Market Thinking

making sense of the narrative

Is RCEP a recipe for a Reset?

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The narrative over the last six months was seemingly almost entirely around the twin themes of Covid and the US Election and it looks like November will come in as a really strong month in Global Equities, principally because the risk premium around both of those has fallen. Having said that, we would be somewhat cautious in so far as there may be some poor news flow from both areas – certainly compared to expectations. There remains a non zero risk that the Trump lawsuits will not only get to the Supreme court, but also further delay the declared ‘done deal’ of a Biden Presidency and so increase short term uncertainty. Equally the drift towards an accidental ‘zero Covid’ policy by many western politicians is making the magic bullet vaccine strategy an important economic variable. If, as certainly seems to be the case in Europe, politicians are going to maintain economically damaging lockdowns until a vaccine is fully distributed then the V shape recoveries keep getting postponed, raising medium term risks.

On the flip side, things are looking up in Asia, especially for longer term trends. Last week we discussed the 5Cs strategy to diversify some portfolios in the light of emerging longer term trends – Cash Flow, China, Convertibles, Commodities and Crypto Currencies and three of these are caught up in the important news that came out last week of the signing of the RCEP, the Regional Comprehensive Economic Partnership. While the UK struggles with the seemingly interminable negotiations with the EU, this broader alliance has been pushed through with surprising speed. This can best be thought of as a combination of the ASEAN elements of the 2018 CPTPP – the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, (which in turn had sprung from the failed TPP – Trans-Pacific Partnership) with the smaller ASEAN countries plus of course South Korea and China. Thus whereas the TPP was proposed as a trade bloc specifically to exclude China, the new RCEP has China at the heart of it and the US (and India) now on the outside looking in.

Figure 1: Members of RCEP and CPTPP
(Numbers present 2018 GDP in trillions of U.S. dollars)

Chart showing members of the CPTPP and RCEP trade blocs.

Source: https://rcepsec.org/2020/11/26/rcep-a-new-trade-agreement-that-will-shape-global-economics-and-politics/

For advocates of Free Trade, this is however undoubtedly ‘a good thing’ as it creates the world’s largest Free Trade area, covering over 2 billion people and 30% of world GDP. It accounts for around 28% of Global Trade, but perhaps more important for investors 23% of Global Foreign Direct Investment (FDI) and the group as a whole provides 34% of all outbound FDI – mostly from Japan and China obviously. The biggest short term benefit is that it helps with intermediate goods and components, allowing members to maintain bi-lateral agreements with other countries while avoiding tariffs between themselves on account of those sub-components – as had previously been the case.

In many ways the best way to think of this is the facilitator of the new global supply chain in the wake of the US/China trade wars. This is ASEAN led, since neither China or Japan could be seen to take the lead here and importantly we note who is not there (apart from India); Taiwan. The fact that Xi has made it clear that concluding RCEP opens the way for bi-lateral talks with South Korea is also clearly very important here in the ongoing Chip battle.

From an investor viewpoint, for the outlook for 2021 – looking past Covid and the aftermath of the US Elections – we ought really to be thinking more about some of these trends and in particular whether a greater exposure to this grouping makes sense. With less damage from Covid policies and with agreements like this allowing for greater efficiency and integration of the new supply chains then we would suggest that a decent size – perhaps as much as 35% of a global portfolio – should be focussed on this region in general – especially as the trade weighted Dollar continues to weaken. Thus in addition to the existing consumer focus, we can extend to a more cyclical focus on trade, commodities and intermediate goods as well even some capital expenditure, particular in the technology areas. Obviously we have effectively been exposed to these regions via multi-national companies already, but increasingly ‘local’ ways to play them will become more fruitful.

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