The Coming Shift in Global Capital: Are You Ready?

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• China's recent stimulus measures are more than a "kitchen sink" reaction; they signal a strategic shift with global implications.
• A Trump victory in the U.S. election could trigger a weaker dollar and a surge in emerging markets.
• Europe's economic challenges run deep, with misguided energy policies and declining productivity undermining its future prospects.

Global markets are on edge. From persistent inflation and rising interest rates to geopolitical uncertainty and concerns about a slowdown in China, investors are grappling with a complex and unpredictable landscape. Amid this turbulence, however, contrarian voices are emerging, challenging the prevailing doom-and-gloom narrative.

Louis-Vincent Gave, founding partner and CEO of Gavekal Research, is one such voice. Known for his sharp insights on Asian markets and global macro trends, Louis-Vincent believes that investors need to broaden their horizons and look beyond the usual suspects, particularly in light of China's recent policy shift.

He argues that the wave of stimulus measures announced by the Chinese government is not simply a desperate attempt to prop up a failing economy, as some have suggested, but a calculated strategy with the potential to trigger a significant shift in global capital flows.

"I think it's definitely the turning point for the Chinese markets," said Louis-Vincent. While acknowledging the real challenges facing the Chinese economy, particularly in the real estate sector, he emphasized that "markets do anticipate these kinds of things."

Louis-Vincent's core argument rests on the idea that investors are often overly focused on the magnitude of a problem rather than the direction of change. "Very often, where there’s the most money to be made is when a situation goes from very, very bad to just mediocre," he explained. "And just in that move from very bad to mediocre, a lot of assets get repriced."

China’s policy pivot: More than meets the eye

Despite Louis-Vincent's optimism, skepticism abounds. Many market commentators have dismissed China's stimulus efforts as a futile attempt to revive an economy burdened by excessive debt and a slowing property market. However, Louis-Vincent argues that this time is different.

"This isn't going to trigger a new construction boom," Louis-Vincent asserts. He draws a parallel to Ireland's recovery from its real estate crisis, noting that it took years for construction to meaningfully pick up, even after the initial stimulus measures were implemented.

Louis-Vincent points out that much of China's infrastructure spending in previous cycles focused on building out high-speed rail networks and other large-scale projects, but these are now largely complete. "90% of Chinese people now live within an hour's drive of a high-speed rail station," he explains. This lack of a need for further infrastructure development, he argues, will dampen demand for commodities like copper and iron ore, even as the government eases fiscal and monetary policy.

Instead of fueling another construction frenzy, Louis-Vincent believes that this stimulus package is designed to address specific vulnerabilities within the Chinese economy. He highlights two key demographics that are currently experiencing economic hardship: millennials in tier 1 and 2 cities who have been impacted by the property market downturn and older demographics in rural areas who have been left behind by China's rapid economic growth.

"If you're the government, you think, 'Okay, these are the two groups that basically we need to help out because they’ve been screwed over in the past five to ten years,'" Louis-Vincent explains. "So what you do is you do handouts to the guys in the countryside, and this has already been announced. We’re going to send checks to the poorest 15% of the population, which basically is the older folks in the rural areas."

For millennials in major cities, Louis-Vincent argues that the government is deliberately engineering an equity market boom to bolster their wealth and confidence. This approach, he notes, is evident in the government's decision to cap bonuses for financial professionals, preventing them from profiting excessively from the market upswing. "You crank up the stock market," he says, "and you make it very obvious to these guys, you say, 'Look, you guys actually do have some savings. Put them in the stock market, we’ll crank that up, and you’ll make some money.'"

The U.S. election: A Trump victory could spark a global reflationary boom

In the United States, Louis-Vincent sees another potential catalyst for a global reflationary cycle: the upcoming presidential election. While acknowledging that the betting markets currently view the race as a coin flip, he expects a Donald Trump victory.

