RYK VAN NIEKERK: The coronavirus is disrupting all aspects of our society. It has changed social interaction, prospects of countries, and economies – and the effects may be felt for generations to come. It is as if the new normal of the future still needs to be properly defined. Michael Power is a strategist at asset management group Ninety One, he’s also one of South Africa’s premier futurists. Michael, thank you so much for joining me. We have seen many events that have changed the course of history. The coronavirus is surely one of those events. It is just unbelievable how fast it is changing the way we work, live and play, and probably the way we invest. Can you contextualise that?
MICHAEL POWER: Yeah. I read this morning, Larry Summers [former US Treasury Secretary] called it a hinge, and he likened it to the assassination of Archduke Ferdinand, which not only obviously set off World War I but brought about the end of three empires and completely, as it were, ended the previous century and started the 20th century, and brought us into a completely different world. I think the coronavirus is going to do exactly that. It’s like that shot that was fired in Sarajevo and a whole new world is arising.
RYK VAN NIEKERK: That new world you are talking about, we will have to live in that world. How do you think it will look?
MICHAEL POWER: Well, it depends to some extent who we are. Now that might sound like a grand statement, but I think that the ‘old world’ is going to live in a very different and much tougher environment than they’ve been able to enjoy for the last 100 years or so. The new world – and here I’m thinking particularly of Asia – is, after a period of adjustment and obviously a period of recovery, going to move into a far more privileged space in terms of its standing in the global economy. And I think that here in South Africa for instance, our job is going to have [to be] to rearrange ourselves, our economy, how we think around the fact that the centre of economic gravity is moving away from the West to the East, and an East centred on China.
RYK VAN NIEKERK: That is a very, very interesting perspective. How quickly will this happen?
MICHAEL POWER: Probably in some respects quicker than we realise. For instance, Yuval Noah Harari in the Financial Times wrote an amazing essay a few weeks ago in which he said, and I paraphrase:
‘Pandemics fast-forward history.’
I had, as an original forecast, sometime around 2028/30 when the Chinese economy would overtake the US economy in size. I think that’s now going to happen within the next three to five years. So some aspects of that will happen very quickly, but institutional memory takes longer to adjust. And so we’ll probably think we’re living in a world that’s still dominated by the West when, in reality, the centre of gravity has moved to the East. So in certain respects it’s happening [and] in certain respects, it’s already happened.
Think about own trade relations here in South Africa – who is our number one trade partner, both in exports and imports? It’s China. Even if we do pay a lot of attention, for instance, to what happens every day on Wall Street.
RYK VAN NIEKERK: Well, as soon as five years the Chinese economy could surpass the US economy, but that would mean that there will be a significant change in the whole world economic dynamic.
MICHAEL POWER: There is already a significant change in the whole world economic dynamic, but I think it’s just now being reflected more in trade than it is in finance, and finance is going to have to catch up with what’s already showing in the world of trade. As I say, institutional memories take longer to change and the way that we’ve all – we, you and I – been brought up to think is going to have to change, and it’s going to be tough for us to change. Take for instance our infatuation with the dollar. It’s as if when it comes to international currencies, we only speak one language, dollar. Well, we’re going to have to become bilingual. We’re going to have to become fluent in the dollar and in renminbi, and that’s going to be tough to learn for many of us, especially someone like myself who’s now in his 60s.
RYK VAN NIEKERK: Do you believe any of the conspiracy theories that there’s more to this virus than just merely someone eating a bat?
MICHAEL POWER: I think it extremely unlikely, and every epidemiologist and virologist in the world has essentially said this does not in any way look like something (a) that was manmade and (b) that didn’t transit from the bat through another animal species into humans. All of that suggests that it would actually be extraordinarily difficult to engineer on the part of the Chinese. And I’m afraid I’m even not listening to the Chinese of course who deny it, but listening to the virologists, listening to the WHO [World Health Organisation], listening to everyone except conspiracy theorists on the right and probably Donald Trump in the United States. There are not many people out there who are serious commentators who believe that this is some vast Chinese conspiracy.
RYK VAN NIEKERK: Let’s talk about money in this new world order you have described, obviously this will change investment strategies. What do you think will be the main themes of this new investment world?
MICHAEL POWER: First of all, I think that even in Europe and United States, to the extent that the latter is going to be allowed to by Donald Trump, you’re going to see institutions starting to diversify away from an extraordinary concentration on the West to have at least some or greater exposure to the East. I mean, the All Country World Index at the moment, which is the main global index, is still over 50% geared towards the United States, even though the US only has 4% of the world’s population.
