This is extra the Goldman Sachs, where we discuss developments currently shaping markets industries in the global economy, I'm Jake Seaward Global, had of corporate communications here for the global reflation trend that supported rising equity markets to start years been broadly felt in Asia. Pacific with the embassy I Asia, Pacific Ex Japan index, which is a key regional benchmark, shown its best returns, in the first quarter of this year in twenty six years, my guest tomorrow is the cohesive macro research in Asia and the Chief Asia Pacific regional equity strategies for Goldman Sachs Research. We'll talk about what expects to do. I've market performance going forward in the region and key issues. Facing chinese stocks to welcome to the programme is a great pleasure to be here

TIM, you ve, identified three dynamics and are likely to influence equity performance in Asia. Pacific in the coming months. At the top of the list is the reflation trend What does the return to a more normal inflationary environment mean for investors in Asia, Pacific, report means better returns and the reason for that is add Asia, extra pan has been for the last five years, nearly six years. Deflationary environment which has put a lot of pressure on corporate profits. the updated numbers which are quite fresh or that the period for Two thousand eleven, sixteen Inclusive Lee screw two points percent on an annual basis in local, see, and just one percent in the US dollar terms so effectively for the past five six years, there's been very little: copper profit, Grove, therefore surprising, the index is basically chopped around and got nowhere. The good news

is that come out of his period of deflation, and this is most senior It was shown in the turnaround in chinese producer price inflation, suckled, p p, I put some numbers on this at the beginning of twenty. Sixteen that was mine is five point: eight percent, very deflation, Arie and the function of the collapse in commodity prices and some other xs issues, the latest data point we have four February. It was seven point. Eight, so around we're going for minor. Sixty plus eight is a huge shift in the commissioner, environment- and that is directly flowing through into corporate earnings growth and to give you just one number there is National Bureau statistics. Assessment of the profits of the industrial. After both listed and understood a great number of companies and hundreds of thousands Chinamen China may lead itself and for in February, compared to one ago- the profits from three point: five percent- thirty point, five so

that's a dramatic turn around from the prophet decline we were seeing and it's that shifting corporate profit environment, that is propelling equity markets, now So that's a good news. You ve, also written that we seem to be entering a phase of peak momentum, went to come the global and regional growth. How can you make determination and what might mean for equity investors in the short and medium term. This is a really important points and thank you for asking this the evidence that we ve got first at the global level and then at the regional level. At the global level, we have a monthly GDP proxy technically called our current. Video indicator see I, and that has improved from in rough numbers below two percent global growth level, too for four percent. Currently, so the Good NEWS that the global economy is clearly shown signs of improving in its growth momentum, the less good news is that the data

prizes they ve been coming out, which were can definitely positive. In the second half of twenty sixteen have flattened. And no longer surprising on the upside so There is very good evidence at the global level that this recovery in momentum we ve had, is probably peeking right now now that onto the Asia Pacific region, we can the same thing, and if we look at our current activity indicator for Asia that also looks like it's probably at its peak for the time being. If we look at the phases of the business cycle and conceptual you can think of four phases where, if you think there's a trend to growth, phase one would be when you're above trend in improving phase two would be of trend in decelerating. Faced, we of course is below trend again. worse, a vase force when you're recovering we ve been in phase one,

trend and improving and typically over the past decade and a half your average three month returns during that phase is seven point. Nine percent for the Embassy Asia, Pacific, Japan Index in phase two, which is still above trend, but moderating your tip returns are more like one point: five percent and we we're going into that now. So the punchline Is that we think we're going from a period of really juicy good turns which, as you said in your introduction, is quarter in Asia was the best in twenty six years. The second best meet our history. The index. We think we're going to have read where returns will still be positive, but decidedly more muted in their magnitude? So, given that drop you and your colleagues recently upgraded chinese equities overweight. How do these trends we in talking about a line with that view, is there still more value to be gained from us it's so against a backdrop, our view Our strategy has been to try to identify the port the region that

the most idiosyncratic positive support because of these costs. words that are in the aggregate investment environment and China exemplifies this or is the best example of this. Why three key reasons number one as I just mentioned, you ve got this nominal gdp improvement because of this change in the producer price index I was mentioning earlier and that's giving China the best. delta, the best change, as well as the best level. Nominal GDP growth and that's directly filtering through two earnings set point number one point number two is that we have this concept of a policy put I e There is a very important meeting politically in late October, the Nineteenth Party Congress and all the policy mix that we speak to indicate that, in the run up to that stability is gonna, be top of mind is, can be the priority. So think we ve got every little likelihood of surprises in the policy front.