"I think Trump’s going to win," Louis-Vincent states, pointing to historical polling data and current trends in key swing states. "So, if we assume that Trump wins,I think the general perception of a lot of investors I talk to is that, if Trump wins, he comes in and he’s very brash, and he’s rude to all the countries, especially China, and that this leads to a further deterioration in the China-U.S. relationship."

However, Louis-Vincent challenges this assumption, arguing that Trump's current circle of advisors, including figures like Elon Musk and Robert F. Kennedy Jr., suggests a more nuanced approach to foreign policy. "Fast forward to today, and Trump is surrounded by people who are far less abrasive with the rest of the world," he observes.

He also notes that Trump has been careful to refer to China as a competitor, rather than an enemy, on the campaign trail, suggesting a willingness to find common ground. This, combined with Trump's stated desire to find a solution to the Ukraine war, could lead to a more constructive dialogue between the two superpowers. Louis-Vincent suggests that such a scenario could involve the U.S. easing sanctions on China in exchange for pressure on Russia to agree to a peace deal favorable to Ukraine.

"I think in terms of foreign policy, it could be quite a good thing," Louis-Vincent contends.

Looking beyond geopolitics, Louis-Vincent believes that a Trump victory could have significant implications for the U.S. dollar and global markets. He suggests that a new "Plaza Accord" scenario, similar to the one enacted in the mid-1980s, could be on the horizon, with the U.S. pushing for a weaker dollar to boost its exports and rebalance global trade. This, he argues, could involve putting pressure on countries like Japan, China, and South Korea to revalue their currencies.

"The possibility of a big new Plaza Accord in which the U.S. dollar is driven down, I think is a distinct possibility if Trump is elected," he says. "If that does happen, then to be honest, I think most people don’t have enough risk in their portfolios because all risky assets will absolutely rip higher.”

But Louis-Vincent acknowledges that a weaker dollar could lead to a steeper U.S. yield curve, with long-term interest rates rising to 5.5% or 6%. This could create challenges for the U.S. government in financing its already massive debt, particularly given its reliance on foreign investors.

A world of shifting capital flows: Where should investors look?

As China embraces stimulus and the U.S. potentially shifts toward a weaker dollar, Louis-Vincent sees a fundamental realignment taking place in global capital flows. He argues that the U.S., despite representing only 4% of the global population, currently commands a disproportionate share of global capital, accounting for 70% of the MSCI World Index. This, he believes, is unsustainable in the long run, particularly as emerging markets offer more compelling growth opportunities.

"Can you have 70% of the capital allocated to the U.S. when it’s a third of the profits?” Louis-Vincent asks. “There’s a dislocation there."

He predicts that the coming years will see a significant shift in capital away from the U.S. and towards emerging markets, particularly as China's growth accelerates and the dollar weakens. This doesn't necessarily signal a U.S. recession or a bear market, he clarifies, but rather a period of relative underperformance compared to other markets.

To illustrate his point, Louis-Vincent highlights the example of Microsoft, arguing that the tech giant's high valuation has been driven in part by foreign investors seeking a safe haven for their U.S. dollar holdings. As the dollar weakens and other opportunities emerge, he believes this dynamic could reverse, leading to capital outflows from U.S. equities.

"For me, Microsoft, Apple, Amazon, these guys have been receptacles for the excess dollars in the world," he says. "And that made sense in a strong dollar world. But I think this is the phase where we’re now going to be entering is people say, ‘you know what, U.S. dollars no longer going up. I don’t need to keep as much U.S. dollar assets and I can let go of my Microsoft now and maybe I buy Tencent that’s a quarter of the value.’"

Expanding on his emerging market thesis, Louis-Vincent argues that the historical drivers of emerging markets (EM) performance are now aligning, creating a compelling opportunity for investors. "For my whole career, EM either played on a weaker dollar, and now all of a sudden, the U.S. dollar seems to be weakening, or it’s a play on China doing better," he explains. "For my whole career, that’s been it. You buy EM when the dollar is weak, and you buy EM when China’s reaccelerating. And if you have both at the same time, China reaccelerating and the U.S. rolling over, EM [will] do very, very well.”