So there’s going to be some rebalancing of investment and that’s going to happen in part because the growth is going to be in Asia and not in Europe and the United States. So I think that anyone who is actually making hard decisions about where it is they’re likely to seek capital gain, admittedly after a period of convalescence and recovery, but within three years, is going to start moving quite a substantial percentage of their portfolio, both fixed income and equity, out of the West and into the East centred on China.
That’s exactly what happened previously when the British ruled the world. When their time was up, people started moving their money substantially to the United States – interestingly, led by the Brits themselves, who in 1914 owned about 25% of the New York Stock Exchange.
RYK VAN NIEKERK: But that process took decades.
MICHAEL POWER: It does take decades. I think that it’s still going to take time, but I don’t think it’s going to take anything like the sort of decades that it took then. I hope, God forbid, there is no war like there was to some extent that bookended periods in history previously, but I do think that we are going to see, I mean the fact of the matter is that China has the second-largest stock exchange in the world and that’s still because a huge percentage of that stock exchange is not actually measured in the indices.
The reality is that we’re really going to have to start thinking very hard about the way in which we are concentrating our portfolio in parts of the world that are not growing and underweighting our portfolio in parts of the world that are.
RYK VAN NIEKERK: But it will take a brave investor to move out of the dollar at the moment, especially to, you know, [the] Southeast Asian market, because the dollar currently has been seen as the mainstay, the go-to asset class at the moment …
MICHAEL POWER: I think that’s a sort of, yes, I think it’s just a safety move. I mean, to some extent. Like gold. And of course gold – that even outperforms the dollar. But don’t think that the Chinese markets have not done well this year. They’ve done better than Wall Street. So, and we know this to some extent, we’ve always got that strange way of having an insight into what’s happening in the Chinese markets through our exposure via Naspers.
The reality is that we are seeing money, third-party money, starting to move out of the West and into the East. Obviously this is not the time to be super brave, which is why I say there probably needs to be a period of convalescence and recovery.
Okay, let’s fast-forward to 2030 when it’s clear that the Chinese economy is larger than that of the United States, do you really think that the US at that stage should still have 54% of the All Country World Index?
RYK VAN NIEKERK: No, probably not. But again, you know, we need to balance uncertainty and future changes in the world dynamic, and I don’t think that is an easy exercise to do.
MICHAEL POWER: Not at all, and I don’t claim it to be, though I have to say the one thing I would say to your comment there is that while there may not be a great clarity arising with regards to what you say with regards to Asia, what we have seen is a clouding of risk and a clouding of understanding when we look at Europe and the United States. And that’s been both political and economic. So this whole process isn’t just because China or Asia is looking better, but in part, because the West is not looking nearly as good.
RYK VAN NIEKERK: That is interesting. So are asset managers appreciating this changing dynamic?
MICHAEL POWER: I think they are. I think that, obviously not all, but you’re definitely seeing, I mean JP Morgan has 100% control of its asset management company within China, even in the last three months, even as all of this was happening. So yes, just as we saw – and JP Morgan is an interesting one to mention; of course, Morgan & Co was originally set up by JP Morgan’s father in London and his job [the father’s] was to shovel money from Britain to the United States to his son, JP, as it was realised that the growth differential between what was happening in the United States and what was happening in the UK suggested that it was important for money to start migrating out of Britain into the United States.
RYK VAN NIEKERK: What does this mean for the European Union?
MICHAEL POWER: I’m afraid, I mean, separately, I have always been somewhat sceptical as to whether the European Union will ultimately be possible if a monetary union wasn’t also accompanied by a fiscal union. Up until now, that distinction has led to cracks, which have been papered over by comments like ‘we’ll do whatever it takes’ on the monetary side and they’ve been able to get away with it.
The reality is that many of the cracks have now turned into chasms that cannot be papered over. And I do think that we are now facing a particularly rough period over the next five years and whatever the bureaucrats of Brussels say in whether, first, the eurozone can hang together, and secondly, if the eurozone fractures, what consequences that’s going to have on the European Union itself. I think indeed even this summer we’re going to see some of that come to ahead. And I say that because the countries that are in the worst shape in Europe, and not everyone is in any good shape at all, but the worst are the southern European countries, Italy, Spain, Greece, Portugal, and broadly speaking, they get 50% of their GDP in the four months of summer, three and a half months probably. There’s not going to be a summer in the sense of tourism this year.
It’s a bit like a farmer whose crop failed. Their crop is going to fail this year and that’s going to exacerbate the problems that are already there to an extraordinary degree. So I always say rather than use the Game of Thrones ‘winter is coming’, for the Europeans, it’s not winter that’s coming, it’s summer, and that’s really going to expose the fact that southern Europe is in a very, very, very bad space. I think that potentially Italy could leave the euro and if Italy leaves the euro, that’s going to put enormous pressures on the European Union. The northern Europeans are really starting to get annoyed to some extent with the southern Europeans. They’re bailing them out, they’d been them out for the last decade. And I think that they’re probably … [their] patience is starting to run out.
