Download a PDF copy
[00:00:00] Rob Campbell: On this week's Art of Boring, Peter Lampert joins to talk emerging markets as the latest developments and rally in China are top of mind. While there are no easy fixes to China's economy, Peter talks through a probabilistic view of what this may imply with respect to the likelihood of lefthand tail risks, what it means for discount rates and why Tencent is such a terrific business. Peter explains what he means by stealth performers in the portfolio and why Turkey's Bim is one of them.
[00:00:32] Disclaimer: This podcast is for informational purposes only. Information relating to investment approaches or individual investments should not be construed as advice or endorsement. Any views expressed in this podcast are based upon the information available at the time and are subject to change.
[00:00:49] Rob Campbell: Peter, welcome back.
[00:00:50] Peter Lampert: Thanks. Great to be back, Rob.
[00:00:52] Rob Campbell: I'm glad to have you, because listeners should know that we're recording this podcast on October 1, which is the start of Golden Week in China. I think for most investors, it was actually this past week that was the Golden Week for Chinese equities, because stocks are up something like 20% over the past few days on the back of a raft of stimulus measures announced by the Chinese government, pretty clearly aimed at driving consumption, supporting the housing market and the stock market, too. Peter, I know that we are bottom-up investors, but I do want you to put your macro hat on to start. Can you zoom out and just over the past few years, give us some broader context around this most recent stimulus and why now?
[00:01:34] Peter Lampert: Like you said, this was a very significant series of stimulus measures that came out of China over the last week of September, and like you said, supporting the areas that had been particularly weak in the property market, stock market, and household consumption. In aggregate, we estimated about 3% of GDP, and they said they're willing to do more.
The backdrop, like you said, was a very weak economy for the last couple of years. The government had taken a number of actions that was further stifling economic activity, depressing sentiments, depressing business activity, trying to achieve non-economic goals. I think they realize perhaps they've gone too far, and it's time to reverse course a bit. That certainly seems to be the message. We'll see if this is continued.
But why now? A big part of it is with the Fed easing now, the Fed starting their cutting cycle, it gives room for China to also be easing and injecting liquidity without having to worry too much about a major depreciation of their currency, which would have its own disruptions for the economy.
[00:02:39] Rob Campbell: You started with just some of the longer-term headwinds that are facing China versus the stimulus, which obviously, in the very short term, has had a pretty big impulse. How do you weigh those two things? I can imagine there's a case on both sides.
[00:02:51] Peter Lampert: Definitely. We shouldn't underestimate the stimulus though. Despite the challenges that the economy faces, we may look back at this and think of it as a “whatever-it-takes” moment, when Mario Draghi said that to put a line under the European sovereign debt crisis back in 2012. It also reminds me of the COVID approach in China. As you know, they had a very strict zero COVID approach for three years and when it wasn't working, one day they just very abruptly opened up.
It seems that could be the case here, but like you said, it doesn't solve everything. There are still significant long-term challenges, but we think it probably helps mitigate three of the big challenges that we see. The first of those is the weak sentiment among consumers and investors, and that can lead to a reinforcing downward spiral where the negative sentiment drives negative economic activity, etc. If they can put a line under that, boost some confidence and boost some spending, that would help.
The second one being the regulatory interference in business. When we talk to people doing business in China, this is their number one complaint—dealing with regulations that change frequently, that are not enforced consistently. It's just a very difficult environment in which to do business. If the government is in fact more focused on driving economic growth, they know that business and markets are an important part of that, and they do understand that. If they take more business-friendly policies, that would be a significant shift.
Then the third big headwind facing China are the geopolitical risks. Now certainly those don't entirely go away. A lot of the trade tensions, the trade war, economic war that we see between China and the West are continuing around semiconductors, around tariffs. The stimulus does not address that. But, if the government is more focused on economic growth, we think the odds of a significant worst-case scenario for the economy (which would be an invasion of Taiwan) is reduced or at least pushed much further out into the future while the government focuses on economic growth. So again, it doesn't solve all of the underlying issues, but it moves the needle probably on three of those big risks.