Louis-Vincent specifically highlights Brazilian bonds as an attractive investment, noting their high real yields and Brazil's embrace of trade with China. He contrasts this with the U.S., which is increasingly rejecting China's deflationary impact through tariffs, potentially leading to higher structural inflation.

This dynamic, he argues, makes emerging markets that are embracing trade with China a more attractive destination for fixed-income investors. He prefers, for example, "a Brazilian tip offering 6.5% real than a U.S. tip offering 1.7% real, at a time when Brazil is embracing trade with China and the U.S. is doing the opposite."

He also notes that while some emerging markets, such as India, Indonesia, and Malaysia, have performed well even during the recent period of dollar strength, other markets, such as Brazil and Chile, have lagged. However, he believes that these lagging markets are now "dirt cheap" and poised to benefit from China's reacceleration and the potential for a weaker dollar.

The productivity puzzle: Energy policy and Europe's challenges

While Louis-Vincent is optimistic about the prospects for emerging markets, he expresses significant concerns about Europe's economic future. He argues that Europe has made a series of policy missteps over the past two decades, particularly in the areas of energy, industry, and immigration, which have undermined its competitiveness and productivity.

"If you go back 15 years ago, 20 years ago, France had a huge comparative advantage relative to the rest of the world," Louis-Vincent notes. "We were far ahead of everyone in nuclear energy." However, he laments, France, along with Germany, has since retreated from nuclear energy, sacrificing its productivity advantage "to please a small minority of greens."

Louis-Vincent contrasts Europe's struggles with the U.S., which has benefited from the shale boom and the resulting abundance of cheap natural gas. "The U.S. has had one massive comparative advantage, it has been the shale boom," he observes. "It has been the fact that the price of natural gas has gone from $10 down to $2." This energy advantage, he argues, has been a key driver of the recent surge in U.S. productivity.

Looking ahead, Louis-Vincent sees some potential for Europe to regain its footing, particularly as the war in Ukraine has highlighted the strategic importance of energy independence. He notes a "big zeitgeist shift on nuclear," suggesting that there is now greater political will to invest in this technology. However, he remains skeptical that Europe can overcome its deep-seated structural challenges, particularly given the growing burden of its aging population and the political difficulties of reforming its welfare state.

"I hope we’ll see it. I fear we won’t," Louis-Vincent says of the prospects for Europe to enact meaningful reforms. "And I say this as a Frenchman, I fear we won’t."

He highlights the link between defense spending and technological innovation, noting that countries with strong defense industries, such as the U.S., Taiwan, South Korea, and Israel, have also been leaders in technological development. Europe, he argues, has fallen behind in this area due to its decades-long decline in defense spending.

"We spent 25 years cutting out defense spending," Louis-Vincent observes. "Because if you’re in government and you think, ‘okay, I mustn’t have budget deficits and I must reduce my spending, the easiest one to cut is always the army because they don’t complain.’" The result, he argues, is that "we have no more tech sector in Europe."

While Louis-Vincent acknowledges the suggestions from former European Central Bank President Mario Draghi for greater European coordination on defense spending and energy infrastructure, he remains pessimistic about the likelihood of these proposals being implemented. "There’s no appetite for it today," he concludes.

A world in transition: Embrace the change

From China's bold policy pivot to the potential for a reflationary wave sparked by a Trump presidency, Louis-Vincent Gave paints a picture of a global economy undergoing a profound transformation. Investors who cling to outdated narratives and fail to recognize these shifts risk missing out on significant opportunities.

As capital flows realign and new growth drivers emerge, it's essential to challenge conventional wisdom and embrace a more nuanced understanding of the forces shaping global markets. The time to adapt is now.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.