Regional views

A new chapter for China's e-commerce sector, French reforms’ effect on equities, and more weekly insights from around the globe.



New chapter for China's e-commerce sector

China's e-commerce sector is one of the country's greatest success stories. In the late 1990s, when much of the developed world was already starting to buy goods online through platforms like Amazon or eBay, shopping in China was exclusively done with bags in hand. Few had personal computers at home, and even fewer had direct internet connections. Instead, people had to sit in internet cafes or seek out other public areas. Moreover, the only e-commerce sites were for businesses.

But things started to change rapidly in the 2000s. Around the turn of the new millennium, consumers were finally able to shop online. Alibaba's Taobao, the country's first customer-to-customer (C2C) model, launched in 2003. Jingdong, now called, established its business-to-customer (B2C) platform to rival Amazon's in 2004. Foreign capital was pouring in, and other domestic players were entering the market. This period of accelerated development coincided with robust government support – e-commerce development was earmarked as a priority in the 2007 Five-Year Plan – and brisk internet penetration growth; by 2008, over 300 million people were connected to the internet.

Fast forward a decade, and China's e-commerce sector is the world's biggest (it overtook the US this year). The country's over 800 million internet users transacted CNY 28.9trn worth of goods in 2016, according to the UN, and broke a single-day record for online sales (CNY 120bn) on 11 November 2016 (Singles' day) – it broke it again on the same day in 2017 and 2018, with the latter figure topping CNY 213bn. The McKinsey Global Institute estimates over 40% of e-commerce transactions worldwide are happening in China; its share was less than 1% just a decade ago.

Now, after 5–7 years of fast growth (about 40% CAGR), the sector is opening a new chapter as it shifts focus from top-line growth to better efficiency and margins – and we believe this transition will be positive for its long-term development. With e-commerce penetration saturated in the bigger first-tier cities, online leaders are increasingly expanding into the relatively untapped lower-tier markets. They are also using artificial intelligence to boost gross merchandise value, leveraging their user base to cross-sell between platforms, offering cloud and other digital services to third-party merchants, and entering new verticals like travel booking, food delivery and personal finance.

The 4Q18 results season, where top players beat expectations, shows that online operators have been able to deliver better-than-expected margins by controlling costs and leveraging new investments. So, while the sector has entered the mature stage in its lifecycle, one defined by slower growth and lower profit margins, we still forecast above-market earnings growth rates for the top players (over 30% CAGR from 2019–2021E) and the sector overall (25% CAGR).

Our earnings outlook would make e-commerce the fastest-growing segment among Chinese sectors over this time horizon, and it represents a 15ppt premium over our earnings forecast for the benchmark MSCI China Index. Yet the valuations of the top players are lower than international peers in price/earnings-to-growth terms (0.66x vs. 1.4x), even after this year's rally. Hence, we find the sector's medium- and long-term prospects to be attractive from an investment perspective.


Eva Lee, CFA, Analyst


Emerging Markets

Argentina: A brave new world post-primary elections

Since the victory of the Alberto Fernández–former President Cristina Kirchner ticket over incumbent President Mauricio Macri and Miguel Pichetto in Argentina's 11 August primary election, the political outlook in the country has changed markedly.

Our 19 August report "Investing in Emerging Markets – Argentina: Post-primary scenarios and investment implications" outlines four possible scenarios for the outcome of the 27 October presidential vote. In the first, Macri stages a comeback and wins the election. The other three focus on Fernández-Kirchner prevailing: in 2) a moderate Fernández pursues pragmatic policies; in 3) an extended power struggle breaks out among the various factions of the Fernández-Kirchner coalition, with erratic policy making ensuing; and in 4) a radicalized Kirchner calls the shots.

Since the primary, the likelihood that Argentina will have to restructure its debt has increased across the scenarios. The damage that a restructuring would inflict on bond investors increases as we go down the list of them, as does the likelihood of it occurring.

A sovereign debt restructuring can be necessitated by a lack of liquidity, unsustainable debt dynamics, or both. Although the Argentine sovereign's liquidity position the rest of this year looks more challenging now than it did just months ago, the situation should be manageable even under conditions of moderate stress, in our view, as long as the planned IMF disbursements take place. In the next two years, however, conditions look more demanding. Even if the government is able to deliver a primary fiscal surplus, a financing gap may emerge unless the private sector absorbs USD 17bn of foreign currency-denominated bonds next year and USD 25bn in 2021 – a tall order under a market-unfriendly administration.