stability in the real economy or yes, markets were all I mean the markets. It can do the market to get to do, but I was referring to stability in the real economy. So we don't think that can be. A lot of policy surprises no said moves in the rim and be no sudden tightening or the kind capricious policy measures that said the markets off foot and in the third thing, just ITALY is that from a positioning and investor flow perspective, we think we ve got the best set up for China, partly because Got the so called southbound connect coming in this is the money coming in from mainland China into the Hong Kong Stock Exchange, which, as you know, to Hong Kong and is therefore a distinguishing positive factor, and secondly, when we look at a one, you truly universe of mutual funds and look at her their position in China. There are the law levelled allocation to China in over a decade, and since China is twenty, five percent of the benches If China does well, we think that that money will need to close its under way, and so there will be another positive supporting force for the market

so. You talk a bit about nominal GDP growth. Why does it make sense when it comes to equities? Tools? nominal growth, as opposed to inflation, adjusted real GDP and other other. comic indicators, you're watching that show China's economic growth is about more than simply higher prices. The reason Looking nominal GDP is that historically, there's a much higher coral She between Nano GDP, growth and various drivers of equity market performance. The most important one, of course, has corporate earnings, and there's just empirically a much higher link between the nominal growth environment and corporate revenues. Then there has been. In real growth and corporate revenues. Only think about a few mama that makes total sense, because stock markets are not real inflation, adjusted so you're, getting a price

coming through the revenues and earnings, as well as those dark prices. So I know it may be a so called money illusion, but it matters with the price goes up. Price goes out particular economy that transacts, mostly in its own currency, fair point gap point about one is the link between nominal GDP and covered earnings, the roles, Briefly, is a link between normal GDP and evaluation between Nominal he p and foreign portfolio flows and then, of course, between more GDP, an actual market reform itself. So the empirical evidence is very strong that you want to pay attention to the nominal growth environment. She S. Research has written extensively about the improving prospects for the chinese consumer and, see, the government's been very focused on individual, option a long term driver of the economy. Does reflation of the short medium term do anything to affect that transition towards a more consumer led economy. It might help it

at the margin. But I wouldn't say it's a significant driver put it this way, much more consequential for the Upstream manufacturing part of the economy, the materials related or the metal back inquired uncle partly economy, because the old ESA, we correctly I mean they- were really under very substantial profit pressure and many were losing money under that divide. Environment. They were talking about just a few moments ago and with that turning there's been a huge upswing in profits for that sector may getting back to those national beer statistics general, very profitable couple moments ago, they give you granular data on about forty different sub industry, we coalesce those into five larger groups which in rank them from cream down downstream the upstream The economy is the one that was recently has been doing the best, so the delta has been most favourable there because of the switch in economic growth, environment, for the consumer desk.

Going along it more of a steady trajectory. It's a straw. An inexorable trend in our view, and the particularly juicy part of that so to speak, is the trend E commerce is not already have more consumption taking place, but there's more of that technically on line so that the product that giving much stronger growth for e commerce then bricks and mortar Commerce- that's really the sweet spot in terms of the restoring not all companies will benefit from higher inflation in you mentioned some industries that might benefit disproportionately. What's actors might underperform. Given the conditions you have outlined, the elderly more concerned about would be in those more down stream in midstream industries now taking higher input costs because of improvement in commodity prices and if their able to have the pricing power to pass those cost increases along. Then the margins get squeezed and so one area that from a regulatory standpoint could be at risk, would be the utility sector because either

getting higher energy input costs, for example, and they don't have the pricing power, legally to a kind of to raise their tariffs. Then they're gonna get squeezed. So there's been I've seen a lot of concern about the debt load of chinese bags and that's been a topic that ban under discussion, put it amongst investors, but others as well for a long time. What gives conference, but the outlook for that sector this year. So we have significantly raised our view in the China banks, which is probably one of the more controversial opinions that we ve been out with, because there is a strong sense petition, western investors that the chinese banks are tremendous credit stress and there is a risk associated with them and the boy The picture is that China has accumulated a great deal of dead that GDP levels in rough numbers of government. And fifty percent debt to GDP in

two thousand and nine to about two hundred sixty percent. Today's, with more than half a percentage point increase, and typically historically, when you ve had that quantum of increasing debt levels in a fairly short period of time, been associated with credit stress or slower growth or currency weakness and software. So there are clear reasons for being concerning cautious side with regard to China, banks our point, however, is that for whatever level of concern you have regarding the banks that then your term delta? The change in the opera If I am for the banks is underlined the positive, the key you revolves around not performing loans or impels, as the acronym goes and the Urging development is that in pale formation, the incremental new, not performing loans as been tapering and what's driving that improvement in their not performing want

