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by  Jeremy Richardson Aug 20, 2021

We highlight three things for investors to take note of this month. First, are the U.S. inflationary pressures transitory? Some economists argue that the situation is similar to the 1970s when these pressures embedded themselves into the economy; others argue that it is interest rates that denote the price of money. Second, how will the spread of the Delta variant affect the global economy, especially in parts of the world where people are less protected by COVID-19 antibodies? Third, we look at the regulatory changes taking place in relation to the technology industry, particularly in China, and how this has raised doubts about the acceptability of Variable Interest Entities to the Chinese government.

Watch time: 7 minutes 41 seconds

View transcript

Hello. This is Jeremy Richardson from the RBC Global Equity team here with another monthly update.

And I think there are three things for investors to be paying attention to this month, the first of which is this consensus that appears to have formed around the Fed’s view that U.S. inflation pressures are transitory. However, I would describe it as a weak consensus because on either side of the debate, there are two very credible arguments.

On the one hand, we’ve got a group of economists who are arguing that the right way of thinking about these inflationary pressures is something akin to the 1970s. Because if pricing expectations feed into the labour market, that can lead to wage increases and rising cost pressures, and we could see inflationary expectations really embed themselves into the economy.

There are others, though, who think that’s the wrong way of looking at things. And actually, to the extent that the interest rates really denote the price of money, like any market, the more of something you receive, the more of something there is, the lower the price should be. So, to the extent that we’ve got high levels of money sloshing around the system with quantitative easing, then that should mean interest rates stay lower for longer. And so the right way of thinking about this is actually more like Japan rather than the 1970s.

Now, from our point of view, it’s not because we don’t have a particularly strong view on this. This is sort of a macroeconomic question rather than a company-specific question. However, it is a potential source of volatility for equity markets. Because it’s very likely, I think, that every piece of macroeconomic data that gets published in the near future is going to be analyzed and looked through the lens of these competing arguments—Japan as transitory or sort of the return to the 1970s.

And so I think for stock pickers like ourselves, this continues to be a source of potential volatility that we need to take into account with good levels of diversification within the portfolio.

The second thing which I think investors should be keeping an eye on is the Delta variant and, in particular, the very high levels of transmissibility that this particular variant has. And the reason why this is of potential significance is because the high levels of transmissibility really requires very, very high levels of antibodies and vaccine take-up within a population to keep the virus at bay. And although we’ve seen good levels of antibodies within certain groups of populations, particularly around Northern Europe, I would say, and pockets within North America, there are large regions within the world where vaccine take-up is comparatively low and antibodies are not yet widely established within the population.

And for those parts of the world, if Delta becomes established, it has the potential to move through those populations very, very quickly and that could have the result in differential performance within the global economy, and we might see that in terms of a regional variation of equity returns. And again, another good reason, I think, why global equity investors need to continue to remain well diversified.

And the final thing that I just wanted to mention, which is something that has been coming up lots in recent conversations, is around the recent changes we’ve seen in the regulatory landscape in China, particularly with respect to technology companies. Now, it’s hinting at a much more sort of interventionist and muscular approach by the Chinese government towards this segment of the economy, but I think, if we stand back and look at the aims with which this intervention is being applied, we can see similarities, I think, between many of the conversations that are happening outside of China, and particularly within Europe and the United States.

And so, if I try and sort of link these, you can see that conversations around minimum wages for delivery drivers in China have got strong parallels with the conversations around ride-hailing companies in the United States. We can think about the control of information which derailed a recent significant U.S. IPO of a Chinese technology company. Strong echoes, I would argue there, about what we’ve been seeing around many Western governments’ reticence to include certain Chinese technology companies within their telecoms businesses.

And then finally, we’ve got the example of consumer choice, where the Chinese government is arguing amongst its technology companies that consumers should have the power to choose between the different platforms that they want to use. And again, maybe echoes there of what we’re seeing within app stores in the West.

So, some very similar topics being discussed. I would argue, it’s just that the way in which we’re actually getting resolution seems to vary. Whereas in the West, it is driven by the court system, duty of care, common law, et cetera, in China, it seems to be done by government policy, which is being announced and that can lead to rapid change and dislocation in equity markets. But if we step back, actually, probably the direction of travel is actually very similar.

There was one area, though, which is different, and I think that relates in particular to variable interest entities which have been called into question by the recent steps that the Chinese government have taken. Now these VIEs, these variable interest entities, are a way in which overseas investors can get exposure to domestic Chinese technology companies, typically through investing either through Hong Kong or the U.S. And these have never really been tested under Chinese law, and there is a growing sense that maybe they will be, in which case, if the Chinese government decides that these do not meet its levels of approval, then there could be some nasty surprises for a number of investors.

Now, we have been very cautious about this particular governance structure. The fact that it is trying to sort of circumvent a legal requirement in China gives us cause for pause. And also, the fact that these variable interest entities don’t give you true ownership of the underlying operating company; they just give you a stake in a contract that seeks to replicate its underlying cash flows.

So, we’ve tried to mitigate our exposure to this particular area by, at the moment, not investing in any U.S.-listed VIE structures. And where we have got exposure is indirectly, and we’re aligning ourselves with majority shareholders so that if anything was to happen, at least we have a voice in the room. And that’s one way we think that we’re able to mitigate some of these governance issues.

So, a lot going on. As I say, those three topics I think continue to be very much I think towards the top of investors’ minds. And I think with a focus on well-diversified portfolio and actually thinking holistically about the risks around these topics in particular, continue to be very thoughtful about governance structures, there are ways in which investors can continue to focus on the things that really drive successful businesses for the long term, being their stock-specific credentials.

I hope that’s been of interest and I look forward to catching up with you again soon.



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