In terms of solvency, three conditions need to be met for Argentina to attain debt sustainability: 1) consistent real GDP growth above 2%; 2) regular primary fiscal surpluses; and 3) real exchange rate stability. The Achilles' heel for Argentina's debt sustainability is the last condition. Before the latest round of ARS weakness was triggered by the primary election results, the share of total sovereign debt denominated in foreign currencies stood at a very high 78%. Given this debt composition, shocks are amplified: as the economy deteriorates and the local currency weakens in real terms, the cost of servicing the debt increases. Under a sustained real exchange rate shock, public debt dynamics can quickly spiral out of control.

While a run on banks in the current uncertain political environment cannot be ruled out, particularly in a country with a traumatic history of bank runs, our analysis shows that a sovereign restructuring need not go hand-in-hand with a banking crisis, since Argentina's financial system is on relatively solid footing.

For global investors, the dramatic stress that Argentine assets experienced last week offers two important lessons, in our view. First, that emerging market assets continue to mature, with investors able now to distinguish between the various situations that countries face – i.e., a domestically induced crisis in one need country not spill over to others. And second, diversification outside of one's home country is crucial. Bridgewater offers a list of countries that have experienced equity market drawdowns of more than 75% over the last century: Russia, Germany, Korea, Italy, the US, Taiwan, France, Spain, Sweden, New Zealand, Canada, Brazil, and Japan.

For more information, please refer to our Investing in Emerging Markets report published on 19 August and entitled "Argentina: Post-primary scenarios and investment implications."


Alejo Czerwonko, Emerging Markets Strategist Americas



French reforms - little impact on equities

Last week I argued that French President Emmanuel Macron’s reforms since being elected in May 2017 have been a step in the right direction. But many of them will take time to boost French GDP (e.g., the proposed new pension system, which will be debated next year, would not take effect until 2025) and more anti-reform protests are likely in September, after “la rentrée” (the start of the school year).

What do the reforms mean for French equities? Their impact on the domestic economy should, ultimately, improve the overall well-being of the populace, but their effect on the French stock market is likely to be marginal. There are several reasons for this.

First, history reveals no meaningful correlation between French GDP growth and how French equities fare. A full 68% of MSCI France’s revenues are generated outside the country, so factors like global growth, international trade (think of the ongoing US-China trade frictions and Brexit woes), interest rates, and foreign currency movements are more important drivers, at least for French large caps, than the domestic economy.

Second, the French stock market does not represent the French economy. Luxury goods make up 12% of MSCI France, while the industry accounts for less than 1% of the country’s GDP. Similarly, energy accounts for 8% of total market capitalization, but the oil and gas industry is negligible at the macroeconomic level.

Third, societal and economic changes have a bigger impact on the composition of the equity market than on the make-up of domestic GDP. Take luxury goods again: the sector’s index weighting has quadrupled, from 3% 15 years ago to 12% today, a change much larger than the one at the GDP level. This contrasts sharply with the weighting of the French car industry, which has remained stuck at 4% of MSCI France over the same period.

This dramatic change in sector weighting, by the way, reflects the rising economic inequality that has been an unintended consequence of central banks’ exceedingly loose monetary policies since the Great Financial Crisis in 2007-08.

From a market perspective, such shifts in sector bias make historical valuation comparisons less meaningful as well. The soaring importance of the high-growth luxury goods sector to the index and the structural decline of, say, the no-growth financial sector (it has shrunk from 18% of MSCI France in 2004 to 10% today) implies a higher market price-to-earnings (P/E) ratio today than 15 years ago, all else equal, simply because growth stocks trade at above-average P/Es.

All in all, French reforms are welcome from an economic perspective, but are likely to have a very limited impact on the French equity market, especially in the near term.
We have a neutral stance on French equities in our Eurozone country allocation and, within international developed stocks, recommend an underweight to Eurozone equities.


Bert Jansen, Strategist


United Kingdom

Slightly weak second quarter earnings season

With global and UK economic growth having weakened of late, investors have looked to second-quarter results to judge how this is affecting corporate profits.

UK quarterly earnings data is always to be taken with a pinch of salt, due to the small sample size (not all UK companies report quarterly, and of those that do, not all have a consensus quarterly number available to compare against; not all companies have December year ends either).

However, on average UK companies have missed earnings expectations by about 3% for the second quarter. Energy missed expectations in aggregate on disappointing upstream and refining, but some companies managed expectations into numbers better than others. Materials also missed expectations. But Healthcare exceeded expectations thanks to slightly better top-line results because new products have done better than expected, as well as some currency benefits. The banks sector has been mixed, with some mortgage competition domestically, but also some currency gains for those with international exposure. A continued focus on costs, cash returns and some management changes also influenced the shares.