It really is the improvement in the profits of the most stressed part of the manufacturing sector, which is the upstream part, and as a direct consequence of the improvement in the nominal of environment and that's flowing through too profit, so, for example, a year ago the coal come, these steel companies were losing money and actually making very good profits, so proven in their cash flows means. Are there better able to service their debts. turn means lower pressure on not performing loans for the banks, and indeed look at the recent results for the fourth quarter for the big banks. They all met or beat expectations. Not just profits, but also in the provisioning. So or argument is that the delta on the banks is clearly turn more favourable from an operating stand Lloyd, the bank's valuations are priced at a significant low end of their say, ten or fifteen years. To arrange

cross sectional basis. They compare very favourably with other banking sectors across the emerging developed markets and therefore the nearer terms over the next one or two quarters risk reward for the banks looks to be much more favourable than it did before. Stock about some of the risks to view and China, which means those talks with the United States, the FED signal that it's likely to raise its benchmark interest rates at least twice more this year, higher. U S, interest rates, typically attract investors way from developing markets is Chow insulated enough to avoid The big drawback, you can say, you're fully and later from a drawback. You can always paint a scenario where outside conditions can be contagious and joy is a volatile market and investors can be skittish, so we wouldn't be so bold as to say that it would be fully inoculate from any external risks.

In the current environment. We feel that in terms of the rain, tat we ve got for our expectations for the fair for the dollar and for potential trade barriers that we think those are manageable to be more specific, the feds to be signalling. That is did in raising at a moderate rate, and it seems to be Ning responsive to developments in the economies is almost this feedback loop. That says that if the U S, economy turns out to be not as strong as may be. People had been expecting, perhaps because some of the fiscal stimulus of current administration may not be enacted either as swift or has significantly as may be. The market have been expecting in the fourth quarter than corresponding the FED. My dial back the pace of its industry likes and correspondingly also. The dollar would therefore not rallies much if the FED and raising rates, to the extent that the market and earlier thought so

within a an acceptable band of fate increases in dollars, strength or sense is that China, specifically in other parts of Asia, more broadly, would be able to take that in its stride. As long as the underlying corporate profit growth dynamic, is in place, which we think it is. So It really gets live attention, particularly in the U S, and is had terrified policy, should increase overtime, devalue, the? U S, dollar, which might make Chinese? relatively more competitive hiring. Stronger dollar, that net neutral for China. In your view of the long term,. It all depends on the magnitude when we're coming off a low point in U S interest rates, and you begin to tighten and did not too many exam those of us in the last twenty years, but therefore, five periods, when rate recorded in the FED, began to raise historically, aid Mortgage tend to do well through the fourth FED Ike and

The narrative you can tell behind at is that when you're coming off a period of FED cuts which Jos because growth has been poor, that when you ve done, from the corner- growth gets better, which then elicits a tightening monetary policy definition first steps in that are absorbed. Bob. I equity markets, because the basic you take the trade of better growth for little bit firmer in straight and stronger demand corrected. Big importer and the growth element. Such a strong, fundamental compose have equity markets that alone, but higher rate, especially from the super low levels that we're at right now or definitely absorb able. But after a certain point, weird and we can debate how much but, let's say historically about four hikes or five, then rate start going up enough that the markets to say, lying on a second? The absolute level Trade is going up, voting had our growth benefit, so the risk rewards darts turning less favourable and then it's much more of a problem, but I dont think were quite at that

age? Now, let's talk eleven about trade present from so far stuck mostly to rhetoric with regard to trade, although the rhetoric spin strong he they announced some executive orders in the space He hasn't forgotten about the issue and how are you advise inclines to manage the vast uncertainty around trade? Are there any and posts out there that you're looking at as a potential clarifying point. Absolutely, I think, a useful mental construct for thinking about trade issue is to imagine a line agreement with it. By being the most negative outcome on the right side being the positive one and on that site you can position the roughly three or four broad categories of likely trade developments that may take place in the next weeks and months at the left. Most part of that line, the most negative one would be the border adjustment tax. The reason why that is the case

is that it would be profoundly disturbing or changing to the profits of a number of industries you would likely see a very significant increase in the dollar, which could have a lot of second third or rebel affects around emerging markets. So that would be very relative, also negative, but not quite as negative, would be the forty five percent across the board systemic tariff increase that was discussed during the trunk. Pain. We dont think either. These are likely, but they would be quite negative effect of place effectively for those two. You ve got a low probability chance of a very high impact event and then much more towards the right into the spectrum would be sector specific terror for other forms of restraint which allows a hit the companies involved but would be systemic in nature, and we think the market could absorbed that in its stride and they would give the president the political announcement capability

to claim victory without having significant systemic disturbance, gather, by the way, which would be the most positive end of the spectrum would be if a deal was done to increase yours exports to China as a way of narrowing the trade gap, so instead of hurting China by constraining its imports in the United States. You could solve the bilateral trade imbalance by encouraging China by more. U S stuff, and if that was the case. It would be a great when, because it be good for employment in the EU, as it would solve the deficit in aid without the deficit, but the daddy this would improve it. There's been a party is having some precedent for that. The path we are opening up to you as agriculture, exultingly, etc, and even there's been some talk among clients, have been speaking with about protectionism. Energy deal being done good, try to divert some of its energy purchases from Middle EAST or elsewhere towards the United States, and that would be a big boost for some Centre Party United States, which would also play to the blood I base my Lord your point as you can imagine a spectrum of outcomes we can handicap with

can it be that we do have a strong view that the probability- extreme negative ones, is low, because, although Chow he'll be hurt. More deals would also be heard by those in that would obviously be antithetical to the larger ambition of having the, U S grown, having more job creation. go to your point about what you do about that, we think that the situation of a low, problematic hi, negative impact event is something that, if you have the capability of doing, this is best dealt with an option space, because options are basically downside. Insurance programme insurance protection against, as I just said- a low price Lloyd? What high impact of it you talk a little bit about the meeting is fall Channel, hostess, Nineteenth National Congress of the Communist Party and this is only twice a decade event. Their government leadership changes are usually house. You out The current policy put these talked about earlier surrounding this year's vat. an you pointed out that in the past equity markets perform reasonably well in the run up to the Congress. How does the butt

angel for trade dispute with the United States, a fact that usually, recently reliable framework. it's obviously a new king, system so to speak, and I think the answer to that would maybe breakdown in two parts. How significant with that trade spat be, if where is something that was to get back to my mental model on the right side of that spectrum, maybe sector specific in that systemic in his nature, then I think that that wouldn't really start things too much. On the other hand, if it was more of a full blown trade war- and we strongly- you bet. If the? U S was to go and imposed, for example, a forty five percent across the board tariff on all chinese goods that It would certainly respond in kind, and that me that everyone would get bloodied and it would generally be bad all the way around and most likely. That would be something that would dominate.

the scenario that I mentioned earlier of a stable policy run up, so it is a wild card and that's why we think that having some serve downside protection, if one is able to, is a sensible, At this point, I said to him: you know, views on China cannot lay between extra. even within our own firm. When you talk to our clients, What are the issues where you see the broadest difference of opinion and how does a dynamic impact, your pro as an analyse chatting with these firms. I think it really revolves around the longer term structural view on China. So the key pot button topic is credit. The significant amount of credit which accumulated and the bears a strong case to make that there has been this unprecedented debt boom, at least some part of it was inappropriately invested been evidence of so called Mal investment

moral hazard in terms of people diverting capital into various products, a wealth management or trust products that were probably over, guaranteed or Miss old, and so no doubt there, some mess that needs to be cleaned up, and I think, with the debate in is, is whether and it can manage that clean up process, so to speak and weathers got the time to kind of on its way out of the problem and the good comparison between China, Japan for apple is that Japan got into a significant. Problem, as we all know, in the late Nineteenth Eightys and the last two decades notified and had to recap the bag several times, but the key did is that Japan wasn't growing and serve growing into a deflationary environment, your debt burden just sits there to get bigger and bigger every heavier in China's case. Fortunately, you You have a general inflation environment. You still haven't lying trend, growth of six percent. You can argue about the exact number, but it still meaningful.

So if time is on your side, when you are to continue to grow. You re out of that problem and I think that's really The debate is, between the more pessimists, side of the market in a more constructive side. Anyone is sort of full. Pollyanna, like China, no problems and is a very small portion, the market, which is dogmatically of the view that China is going to court on core blow up in the river in your term but there is this spectrum in between of the more bearish in the more baby sanguine, and I think it really turned on the view the ability of policy makers to kind of, manage their way out of this tricky situation that have got themselves and in so far policy makers have met or beaten expectations absolutely in the last fifteen years or so. For short, I've had many conversations partake in the last forty five years and oftentimes, particularly when we ve had stress points like the renminbi many device,

nation, which we had twice once in late twenty fifteen in August and again, twenty sixteen. January, where this really fan thee Bear sentiment. People are of the view that China was going to devalue, say twenty percent imminently the economy, is really can have a so called hard landing and so on and so far The policymakers have managed to diffuse who's. That immediate threat, The economy is actually printed somewhat better than consensus, expected growth, numbers and Currencies been stable and it looks as though the banks, or continue to earn sufficient pre provision operating profits to continue to accumulate reserves against potential MP. Also So far they have done a good job of managing their way with a number of conflicting objectives. We still out as to whether that will continue if this can be any mistakes made etc, but so far taken the last three to five years. I think the policymakers done a better job than the more immediate.

Bearish contingent. The market, as expected, TIM thanks for many us again fascinating. Thank you very much appreciated That concludes this episode of exchange. The Goldman Sachs. Thank you very much. listening and we hope you join us again next time this spot gasters recorded on April. Third, two thousand. Seventy all price references and market forecasts correspond to the date of this recording. This podcast should not be copied distributed, published or reproduced in whole or in part. The information contained in this package does not constitute research or recommendation from

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