A shifting China has big implications 
Trade tensions between the US and China have gained significant attention, but other substantial shifts are also occurring in China which have important implications for Australia. Matt Gertken, BCA Research Chief Geopolitical Strategist, highlighted during session one of the Lipman Burgon & Partners expert speaker series last week that a slowdown in China’s growth is a historic shock.  Matt argues that China’s rapid growth, which has been a pillar of the country’s stability, is now over.

China’s rapid growth is gone
China Real GDP Growth (%)

On Friday, at the National People’s Congress, China formally abandoned a GDP target for the first time in decades. Rhetoric focused on employment and standard of living instead of hard economic targets. China faces unprecedented socioeconomic challenges, but its political response is becoming more rigid rather than flexible. This is well demonstrated by China’s decision to bypass Hong Kong’s legislature and impose its own national security law – something that is also gaining international attention. The global protectionist backlash adds to China’s woes.

China’s shifting focus has important long-term implications for Australian investors. China’s rapid economic growth in the early 2000’s drove the significant out-performance of Australia’s equity market, as commodity price increases fuelled resource company valuations.

Australia resource driven out-performance in early 2000's
ASX All Ordinaries Index and MSCI World Index

That phenomenon is unlikely to be repeated. This underscores why Lipman Burgon & Partners has increased client equity exposure to international markets in recent years, and is one of the reasons that we are likely to continue to do so.

Negative rates and asset allocation
Weak economic data has led to a growing debate about the potential for negative nominal interest rate policy to be adopted beyond Europe and Japan. Amongst central banks, the Bank of England and Reserve Bank of New Zealand appear most open to implementing a negative interest rate policy. The US Federal Reserve and the Reserve Bank of Australia (RBA) are resistant (at least for now).  Despite this, the market has begun pricing negative US Federal Reserve policy rates from 2021. RBA governor Philip Lowe says the “costs exceed the benefits” of negative interest rates. Importantly however, interest rates in Australia are below inflation, meaning that we already have negative “real” interest rates.

Assuming the RBA doesn’t fail dismally in meeting its 2%-3% inflation target over the next 10 years, an investment in a 10-year Australian government bond today yielding 0.87% is guaranteed to result in an erosion of purchasing power if held to maturity. Negative real interest rates are relatively new in Australia, having only been the case since early 2019.

The implications for asset allocation are significant.  When looking at the use of “safe haven” assets in a portfolio, we assess them on two factors:

  1. protection and
  2. cost.

Protection is about how effectively the asset helps to diversify your other portfolio holdings. Ideally, a safe haven asset will increase in value when equity holdings are decreasing (e.g. in a recession). The cost of holding the safe haven asset over time determines its impact on portfolio performance over longer periods, other than just the period during which it protects the portfolio. The advent of negative real interest rates has significantly deteriorated the safe haven properties of government bonds, as shown in table 1 below. We are considering avenues to address this issue for clients.

Government Bonds as a Safe Haven Asset
Real Interest Rates vs. Government Bonds