Red-Headed Stepchild

“Just about everything in the investment world can be done either aggressively or defensively. In my view, market conditions make this a time for caution.” – Howard Marks

In the red ocean of the internet, fake news and clickbait-y articles abound to such an extreme these days that the line between fact and fiction has been greatly blurred. I’m not going to jump down the rabbit hole of “conspiracy” theories today, but suffice it to say that most of the news you read or hear out there these days is just noise. The average American’s perception of current world affairs is vastly different than what is actually happening and as investors, it is our jobs to sift through the noise and make sense of what is actionable and what is not.

I fully embrace this divide. It is, after all, why arbitrage opportunities still exist. If everyone in the world had perfect information, then all assets would be priced to perfection and no one would actually make any money. A couple weeks ago I woke up to a pretty clever Bloomberg headline:

Source: Bloomberg

As someone who digests information flow religiously and more or less for a living, I’ve developed a pretty good sense of what is real and what is just outright bullsh*t being peddled by mainstream media. Financial media is particularly guilty of this crime which cost many innocent citizens a lot of money during the last financial crisis.

Anyone who follows Howard Marks knows that the clickbait-y headline above is only the second half of his usual narrative. Bloomberg just so happened to extract it out of context and make a nice, highly viewed article out of it.  The first half of Marks’ mantra (which Bloomberg conveniently left out) has and always will be to take a staunch value-oriented approach to investing and to always operate conservatively with a margin of safety before jumping into a trade.

That all said, when the proverbial blood hits the streets and fear is in the air, savvy investors who have done their work ahead of time (I can’t stress this requirement enough…and by the way it doesn’t entail eyeballing a few charts and checking the RSI…I’m talking about real, deep work…), will know when the falling knives are actually close to hitting the cutting board and they would jump into undervalued assets accordingly.

I can’t help but think of Emerging Markets when I think of falling knives. Concerns over the US-China trade conflict and the pace of US interest rate hikes have continued to dominate investor sentiment in the past few weeks, leaving EM looking like the red-headed stepchild at the 7th-grade dance. Adding fuel to the fire has been the recent Apple “sneeze” and of course the weak Q4 2018 economic data out of China where the country recorded its weakest quarterly growth since the global financial crisis. Both industrial production and retail sales slowed which prompted policymakers to respond with measures to boost the economy which included the cutting of banks’ RRRs and measures to relax the credit supply for SMEs and private corporations.  China’s stock markets were down over 30% last year so if there ever was a falling knife, this most certainly was it.

China looks a lot different than it did 10 years ago during that last major global financial crisis but there is no denying that the negative news (whether real or not) is affecting real investor sentiment at the moment. But sentiment aside, it’s important for us to look beyond the noise put out by the mainstream media and investigate what’s really going on.

It has been my contention for quite some time that the trade conflict between China and the US will ultimately be beneficial for Asia overall, but particularly for China as a county at this point in history. After the last 40 years, China has now entered into a new stage of countrywide reform.  I believe the pressure from the US will spur greater innovation, open more access to markets and curate a higher level of intellectual property than the world has ever seen before. China has been aggressively shifting its economic model to be less dependent on exports and more dependent on domestic consumption and demand for services. With President Xi fully in control for the foreseeable future, his administration has actively been rolling out measures to promote private enterprises including a swath of tax cuts aimed to support a private domestic demand agenda.  

China will for the next few decades own the largest consumer market in the world. The growth of the country will offset any of its neighboring countries offering lower unit labor costs of production. China’s consumer internet will continue to grow led by industry titans Alibaba and Tencent who are actively leveraging the country’s deep social and mobile payment networks.  In the private markets, there are clear signs of optimism including large global investor Lightspeed Venture Partners (an early investor in Meituan and Pinduoduo) who recently announced their largest-ever China dedicated fund with US$560mm committed. One area that I am keeping a close eye on is education. China currently spends 4% of its GDP on education and as a father of three young children, I can attest to the fact that this demand will only continue to grow exponentially in the future.

Another region that I remain excited about this year is Southeast Asia. The region is home to 650mm people of which 350mm are internet users.,  This provides a strong macro backdrop for growth in the coming year. Some of the thematics that are on my radar include online travel, e-commerce, online media, ride-hailing, and food delivery on-demand services.  Ride-hailing received a lot of attention last year after Grab acquired Uber’s local business in the region and Go-Jek, which is Indonesia’s rival service, continued to gain market share in Southeast Asia. Both Grab and Go-Jek also offer food delivery and on-demand services to round out their product offering.

Indonesia, a small country of 265mm people which is comprised of over 13,000 islands, is at the top of my scouting list for opportunities. E-commerce and logistics are two areas that are undergoing massive disruption at the moment as income levels and internet/mobile penetration continues to see explosive growth. Companies such as Tokopedia (backed by SoftBank/Alibaba), Bukalapak, Shopee (backed by Tencent) and Lazada (backed by Alibaba) are all aggressively aiming to tackle these two rapidly expanding segments. All of these companies aim to use their local knowledge and network of offline intermediaries to gain market share.

A new year always brings with it new innovation and a fair share of expectations from investors. As China sets her course for the future and Southeast Asia continues to mature, Emerging Markets will eventually recover spurring higher commodity prices across the board. The supply issues of the region will not be going away any time soon and when the overall consensus is negative for a prolonged period of time, great investment opportunities arise. I remain excited to sit in a front row seat to witness the great innovation this new year will bring, tactically positioning myself to catch the proverbial falling knife.