MARKET WATCH

Equity markets have mostly been lower in December with the exception of emerging markets (EMs), which have risen a few percentage points.

On a yearly basis, 2024 has been a strong year. International markets (Japan and Europe) are nearly 10% higher, while the Canadian, U.S., and emerging markets have risen about 20%. Commodities, as usual, have followed their own path. Canadian energy and metal stocks are up about 5%, and the value of gold (in Loonies) and Canadian gold stocks have surged more than 35%.

Looking to 2025, I don’t expect similar returns. Though not unprecedented, two consecutive strong years is fairly rare. Next year won’t necessarily bring poor results - most economies and markets still look stable. However, with U.S. equity valuations elevated and numerous geopolitical issues at hand, caution, especially in regards to American equities, is not a bad idea.

Speaking of geopolitics, a few noteworthy issues have recently occurred: Syria’s dictatorship fell; South Korea’s president was impeached after a failed attempt to implement martial law; and with Chrystia Freeland’s recent resignation from cabinet, plus Jagmeet Singh's statement that the NDP will vote against the Liberals in the next vote of non-confidence, it looks likely the Canadian government will fall in the near future. These, of course, are in addition to conflicts in the Middle East and Ukraine and the potential for prohibitive tariffs once Donald Trump is sworn in.

Given the current environment, I continue to favour commodities, especially over U.S. equities. I am also increasingly excited about EMs, particularly those in Asia. While developed countries have seen their share of global GDP fall to 50%, their stock markets still represent 80% of global capitalization and 90% for bonds. This disparity should narrow in coming years. Should this happen, EM stocks and bonds will inevitably rise, while developed markets would underperform. The question is, would underperformance bring negative returns, or merely less than that of EMs.

As this is my last newsletter for the year, I also wanted to take the time to wish you all a very happy holiday season! Happy New Year and all the best for 2025! 

As always, feel free to reach out if you have any questions, and if you’re looking for more timely information on the markets, you can find them on the research section of my website, or on my Twitter, Facebook, and LinkedIn feeds.

A GREAT BOOK

How Asia Works by Joe Studwell: It’s a rare book that changes the way you look at the world. How Asia Works did just that when I first read it a few years ago. With my recent focus on Asia, a re-read was in order.

Published in 2013, it explains why some Asian countries (Japan, Taiwan, South Korea, and China) enjoyed strong economic growth, while others (Malaysia, Indonesia, and Thailand) hadn’t - at least up to 2013.

The first group implemented robust land reforms to improve agricultural output. This initiative not only ensured food security, but it also reduced the funds spent on imports and made agriculture profitable.

With these moves, the first group of countries was able to invest in the second phase of development: manufacturing. Their manufacturing policies strictly focused on exports, which brought money into their countries and incentivized competition by forcing businesses to improve and acquire new technologies. Successful companies were rewarded; those that weren’t, were shuttered or folded into other businesses.

The third prong these countries harnessed was banking. Either centrally controlled or directed, bank finances were generously doled out to successful export-oriented enterprises. Domestically focused companies either found it difficult or impossible to access capital to sustain, never mind grow, their businesses.

On the other hand, the second group of countries either bypassed land reform or did so half-heartedly. Their manufacturers were allowed to operate as they saw fit. With profit more easily made in a less competitive domestic market, they usually opted to stay within their own borders, often becoming national monopolies protected by tariffs - further reducing the incentive to improve. Lastly, the banking sectors often supported nepotism and those close to the country’s leaders. This often resulted in inefficient boondoggles and real estate ventures. Though luxury properties often encouraged tourism and foreign investment, which brought in some foreign currency, it was not nearly to the degree seen in export-focused companies. More importantly, it didn’t help them acquire the foreign technology that enabled the first group to improve so quickly.

So why did How Asia Works change the way I look at the world?

I’d always believed centrally directed (not to be confused with centrally planned) economies were inferior to those in a more laissez-faire environment. However, after seeing Japan, Taiwan, South Korea, and China (and now Vietnam) thrive due to a more restrictive capitalistic model, it’s hard to argue that success. But I shouldn’t have been so surprised. I forgot the U.S. and Britain implemented restrictive policies until their economies were mature enough to flourish on their own. In other words, there is a long history of developing economies benefiting from a firm hand, or training wheels, so to speak, at least until they are strong enough to ride on their own.

Moving forward, as I look to developing markets to invest, I’ll focus on nations following this successful playbook.

THOUGHTS ON ASIA

Since July I’ve more actively focused my research on Asia. The region has a huge population, relatively strong GDPs, and most countries are early in their economic development cycles. Simply put, the majority of the globe’s economic growth will come from Asia, and I want to be on top of these opportunities.

Here are my thoughts so far (keeping in mind that five months is just enough time to scratch the surface).

