“Ivan’s Reflection” is my monthly investment note. The purpose of this article is to document my thought on stocks markets and investment ideas at this specific moment so I can review if they are right and wrong in the future.

The strategy I use is called Global Momentum Compass which I have developed over the years through my experiences of helping clients manage their investment portfolios. Leave your email below so you can be updated when I release the next investment outlook.

About 200 years ago, Napoleon returned from China and said, “That is a sleeping dragon. Let him sleep! If he wakes, he will shake the world.”

We all know the US has been trying to suppress China from rising since Trump’s era. China has been playing along, but largely passive and reactive. When the US raised its trade tax, they followed the same amount just to counter it. When the US cut interest rates, they followed just like other nations. For the sensitive issues such as Hong Kong, Taiwan, Xinjiang and South China sea, they were just responding to the US provocations similar to what they have done for the past 20 years.

But Covid-19 changed everything, it gives the central government a once in a lifetime opportunity to fully grasp the power and unite the nation. I have never seen such high patriotism in China for a very long time. If you read China’s netizens’ recent comments for world affairs, from Hong Kong to Taiwan, from tech crackdown to vaccine diplomacy, you can sense a high level of approval for the government’s actions.

I am not here to talk about politics, but this matters a lot to overseas investors like us.

It is not just about investing in China, it is a global matter. I think China has finally decided to go head-to-head with the US and re-position them on the global stage. On the contrary to everybody’s expectation, they are closing the door instead of opening up.

What will happen when China decides to close the door?

As Richard Haass, president of the US Council on Foreign Relations said: “The U.S.-China relationship, more than any other in the world, will determine the character of the lives for you, me, our children and our children’s children.”

The financial market will no longer just look at what Fed’s announcement, but China’s central bank’s policy as well. It is no longer just the US targeting China’s companies, but vice versa.

Tech companies, and whoever possesses a large amount of Big Data, are going to be at the centre of the battleground. It is not just about trade, it is about national security now.

Globalization is past tense, the world is already divided by the two largest economies, and everyone else is forced to choose the side.

If you pay attention, China has changed the usual tone in the past few months. I think China has decided that they are going to fight the war by themselves. They have few allies to rely on, not even the Russians. The US, riding on its global influence, has been successful in lobbying the world to isolate China.

There is an interesting development at home. On July 7, Singapore officially announced “Sinovac Covid-19 vaccine recipients not included in Singapore’s national vaccination count”. On July 9, it was reported: “Hong Kong government urged to scrap travel bubble plan with Singapore”. Think about it.

China and the US have also gone to their separate path in terms of monetary policy. The US started to signal the tightening of liquidity, but China’s central bank said on Friday (July 9) it would lower its reserve requirement ratio, releasing around 1 trillion yuan (US$154.19 billion) in long-term liquidity. This is effectively a monetary policy easing.

Internally, China is making big changes in many industries.

• Tech sector / Data security – China’s crackdown on Didi, Alibaba, Tencent are all over the news.
• Education sector – China is cracking down on school tuition.
• Property sector – China is setting redlines to control the debt level of property developers.
• Infrastructure – China bans super skyscrapers, putting a ceiling over new buildings
• Stock market – tougher penalty for market manipulation and insider trading.

This gives headache to other countries as now you have two different directions to follow.

Related Reading: Should you buy China tech stocks after China’s tech crackdown?

Let’s talk about inflation again

I want to talk about inflation again as it is a very important factor going forward. Let me recap what I said last month for the 3 stages of inflation.

• Early-stage inflation – it is good for value and stable dividend stocks as investors will rotate out of growth stocks due to poor future valuation. Bonds will be dumped as the low yield now is not able to compensate for the loss of inflation.
• Medium stage inflation (less than 4%), the dividend incomes and stable returns from value stocks can no longer compensate for the loss of purchasing power due to inflation, thus people will look for high-quality companies which have the potential to continually grow in the long term.
• High inflation – when inflation reaches an unbearable level, all assets will crash, companies close down, people start losing jobs. The economy enters into a recession and the financial system will be reset.

Inflation affects bond yield, bond yield affects every other asset. For example, the bond yield has dropped in the past 3 months and you can see that the financial stocks have performed poorly during the same period. Global bonds price rise for the same period.

But bond yield should not be lower than inflation. It doesn’t make sense. Because bond, as an investment, must give investors’ positive real returns. If you look at the chart below, the 10-year bond yield is lower than the 10-year inflation now. It means either the inflation will go up or the bond yield will come down, or both.

If we think about this further, if bond yield continues to be lower than inflation, it makes bonds little investment value, which means the investors have to invest in equities, even if the valuation is high.

Therefore, my conclusion is that equity, especially the developed market equity, will continue doing well. However, research shows that the second year of a bull market is typically choppy. So do expect the portfolio to run up and down in a range in the next few months.

To Summarize…

Here’s how I look at it.

• China has politically decided to be head-to-head with the US.
• China’s “dual circulation” actually means to close the door. They have decided to be isolated since they can’t find a friend on the global stage anyway.
• Smaller countries, even including Europe, are asked to choose a side, politically and economically.
• China’s atmosphere of patriotism is extremely high. This paves the way for the government to make even bolder moves.

What do these mean to the investors like us?

• Geopolitical conflicts will continue to escalate, causing more volatility in the Asia stock markets.
• China seems to be willing to accept disruption in the capital market for long term political success.
• Bolder moves in China is bad for the international capital markets that are linked in China, Hong Kong is a perfect example.
• In fear of political uncertainty and maybe some new regulatory requirement. Foreign capitals will leave Chinese capital markets and avoid investing in Chinese companies, willingly or unwillingly.
• Developed markets, such as the US, Europe and Japan, will be the capital market’s safe haven.
• China may be moving to self-sufficiency and less reliant on global trade. This will affect China’s trade partners, especially in the Asia region.
• With China’s restriction, supply chain disruption will continue, mid-term inflation is inevitable.
• Globalization is a thing of the past, we need to relook at a company’s business model and try to avoid companies that rely on cross-border business models.

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