Redressing the Balance
James Anderson, CIO at Baillie Gifford, talks to Heather Farmbrough about inflation, deflation and why China matters.
This interview took place on 7 August 2008
I think the question that most readers would like to ask is, is this as bad as it is going to get? Companies are cutting costs, food is going up, the euro is expensive and it's a bear market.
It may be. You mention cost cutting and that's why I think that the inflation 'threat' is a myth. This is not an environment in which many of the outside commodity producers have any pricing power - I'd be surprised if my colleagues in the financial sector are still expecting big rises over the next few years. I think also that higher oil prices are effectively more of a tax than an inflationary force. When we talk next, I would not be at all surprised if people are worrying about deflation rather than inflation. The stock market is preoccupied with inflation and the idea that nothing can be done because of it. But if we don't need to worry about inflation, the environment changes dramatically. For Western consumers it will be a hard few years, but the corporate sector will cope better because it is more international. I see this as part of an essential global rebalancing from West to East. Many of the stocks the market has worried a good deal about over the last six months have delivered better than expected earnings.
I assume you are excluding the banks?
Yes I am, although Scottish Mortgage has recently bought Banco Santander, which was less over-borrowed than most. What I mean is the consumer and industrial companies who have made adjustments in order to balance their business from the Western world to Asia. China is going to grow and we're not, and we have to get used to that. Adidas, the consumer leisure and fitness brand, is a very good example of a company that recognised this: it now has more business in Asia than it does in North America.
How do you evaluate which Western companies to buy in China?
The question here is not so much about whether they are there but whether they will beat off local competitors. Baidu, the Chinese search engine and online encyclopedia, did well when Google was shut down in China. Baidu has developed a business culture as well as an internet algorithm and a sales force. It does not seem to be rolling over and dying as a competitor to Google as almost every company from Microsoft onwards has.
Your colleague Gerald Smith [Trust Article 05] is concerned about inflation in China. How do you feel about Asia?
It does usually worry me when I have a different view from Gerald, because he may very well turn out to be right, but for now I think that my argument holds up. The main issue in Asia is what is happening in China. Recent data on the annual food and fuel prices there were encouraging and the authorities have said subsequently that continuing growth can now be more of a priority. Capital productivity is increasing, which justifies higher wage increases. The emphasis has moved from selling cheap T-shirts to the West to a higher capital productivity.
Chinese consumer demand is growing very quickly, and there is a strong demand for branded goods. Do you think that this is sustainable?
I don't know, but I think it is striking how important the Western brands are. People were sceptical about whether Nokia could compete against the likes of Samsung, yet it has. PPR, the brands company owning Gucci, has lost sales in the West, but is booming in China - very intriguing in a country with a 3,000-year tradition of making money from silk products.
Could this situation be a case of a 'first man in' advantage?
That has not been the case in Japan, where Louis Vuitton has been the most successful luxury goods company. It is hard to think of a successful Japanese luxury brand, other than Shiseido - although this is not really international. Hermes' share price has held up - this is a luxury brand company 170 years old that takes things very slowly.
China appears to be a very different picture from Russia [see Trust Article 06] where wealth is highly concentrated and often dependent on the ownership of raw materials.
Yes, development is broader. I personally welcome the different concentration of wealth. But the big question is, how does the world economy and environment cope with the scale of Chinese demand? What happens if every person in China wants to have a car? This could only happen if there is a rather substantial technological change in order to prevent overwhelming rises in oil prices and horrendous environmental problems.
Elsewhere, particularly Latin America, the story has been the strength of countries with mineral resources. But things move on. What now?
Funnily enough, we have just had that discussion. I think the challenge here is to understand the ripples caused by an extraordinarily advantageous position in commodities combined with a very sensible macro-economic policy being implemented over the last few years.
Readers may question how the world will fit together economically in the future, as there are such differences in social and political ideology.
Perhaps this conflict is important. As Orson Welles commented, you can have peace and stability in Switzerland, but what you get is a cuckoo clock.
You mean there has to be a dynamic?
Yes, a dynamic. Shanghai is potentially the city in the world that might start a revolution. Is that good or bad for me as an investor? We have to prepare our minds so that we can react, whichever way it goes. I think that it would be dangerous to be too dogmatic about China's political evolution. Investment returns are likely to favour the prepared mind, regardless of the route.
Everywhere you look, there is a bear market. However, there is such global diversity in industrial growth that the generalisation seems a bit odd.
Absolutely, but while it is not great fun for us or investors, it's precisely this that creates the opportunity. Everything from Petrobras to Petrochina has collapsed. I see this as a sign that people are too depressed, and as evidence of forced sales. If the world's growth continues shifting towards China and other specific markets, we do not have major inflation in the West or East, and stock market valuations remain attractive, there is hope. One can either wallow in despair about what's happened or think this is precisely the time to be interested. Only if the world is imploding and taking itself down do you want to be pessimistic.
Investment markets, including the currency exchange rates, can go down as well as up and market conditions can change rapidly. The value of your investment and any income from it can fall as well as rise and you may not get back the amount that was invested. The views that are expressed in this article should not be taken as statements of fact and no reliance should be placed upon these when making decisions about investment. They should not be considered as advice or a recommendation to buy, sell or hold a particular investment. The information on investments included here does not constitute independent investment research and therefore it is not subject to the protections afforded to independent research.
Heather Farmbrough is editor of Trust
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