At a sector level, expectations coming into the earnings season were clearly reasonably cautious. Most sectors demonstrated flat or positive performance on the day overall even if at a sector level earnings may have missed. Once again, it also reminds us that the market moves slightly ahead of earnings and remains focused on cashflow generation and the ability of companies to reward shareholders with dividends or share buybacks.

Overall, perhaps unsurprisingly, the slightly weaker earnings season is a result of the weaker macroeconomic backdrop, but companies are not reporting conditions to be nearly as bad as the bond markets would have you believe.

We anticipate low-single-digit earnings growth for the MSCI UK earnings in 2019, and believe consensus is broadly on track with that. Clearly sterling, oil and the global growth outlook will continue to influence the future direction of earnings for the UK equity market.

On a tactical basis we are neutral on UK equities versus other regions. Valuations look attractive but this is offset by the lack of earnings momentum, and comes coupled with weak sentiment around Brexit uncertainty.


Caroline Simmons, CFA, Strategist


United States

Tapping into Seattle

While in Seattle this past week for a work-related event, I was fortunate enough to engage in three separate conversations that provided me with differing perspectives on the current trade dispute. The first of these was a client who is an owner of a small business that is dependent upon overseas sourcing of products as part of their supply chain. The second was with a financial advisor who had just recently listened in on the earnings call of a major technology company. The last was with the sales manager for a mid-size industrial company that both produces and distributes their products domestically. While all acknowledged the importance of escalating trade tensions between the US and China, each viewed the impact quite differently.

Let me begin with the client. At the conclusion of a presentation to a group of our clients in Bellevue, one of the attendees approached me to share the story of how his company was being heavily impacted by the trade dispute. He noted that the tariffs themselves had not only significantly added to his business costs, but were also creating disruptions to his access for certain types of products. He further mentioned that the uncertainty over tariffs and other potential retaliatory trade measures had cast a chill over spending decisions and also negatively impacted his hiring plans.

My conversation with the financial advisor had a different tone. According to the advisor, one of the world’s leading technology companies that manufactures, sells and services both software and hardware products disclosed on an earnings call with analysts that the impact from current and proposed tariff measures on its own profitability would be limited and manageable. It appears that the company has been moving aggressively in recent years to diversify its sources of production to reduce dependence upon any one country or region. Likewise, as a global distributor it is also less reliant upon any single economy for revenues. So while the trade conflict is having some impact, the pre-emptive steps taken by the company have limited the scope and scale of the damage.

My final encounter with the sales manager differed as well in two regards. First of all I met him while I was grabbing dinner at the bar of the Tap House Grill in downtown Seattle while watching the Mariners game rather than a work function (160 beers on tap; largest collection of local craft brews in the Pacific Northwest; 30 flat screen TVs all tuned into sporting events – enough said). But more importantly, his take on the trade dispute was a bit more upbeat than my prior two conversations. Rather than being negatively impacted by the tariffs, he was seeing increased interest in his product and a modest pickup in orders. While he acknowledged that some of this regular customers were more cautious amid broader economic uncertainty, he noted that this was more than offset by new customers. So overall his business had improved modestly over the past several months.

Although my encounters all took place in the Pacific Northwest, I suspect others have had similar experiences across the country - which helps to explain both the mixed economic data and divergence in market performance. This is because assessing the impact of tariffs and trade-related retaliatory measures on such a complex and diversified economy as the US isn’t as straightforward as it may seem. While we may be able to quantify first order effects, the second and third order effects are far more significant and therefore more difficult to capture in GDP forecasts and earnings projections.

Despite the limitations in trying to quantify the effects of rising trade tensions, these types of conversations can still provide us valuable insight with regard to both the overall economy as well as specific sectors.

First, the longer the trade conflict goes on and the greater the escalation, the more significant and widespread the effects. Second, multinationals with greater flexibility in diversifying their supply chain options and revenue sources have a better opportunity to weather the conflict. Third, smaller operations that have built their business models upon lower cost products from China are especially exposed. Fourth, while domestically focused companies may benefit from a trade fall out in the short run, the health of the overall economy could have a more significant longer-term impact upon their fortunes.

Although unrelated to the current conflict, I also learned that while Seattle may be saddled with a pretty mediocre baseball team, it is also blessed with some of the finest craft brews in the Pacific Northwest. And that seems like pretty fair trade to me...


Michael Ryan, CFA, Chief Investment Officer Americas

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