JUL 2019 2019 Mid Year Outlook

 

RARE Infrastructure Limited – RARE Insights

 

Despite a brief pause to the trade war (as agreed to by Xi and Trump during the G20 Forum at the end of June), we expect tensions between the US and China to be a continuing source of uncertainty for markets. With the remarkable rise of China in recent decades, we now very much live in a bi-polar international system. This is inherently more unstable than the unipolar world in which the US was the only global superpower.

In the US, getting tough on China has become one of the few issues with bi-partisan support. Both sides of politics are keen to appeal to voters in the “rust-belt” states who have been impacted by the shifting of jobs to cheaper labour forces offshore. Equally, Xi is unlikely to make any significant concessions. Xi has reasserted the primacy of the Communist Party in Chinese society and within the economy. Demands to refrain from state-directed capitalism will likely fall on deaf ears.

Over the next 6-12 months, US China tensions will likely continue to create uncertainty. In our view however, there is little chance that the global economy will be pushed into a recession. This is due to the likelihood of Chinese stimulus throughout the second part of the year, along with an expectation that major central banks will take a dovish turn.

It is important to note that the Chinese economy was slowing prior to the trade conflict. As such, Beijing has been attempting to rebalance China’s economy from one dependent on the debt-fuelled building of apartments, factories and bridges to one with a greater focus on domestic consumption and services. This being the case, Chinese authorities have been (until recently) reluctant to revert to economic stimulus, nor have they seemed inclined to direct banks to lend to SOEs (State Owned Enterprises) for development purposes. The slowing of the world’s second-biggest economy has seen the rest of the world’s economy begin to slow – with one exception, the US (or so it seemed). Recently however, this has been called into question, with US leading economic indicators, such as PMIs (shown below) starting to soften:

 

Source: FactSet

Despite record low levels of US unemployment, inflation has been missing in action. A slowing global economy, overlaid with the Sino-US trade war, has led the Federal Reserve to switch from a tightening monetary policy last year to a loosening bias this year. The European Central Bank subsequently followed suit. The trade war has also forced Beijing to broaden its economic stimulus beyond that targeted at the consumer (such as tax cuts) to more traditional measures such as spending on infrastructure.

These two factors, namely a looser monetary policy and Chinese stimulus starting to find traction, will in our view ensure that a recession is avoided. After all, the US consumer continues to be in fine form. With unemployment at multi-decade lows and wage growth starting to come through, consumer sentiment is still very strong. In this environment, we believe that investors should remain fully invested in equities.

This being said, given the uncertain global backdrop and the later stage in the cycle, we believe investors should have at least some of their portfolio allocated to more defensive equities, such as infrastructure and utility stocks.

While this sector of the market has rallied significantly so far, we still see opportunities. For instance, we believe one area in which quality infrastructure companies are being undervalued is in UK utilities. Brexit, along with the UK Labour Party talks of nationalisation, has led to periodic, indiscriminate sell-offs. National Grid is one such example. Two-thirds of the company’s revenue is generated from regulated utility businesses in the US. Despite this, the stock continues to be caught up in UK centric sell-offs. This allows us to buy a quality defensive stock, with strong, predictable, regulated cash-flows, at a discount. Identifying this and similar opportunities for investors is core to RARE’s investment philosophy.