., these geographies are also emerging earlier. They are showing that the crisis can be dealt with—I will touch on that later. We are still able to do a large volume of company meetings—by audio and video conference calls. The IT systems at Matthews Asia were designed to withstand a crisis. We feared it might be an earthquake that closed the office not a virus; however, the investment team has had easy access to executives of portfolio holdings and non-portfolio holdings. Such access enables us to both monitor companies that are in our portfolios and search for new opportunities. As I scan my Microsoft outlook for this workweek, I see that we are expecting to do 15-20 meetings a day on average across the team, starting early in the morning and continuing late into the night, to catch the working day in Asia. These meetings provide information, the salient points of which we can share at a daily investment team meeting and in innumerable emails and phone calls between team members. Traders, too, have been able to execute trades with minimal disruption to normal working life.
And it has been important that we are able to maintain the flow of ideas and trading, as the crisis has created both new risks and opportunities as it has spread, and the effects have impacted the regional and global economies in different ways. I would like to try and trace for you the stages of the pandemic, as it has been reflected in the capital markets. In so doing, I will also outline how portfolio managers have tried to deal with each stage. Finally, I will try and outline the key risks we see going forward that are informing our efforts. There are three stages: the virus outbreak in Asia; its global spread; and the dollar panic. We can look at these through the lens of reactions in the equity, bond and currency markets.
The first stage, starting from the beginning of the year and lasting until about the third week of February, saw the virus largely contained to China; within China, largely contained to one province. We looked to historical outbreaks to try and understand what was happening: SARS and Swine Flu offered recent examples. They suggested that similar outbreaks could be contained and that the actual economic impact of the virus would be minimal. Consequently, markets in Asia were weak but not acutely so; global equity markets were resilient; the dollar was stable, and bond yields were falling slightly, though that may have been due to somewhat tight monetary conditions. Throughout this stage, our portfolio managers were mostly looking at China as a place where we might find new ideas. Partly because of the impact of the virus, but mostly because we had already been optimistic that earnings in China were accelerating into 2020, and that government policy was likely to be supportive.
The second stage of the virus was its spread to other countries in Asia and ultimately to Europe and the U.S. This hit equity markets hard. Bond yields came down, too, as the impact of entire countries facing lockdown started to be factored into prices. The dollar weakened—this was a good sign, as it meant that there was still liquidity in the global system. This period of the crisis offered up opportunities in Korea and perhaps even more so in Japan; portfolio managers also cast their eyes to some of the multinationals that derive a large portion of their sales from Asia. The focus was on consumer sectors and areas such as tourism and retail that had been directly hit. We were able to buy quality businesses that had always seemed too expensive, but were now trading at reasonable valuations.
The third, and most acute, stage of the crisis began over the weekend of March 7th and 8th—a dash for cash, a dollar panic. The following 10 days or so saw global equity markets tumble, as bond yields rose and the dollar strengthened. This was a true panic; investors were selling anything to own U.S. dollars. Although this was the most acute part of the crisis, fortunately, it was also the most easily solved. If there appears to be an almost infinite demand for U.S. dollars, we have at least the Federal Reserve that is able to create an infinite supply at zero cost. The Federal Reserve quickly met the demand and the panic was over. It was, however, the period when portfolio managers were perhaps the most active within the portfolios, as we were able to get some real bargains.
We did emerge from the fog of this panic with upgraded portfolios on the one hand and an ability to make thoughtful assessments of how the lockdowns across the world might impact businesses in the portfolios. There are three basic risks I see: first, the risk that panic returns, which is likely to affect India, Indonesia and Australia as current account deficit countries. It would also impact Japan, where the financial sector, through the insurance industry, is also exposed to a strong dollar. But such a panic would be short and easily quelled. There are the economic impacts of the lockdowns—likely to be most severe in Europe and the U.S., and in places like India, where lockdowns were announced relatively late and the virus may already have taken hold. Finally, there is the risk that some areas will be more constrained in their ability to use fiscal policy to offset the effects of the lockdowns. I worry about Europe's ability to coordinate a sufficient response. The U.S. has done a good job. The need for fiscal stimulus will be much less in Asia and I would expect most governments in the region are able and willing to respond appropriately. India, once again, though, looks to be more limited in its ability to respond. Finally, it is important to note that some businesses may be asked to help ease the frictions in the economy—banks may forgive interest payments and rollover debt; landlords may forgive or defer rent. These have to be taken into account when analyzing companies. We are already seeing some impact on the banking sector.
It is too early to know about long-term impacts of the pandemic and associated lockdowns. However, one thing seems to be emerging: China has been relatively isolated from the worst effects of lockdown; it is relatively well-placed to respond to weakening demand, and was never really affected by the dash for cash dollar panic. Global supply chains are going to see disruption, either through relocation of factories or increasing inventories. This is not the time to be trying to buy extremely cheap marginal business with high financial leverage. We are, however, keen to buy high-quality franchises which may be suffering due to operational leverage.
Finally, one last comment on the global macro. The pandemic might just be enough to tip Europe's stagnation into a Japanese-style funk. It is not inconceivable, too, that the U.S. may fall into a prolonged period of negative interest rates (they already are in real terms). The remedy for this would be for governments to issues large amounts of debt, purchased directly by the monetary authorities, to spend on social programs and minimum income initiatives. In such a world, China might stand out as the one large economy able to maintain aggregate demand through relatively traditional monetary policy. This is speculation at this point but it would be a world with tremendous reflationary policies at work and one where Asia might be able to prosper.
I have experienced more than my fair share of crises—that is what a career in Asia markets has meant over the last 25 years. We will get through this and I anticipate we will emerge stronger. The investment team will maintain a thoughtful but opportunistic approach to the environment; we take seriously the stewardship of your assets and revel in the hunt for good businesses at great prices.
Robert Horrocks, PhD
Chief Investment Officer