Market Overview

From London, Brandywine Global Managers See Increased Risk From China


Weakening Chinese Growth Could Continue To Impact Global Markets - Particularly Europe

LONDON, July 7, 2015 /PRNewswire/ -- At a recent Legg Mason conference in London to discuss prospects for the often unpredictable global financial markets, portfolio managers from its affiliates were asked, "What risks do you think are not fully appreciated by investors now?"

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Their answers covered several broad areas, but for Brandywine Global, the focus settled squarely on China.

"A principal risk that is not being considered by most investors is the structural decline in growth rates in China," said Gary Herbert, Global Credit portfolio manager with Brandywine Global. "When we look at retail sales, rail car shipments, vehicle sales, retail sales – they are at effectively Depressionary levels. When we look at producer price indices, those numbers have been negative for roughly 36 months."

"If structural consumption and economic growth does not occur in China, this could have a very negative knock-on effect in many emerging markets."

His views were echoed by co-lead portfolio manager of Global Fixed Income with Brandywine Global, Steve Smith: "To me this big bust in commodity prices that we've seen in the world, the big slowdown in global growth, is a combination of not just the Europeans but also the Chinese, which are the second and third-largest economies in the world."

In 2014, most market watchers were focused on monetary policy in Europe. That culminated on March 9, when ECB President Mario Draghi announced the central bank would pursue quantitative easing.

"What they really missed is what was going on in China," Mr. Smith said. "PPIs have been negative for 37 consecutive months and the country's headline consumer inflation rate is lower than the U.S.'s in 2012, yet real short-term interest rates are at 10 percent. Not only that, but China loosely pegs its currency to the U.S. dollar. The dollar, Swiss franc and of course the Chinese renminbi are the three strongest currencies in the world. Can you imagine 10 percent real rates for an economy with such a strong currency?"

"The reason China's economy has been struggling is that monetary policy is just way too tight.  China, I think, has been way too late in easing policy, overly cautious not to encourage a further build-up of speculative borrowing. But I think China is now pressing the panic button. The country's policymakers finally have figured it out. If they don't continue to lower interest rates and get funding costs down for the private sector, I think that would be the real risk in the market."

Mr. Herbert agreed with Mr. Smith's analysis, adding another perspective.

"Currency yields in emerging markets, as well as bond yields, have been elevated over the last, roughly, year or two," Mr. Herbert observed. "It's an asset class that's underperformed relative to corporate high yield, as well as more safe-haven assets. Our concern is that if growth does not return to China, if monetary policy does not become more stimulative, many of these emerging markets could see their currencies continue to weaken against pound sterling, the dollar, and even potentially the euro."

"Effectively that could reprice risk premia in many of those emerging markets." 

Mr. Herbert believes that the ECB is pursuing a much more stimulative and aggressive monetary policy, and its balance sheet is anticipated to grow from about 2 trillion to 3 trillion euros by the third quarter of 2016.

"We are still, however, waiting for the Chinese authorities to introduce a much more stimulative policy," Mr. Herbert warned. "They have had a significant period of mal-investments, whether it's been property investment or investment in some of the core commodity markets. Some of those sectors as well as state-owned enterprises need to adjust their capital structure."

He concluded, "We view that as a predominant risk in the broader economy at this time."

Notwithstanding these trepidations, Mr. Smith sounded hopeful notes.

"We are relatively optimistic that China has figured it out and are going to continue to move forward in bringing short-term interest rates down. Because they need to… because the currency has been so strong. If they do it, I think it is really going to be a help for global growth."

About Gary Herbert

Gerhardt (Gary) P. Herbert, CFA is a portfolio manager for Brandywine Global's fixed income group, with a concentration in high yield securities. Mr. Herbert joined Brandywine Global in March 2010 and has more than 25 years of high yield experience. Previously he was a managing director, portfolio manager with Guggenheim Partners, LLC (2009-2010); a managing director, portfolio manager with Dreman Value Management, LLC (2007-2009); and an executive director, portfolio manager (1999-2007) and associate (1994-1998) with Morgan Stanley Investment Management. Mr. Herbert earned a M.B.A. with honors from Columbia University, and a Bachelor's degree from Villanova University. He holds a Chartered Financial Analyst certification and is a member of the Philadelphia Scholars Program Investment Committee.

About Stephen S. Smith

Managing Director and Executive Vice President Steve Smith is co-lead portfolio manager for Brandywine Global's global fixed income and related strategies, and a member of the firm's executive board. He joined Brandywine Global in 1991 to diversify investment strategies and start the global fixed income product. Previously Mr. