Edited Transcript
We’ve seen massive moves in Chinese markets of late. How did we get here?
McLean: The Chinese market and economy have been under pressure for several years now, really since the reopening from COVID. We've seen growth slowing. The economy is deflating. They've had deflation in seven out of the last eight quarters and the consumer is not spending. They're saving or paying down their mortgage.
I think that lack of growth has reached its endpoint and the government decided enough was enough. And, as you say, in mid-September, they announced some monetary policy easing. They lowered interest rates, cut mortgage rates for existing mortgages, and lowered the reserve requirements as well for banks. So that lowered the cost of funding and increased liquidity into the system. This is good but we need demand stimulus as well. They followed up immediately after with a statement that fiscal stimulus was coming and that led to the rally in China's equity markets.
In Australia, the resources sector rallied quite strongly and banks sold off. But in a series of announcements since then, that big bang or the bazooka that you mentioned, didn't come. It was much more of a whimper and that culminated with the NPC in November, where they announced a big local government debt swap. But they didn't address the key issues that the market was looking for - on consumption, the property de-stocking, and the re-capitalising of the banks. Since then, the market has given back some of these gains.
Have you made any changes to your portfolio in light of this?
McLean: We are currently underweight the banks because we think the fundamentals and valuations are mismatched. If you think about banks, their returns are in structural decline. Mortgage returns are below the cost of capital, and yet competition is increasing, which is not a rational position to be in.
We continue to be underweight in the banks, but conversely, we had been adding to resources even before the Chinese stimulus announcement in August. We've been adding to iron ore, where seasonally it is a good time to buy iron ore, especially when the iron ore price is at the level of cost curve support.
We've also been adding to copper, although there are some risks around copper in the near term, potentially, if Donald Trump rolls back some environmental measures or implements tariffs. Copper is the key arbiter of global economic activity, and there could be a dent in demand there as well. But, long term, we see the supply-demand dynamics being supportive. Structural deficits are also coming in the later years of this decade, driven by decarbonisation spending.
Indeed, we think that the copper supply is going to be the limiting factor for decarbonisation rather than the sticks and carrots, the incentives and penalties that the government are imposing to force decarbonisation. We've been buying stocks in those sectors where we also see good long-term company-specific growth and reasonable valuations at the same time.
Is the lack of concrete stimulus to answer the market's concerns about these structural challenges the biggest risk moving forward?
McLean: That is definitely a downside risk. I think if there are no stimulus measures and coupled with large-scale economy-wide tariffs that Trump implements, you are going to see disruptions of trade flows, weaker growth in China, and the Chinese consumers just continue not to spend.
But I think there are risks to the upside as well. The Chinese authorities have left the door open for more stimulus measures down the track, and they're likely taking a bit of a wait-and-see approach to what Donald Trump is going to implement.
If he does implement the tariffs, they could stimulate domestic demand to offset that or even depreciate or devalue the Chinese Renminbi, which the Australian dollar is highly correlated to generally, which could be good for Australian exporters, particularly those US-exposed exporters who are also going to benefit from a potential tax cut in the US.
Outside of resources, are there any other companies or sectors that could benefit?
McLean: I think it does depend on reigniting the animal spirits in the Chinese consumer. But yeah, even in the absence of that, I think a company like Treasury Wine Estates (ASX: TWE) looks fairly well placed.
They've only just had the tariffs that China imposed on Australian wine removed, and that coupled with a really strong vintage this year, means that they've got good volume growth in their key brand Penfolds for the next few years.
At the same time, if demand increases because, for all the sources that we look at, it appears that the brand equity in China has not been diminished over this period where the tariffs are in there. If demand increases, it's going to lead to price rises as well. You can see good strong growth in their wine, in their Penfolds division, and at the same time they're talking about divesting their less-than-premium, their commercial grade wines refocusing on that premium luxury segment as well. It's a stock that's trading near its historic lows in terms of valuation.