[00:05:01] Rob Campbell: That last one is most fascinating. Can you help me connect these perspectives? It does sound like you think the stimulus is quite significant, not just a shorter-term impulse. How does that macro lens enter into the work that you and the team does in managing the emerging markets portfolio? Listeners would know that over the last couple of years, we had been reducing our position in Chinese companies. I'm just wondering if you can tie just how much of that was macro-driven or risk-driven versus the bottom up or are they quite intertwined?
[00:05:34] Peter Lampert: They are very intertwined from our view. We are bottom-up investors, and as part of that bottom-up fundamental analysis that we do, the macro awareness is very important. When we analyze and incorporate macro risks into our company-specific analysis, that shows up in our DCF models, in the projected growth rates, in the discount rates. When our perception of those risks shifts, our assumptions or the ranges we use around those variables shifts as well.
As you said, this approach has led to our perception of heightened risk in the last few years and a reduction in our Chinese holdings. But we were also increasing our positions on the day the stimulus was announced in late September, as we think the odds have shifted. Incorporating some of those macro views into the bottom-up analysis and reflecting that risk-reward assessment in the portfolio decisions.
[00:06:27] Rob Campbell: Can you make it a bit more real in the sense that can we talk about a specific company or set of companies and just how that bottom up actually works in the context of a risk framework?
[00:06:37] Peter Lampert: When we assess that the risks are higher, we apply a higher discount rate in China, essentially requiring a higher hurdle, a higher rate of return to compensate us for those risks. That's across the board for all of our investments in China. Therefore, the ones in the portfolio are the ones where valuations are most attractive and where they meet that higher hurdle rate.
The second issue is on the growth rates for those companies, which we deem are more economically sensitive in a very weak macro environment. We've brought down some of those projected growth rates—companies like Milkyway Chemical or Great River Logistics, which are in more cyclical industries, chemicals distribution tied to industrial activity—we brought down our long-term expected growth rates there, given the structural challenges in the Chinese economy, not looking at quarter to quarter, but over a five-, 10-year view. We think the outlook had weakened. When we think about the ranges, the possible rates of growth that those companies could achieve over the long term, those came down and the valuations were no longer attractive enough with that combination of the lower growth rates and the higher hurdle rates to be in the portfolio.
Those were some of the examples of the stocks that we exited. On the flip side, there are other companies, and we're specifically emphasizing the ones that we think have independent growth drivers, independent of the overall economy. No company is entirely independent, but ones with less reliance—companies that can continue to do well in an environment where yes, there are headwinds, but we think the Chinese economy is more likely to look like a stone rolling down a hill rather than that risk of just really falling off a cliff. In that environment, there are a lot of companies that have their own growth initiatives that can do well, even in a weaker backdrop.
[00:08:25] Rob Campbell: Do you have a couple of examples of those?
[00:08:27] Peter Lampert: Certainly Tencent is a great one to highlight. They have a very prudent management team, very world-class, and they're focused on providing the best experience to their customers in their apps. As a result, they've been able to achieve and maintain a very dominant position with their WeChat app. But along the way, they've been very conservative on monetization because they want to protect that consumer experience. Now they have an opportunity to pull some of those levers to increase monetization, to improve their ad revenue and continuing to grow profits. Even if the overall advertising spending is weak and the overall economy is weak, they have their own monetization levers that they can pull. We think the valuation is still very attractive despite being a huge well-known company because of all of the pessimism toward China.
Another example is Tencent Music. This is the Spotify of China. It's a listed subsidiary of Tencent, so it shares that great DNA, great management culture. Similarly, they've been focused on achieving the dominant market position in online music streaming. They have not pulled those monetization levers as much as they could have, so now there's an opportunity for them to do that going forward with more advertising and higher pricing.
[00:09:37] Rob Campbell: We've talked a lot about the impacts of the stimulus in China specifically. I wonder within the broader emerging markets universe, whether there are ripple effects associated with this, or is this really primarily focused domesti
