This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.
China’s Lack of Reform Means…
Global Investment Strategy
May 22: Risk of economic stagnation is why [Chinese] policy makers at the National People’s Congress this weekend will lay so much emphasis on “reform and opening up,” even as they are forced by the pandemic to do the opposite for now and stimulate the economy via debt-financed fixed investment.…
Today’s macro and geopolitical context do not favor liberal reforms, such as occurred in China in the late 1990s, but the changing characteristics of China’s elite political leaders reveal a more specific reason that policy has grown more statist, more “communist,” and less liberal over the past decade.
Members of the Politburo Standing Committee, the most powerful decision-making body, have become more ideological, more authoritarian, less cosmopolitan, and less technocratic over the years. They are far less likely to have studied the hard sciences or engineering than their predecessors, who orchestrated China’s Westernizing, capitalist reforms from the 1980s to the early 2000s.
They lack experience running state-owned enterprises, which might seem like a plus, except that the alternative is being a career politician—a ruler of a province—and never having run any business at all. Leaders increasingly hail from rural provinces, as opposed to the wealthy, internationally savvy coasts. Essentially, the grass-roots interior of the country—the base of the Communist Party—has been reclaiming the party from the corrupt, liberal, Westernizing technocrats. And the party is about to grow even more reactionary.
…New Risks for U.S. Investors
First Analysis: Institute Alert
Wells Fargo Investment Institute
May 22: On May 20, 2020, the U.S. Senate unanimously approved the Holding Foreign Companies Accountable Act, a bill that requires non-U.S. firms to follow reporting and audit requirements prescribed under the Sarbanes-Oxley Act of 2002. The House of Representatives has not yet considered the bill.
This bill is significant, because it eventually could cause some Chinese companies to not list their equities on the U.S. stock exchanges, while some listed companies may be delisted and others may voluntarily delist in favor of other markets, such as Hong Kong and London.…
Investors may have to make an additional decision as to how to invest in these companies—i.e., to choose an exchange and possibly a different investment instrument by which to invest. For example, an investor who today holds a stake in a Chinese company via an American depositary receipt, or ADR, may need to reconsider whether to invest in that company on the Hong Kong exchange and not through an ADR. Of course, changing the domicile of the exchange may introduce additional risk (e.g., the political risk in Hong Kong, and the lesser, but still material risk of a hard Brexit, which could diminish London’s global hub status).
We do not believe that U.S. investors need to switch immediately, but market prices should move to reflect the additional risk that some Chinese companies eventually may forcibly or voluntarily delist from the U.S. equity exchanges. Additional risk may develop—as there is further geopolitical stress arising from the other factors driving this legislation—namely, the ongoing trade dispute, the coronavirus recriminations, and rising U.S.-China diplomatic tensions in Hong Kong, Taiwan, and the South China Sea.
Grim Times for Mall REITs
Green Street Advisors
May 21: Investors in the retail space have largely focused on rent collection in the second quarter as a proxy for the near-term pain the business would suffer. In the longer term, the more relevant period on which to focus, surviving retail concepts will drive occupancy levels and property values.…
Within the strip-center segment, Green Street predicts that power centers will fare better than grocery-anchored centers. This is because grocery-anchored centers derive a large percentage of their income from small businesses and restaurants—a segment that should be particularly hard hit through this recession.
Green Street also expects a greater negative impact on malls than strip centers, given their dependence on apparel sales. Department-store bankruptcies are likely being pulled forward from the next five years to the next two, with Green Street now expecting over half of mall-based department stores to close by the end of 2021. This could trigger co-tenancy clauses for in-line tenants and accelerate the downfall of many malls across the country. Mall net operating income should be about 20% lower than in 2019 when the dust settles in a few years.
ESG Funds Outperform
The Independent Market Observer
Commonwealth Financial Network
May 20: Companies that rank favorably from a corporate governance perspective are generally those deemed to be higher “quality.” These companies are typically run in a more prudent fashion when it comes to how they manage their balance sheets and reward their various stakeholders. Higher-quality companies have shown a tendency to outperform over time and, in particular, during periods of market weakness.
Looking at the relative performance of environmental, social, and corporate governance, or ESG, mandates seems to validate this conclusion. [The] five-year performance of ESG indexes from MSCI compared with their traditional benchmarks makes a pretty compelling argument against the notion that ESG strategies are handcuffed in any way. The data were particularly eye-opening in emerging markets, as the MSCI Emerging Markets ESG Leaders Index was able to deliver more than two percent of annualized outperformance over the past five years.
The outperformance of ESG mandates compared with traditional indexes has been noteworthy…it turns out that the higher-quality bias of these mandates has been helpful in protecting on the downside; 70% of sustainable equity funds delivered above-median performance during the selloff in the first quarter of 2020.
A Second-Half Pop for Stocks
The Informed Investor
May 20: The comeback continues for U.S. equities, as the narrative has now shifted from shutting down to reopening the economy. Decelerating daily Covid-19 cases and encouraging evidence for a timely vaccine have further fueled optimism. The rear-view mirror has essentially been torn of, as the market has moved on from a long list of historic economic wreckage. Washington’s policy response has also helped alleviate investor anxiety and provided much-needed stability to the market. The Federal Reserve has made it clear that it is “not out of ammunition” and will do “whatever it takes” to rescue the economy. On the fiscal side, Congress has rolled out unprecedented support with another potential $3 trillion round of stimulus coming as early as June. Overall, this backdrop provides the necessary catalysts for a second-half recovery.…
The technical setup suggests that the lows of the year have been set, and that a potential pause in price action is likely to play out before a second-half pop. We reiterate our year-end price objective on the S&P 500 index of 3,600.
–Craig W. Johnson, Adam L. Turnquist
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