Retirees and near-retirees may not need to reduce or eliminate their fixed income exposure out of a concern for higher global inflation and interest rates.
I say that not because they’re wrong to believe that higher inflation and interest rates would be generally bearish for bonds. But retirees may be overlooking the bond market of a global economic powerhouse for which the interest rate, currency and inflation trends will be favorable over the coming decades.
That is the provocative contention of Vincent Deluard, head of global macro strategy at investment firm StoneX. I am devoting this column to his argument because it is not one that I have seen discussed widely by the other advisory services I monitor.
Deluard’s argument is that a unique combination of demographic, economic, monetary and political forces in China will keep Chinese interest rates low and the Chinese currency stable in coming decades. That in turn will be good news for Chinese government bonds, since they already provide one of the highest inflation-adjusted yields in the world.
In an interview, Deluard said the core of his case is that China faces a “demographic collapse” that will have a huge deflationary impact over the long term, which in turn will be very bullish for Chinese government bonds. I mentioned Chinese’s long-term demographic trends in a recent column, pointing out that some demographers are projecting that China’s population will fall by 48% between now and 2100.
It’s difficult to overstate the economic significance of this “demographic collapse.” The size of a country’s labor force is one of the biggest determinants of a country’s prosperity. “The slowdown in [economic] growth will be massive,” according to Deluard.
While productivity growth can at least somewhat ameliorate the deflationary impact of a declining population, Deluard says it won’t be much more than a drop in the bucket. “With the exception of the destruction of the pre-Columbian civilizations, mankind has never experienced the kind of demographic collapse which East Asia will face in the next 20 years.”
Deluard acknowledges that it will be difficult for U.S. investors to accept his forecast, since they take for granted that politicians and the Federal Reserve won’t allow deflation to occur. The powers that be will instead always choose to inflate their way out of any deflationary threat—causing bonds to suffer mightily.
Deluard insists that the situation in China is far different, however. One of its overarching long-term policy goals is to have its currency, the Renminbi, become one of the world’s reserve currencies. And in order for that to happen, the government must choose deflationary policies over inflation.
That’s because one of the prerequisites for the Renminbi to be a reserve currency is that the market for Chinese government bonds must grow markedly, both in size as well as liquidity. That will not happen if Chinese inflation or interest rates are allowed to meaningfully rise, so the government will prevent it.
Absence in China of political forces supporting inflation
Such a geopolitical and economic goal couldn’t be pursued in the U.S. because there are too many powerful political interests opposed to deflation. One such group is equity investors, and Deluard reminds us that 72% of the U.S. stock market is owned by large, politically connected institutional investors. As a result, a stock bear market becomes a political problem.
In China, in contrast, according to Deluard, just 9% of the equity market is owned by institutional investors. So a Chinese bear market does not pose a political problem. “China’s stock market is dominated by gambling-prone retail investors. Asking the government for bailouts is seen as absurd as asking the house for a refund after a bad night in Macao.”
One telltale sign that the Chinese government is willing to throw its stock market under the bus is its latest 5-year plan. Deluard points out that it was the first in the country’s history that did not include an economic growth target.
As Deluard characterizes this contrast, the U.S. “euthanizes” its bondholders while China “cajoles” them.
How to invest in Chinese government bonds
To be sure, Deluard’s bet on Chinese government bonds is a long-term one. So even if you’re interested in following his advice, you should only do so as part of the fixed income allocation of a long-term financial plan.
As is often the case, exchange-traded funds are the easiest way to gain exposure to Chinese government bonds. Unfortunately, none of the obvious candidates trades in the U.S., so you will need to get your broker to work out the logistics involved in your purchasing one of them.
Though Deluard offered no specific recommendations, here are three exchange-traded funds that provide exposure to the Chinese government bond market:
GaveKal China Fixed Income UCITS Fund A USD, which trades in Ireland with AUM of USD 1.5 billion. This ETF has an expense ratio of 0.5%.
ICBC CSOP FTSE Chinese Government Bond Index ETF
which trades in Singapore with USD 1.4 billion. Its average duration is 6 years with a 0.25% expense ratio.
NIKKOAM-ICBCSG China Bond ETF
which also trades in Singapore. Its AUM are USD 209 million, an average duration of 4.1 years, and an expense ratio of 0.30%.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]