RYK VAN NIEKERK: We are obviously going to see a lot of change in the near future. How should you approach asset allocation within this whole changing environment?
MICHAEL POWER: Well you make a very, very good point. I think that asset allocation is going to be the singular most important skill that an asset manager needs to cultivate. And it’s all very well and good to be in your silo of fixed income, in your silo of equities, and then a couple of other silos besides, but how you actually blend this together and the weights that you give each of those parts, is actually probably going to be the greatest skill of the coming decade. And I would add a layer over that, which I’ve already alluded to, there’s a currency dimension as well.
So it’s not just asset allocation, it’s the geographic allocation and then asset allocation within that.
And that, I think, that skill is not an easy one. To some extent, what’s going to happen, and giving away the secrets of our profession, is that whatever index it is that you’re being measured on, you’re going to try and push as fast as you can towards what you think will be the new world without going so far from that index as to have an asset allocation that is unrecognisable.
But that is going to mean that the likes of MSCI and S&P and the FT, the people that run the indices are going to have to start to adjust to the realities of what is now emerging. I mean, still having Taiwan and Korea in the world of emerging markets is an absolute anachronism. Korea is the 12th largest economy in the world. It’s bigger than many European economies that are in the Developed World Index. But there’s something strange in the way that MSCI in particular constructs its Emerging Market Index. Can you imagine, let’s say stay with a tenure profile by 2030, China’s the largest economy in the world and still classified by MSCI as an emerging market. That’s just absurd. I mean, it’s already 42% of the index and collectively Asia is 80% of the index, leaving us in Africa, Russia, Eastern Europe, Latin America combined [at] 20%. So emerging markets, even as a name, is increasingly becoming corrupted if you think it represents everything outside of the developed world. Because in large part, huge parts of the so-called emerging markets as defined are actually developed.
RYK VAN NIEKERK: Does that mean that you suggest that active management is the way to go?
MICHAEL POWER: Yes, I think so, but on two levels. I think, first of all, active management as we’ve just been talking about in asset allocation, of course. But secondly, even within, for instance, stock selection and indeed fixed income selection. The reason I say this is because going back to where we started, I think the coronavirus has rendered huge waves of the sector basically dead or close to death, or essentially living on a lifeline that is provided by the government. I mean cruise liners, I mean hotels, airlines and the travel business generally, and I can go on, there are plenty of others, bricks and mortar retail, banks without the support of their central governments. These are sectors that are extremely difficult to value at the moment and they only exist because the government supports them.
So I think that you can, if you’re looking at, for instance an index ETF [exchange-traded fund], an S&P index ETF, you can see there are 11 sectors in the S&P, five or six of those sectors are really not going to go very far over the next five to 10 years and you can probably structurally underweight them though tactically every now and again you might want to be overweight, for instance energy. Broadly speaking, you can see very clearly which of the winning sectors over a five- to 10-year period [will be] and which are likely not to be able to keep up. That then takes you back to being a stock selector, stock picker. You really can be active in such an environment where there is such a huge change going on.
RYK VAN NIEKERK: What do you think are the prospects for other emerging markets like South Africa within this changing dynamic?
MICHAEL POWER: Well, let’s leave Asia out of this, although again, even making the generalisation of Asia covers up a wide variety of countries from Pakistan to China, but let’s assume non-Asia in that question. I think it’s going to be all about how we reorient, and I use the word deliberately, economies and indeed our understanding of how the world works towards Asia.
Do remember that China has been the largest economy in the world for 25 of the last 27 centuries.
This is only a status quo ante being restored after what Deng Xiaoping called ‘200 years of forgetfulness’. We are basically going back to the way it was before and we in South Africa have to wake up. We’ve done so already in terms of our trade orientation, but in terms of almost our psychological orientation, wake up to the fact that the centre of economic gravity is moving to Asia.
Let me give you a stunning example of that. In the 15 years that ends to 2030, the middle classes of the world will probably rise by about 1.5 billion people. Of that 90% will be in Asia. In fact, the middle classes as defined in Europe and the United States, in numbers terms, will actually decline. So we have to, here in South Africa, recognise that the growth, not just in terms of where we have traditionally or least traditionally in the last 10 years tended to source things from, but where demand is going to grow, where the consumer is going to grow, is going to be Asia too. That leads us to make a very, very different sort of orientation. I think that to the extent that South Africa, most of Latin America, maybe not Mexico, Russia, the Middle East, can reorient themselves, will be a marker of how successful they’re likely to be.
RYK VAN NIEKERK: Michael, thank you so much for sharing your insights with us today. That was Michael Power. He is a strategist at asset management group Ninety One.
Brought to you by Ninety One.