China:

• Despite its current struggles, China is growing faster than any developed country.
• It’s already a global leader in EV cars and renewable energy.
• It produces a meaningful percentage of lower-end semiconductors. Though it will be prohibitively hard to become the industry’s global leader, China is rapidly moving up the technology ladder.
• It controls and often restricts access to many rare metals needed for the economy of the future.
• It aggressively projects power throughout the global south in both friendly (Belt & Road Initiative) and less friendly (South China Sea) manners.
• Chinese stocks are cheaply valued and should surge if/when its economy rebounds. (We are overweight Chinese equities.)
• It has the means to combat aggressive tariffs from the U.S. government (see article below).

India:

• Despite a recent downtick in GDP, India should lead Asia in total economic growth.
• With a young and increasingly educated population and business-friendly policies, there are many reasons to believe India will enjoy significant economic growth in the coming decades.
• India is attempting to walk a middle path between the U.S. and China. So far they have been successful, but this may become increasingly tricky.
• Indian equities are relatively expensive.

Japan:

• After decades of kicking the can down the road, Japan is finally implementing meaningful financial reforms.
• Japan’s stock market has had its best year in a long time, but given its atrocious performance since the ’90s, it is still relatively cheap. 
• Its currency is also cheap (some believe it needs to double relative to other Asian countries). Foreign investors could benefit from owning Japanese securities on a currency appreciation basis alone.
• For the first time in my lifetime, Japan is actively, and with the West’s blessing, increasing military spending in a meaningful way - the purpose is to counteract Chinese power.

South Korea:

• Last month’s attempt to install martial law was concerning. South Korea has only been a democracy since the late 1980s. Although the situation was resolved quickly, it’s worth keeping an eye on how things progress.
• South Korea’s economic progress since the 1950s is incredibly impressive. It speaks volumes to the nation’s work ethic and focus on success.
• It has the lowest fertility rate in the world. Without a solution, its already falling population will plummet. An urgent solution is needed.

Southeast Asia (Thailand, Vietnam, Malaysia, Indonesia):

• Though not on many people’s radars, these “middle” countries should be watched. They have embraced improved policies and are proactively looking to acquire new technologies in attempts to grow their economies.
• Fun-fact: Indonesia is the world’s fourth most populous country, while Vietnam and Thailand have 100 and 70 million people, respectively.

Russia:

• A solution to the war with Ukraine is needed.
• I’ve read articles indicating the precarious state of its economy, but also ones on its robustness. I’m inclined to believe the former, but I am open to the believing the latter.
• Its interest rate is a prohibitive 21% - this is to combat its high inflation rate (8.9%) and support its volatile currency.
• Strategically aligned with China, and still able to sell large amounts of energy to India. It’s not completely isolated.

A POTENTIAL GAME CHANGER

China Issues $2 Billion Bond in US Dollars in Saudi Arabia: This may be the biggest economic development of 2024, and few people are aware of it.

Tariffs will be a key bargaining chip for the incoming Trump administration, and China is in its crosshairs.

Until now, China had two primary ways to retaliate: devalue its currency to soften the blow or respond with its own tariffs. Neither are attractive to China. But a third option may now be available - and it’s a doozy!.

Let me explain.

The U.S. has a massive trade deficit with the world. They purchase far more goods and services from abroad than they sell. This disparity results in foreign nations accumulating large sums of U.S. dollars, which need to be allocated somewhere. That somewhere has been U.S. treasury bills, but also America’s stock market. This isn’t terrible for the U.S. It provides reliable buyers for its massive government debt (strong demand keeps interest rates low), and investment in the U.S. stock market helps it rise.

With China issuing an over-subscribed U.S.-dollar bond at a similar interest rate as U.S. treasury bills (T-bills), international investors had an alternative to buying U.S. treasuries.

Why is this important? Should China need to retaliate against U.S. tariffs, it could issue billions in competing bonds, diverting dollars that historically funded the U.S. debt. If this were to create a shortage of dollars willing to buy U.S. debt, America would need to raise its interest rates until sufficient demand was reached. Given the size of the U.S. debt and deficit, it can ill afford higher rates!

What makes this bond even more interesting is that it was issued on Saudi Arabia’s exchange. This is a strong signal to the U.S. that the Saudis (and possibly other Chinese allies) are no longer in America’s back pocket and may be willing to redirect their oil profits to China should the U.S. attempt to throw its weight around.

This could be very bullish for commodities, especially gold, which has already done very well as of late.

SELECTED INSIGHTS

From How Asia Works

“Deininger’s two big conclusions are that land inequality leads to low long-term growth and that low growth reduces income for the poor but not for the rich.”

“It is that a lot of critical learning in the most successful developing countries takes place outside the formal education sector. It occurs, instead, inside firms. This intra-firm learning helps explain the relative failure of the former Soviet Union and its satellites, where investment in education and research was focused on elite universities and state research institutions rather than inside businesses.”

“Deregulation policies do not empower a ‘natural’ tendency for finance to lead a society from poverty to wealth, they simply put short-term profit and the interests of consumers ahead of developmental learning and agricultural and industrial upgrading. There is no case for doing this when a country is poor.”

“It is the job of governments to resist entrepreneurs’ lobbying until basic developmental objectives have been achieved.”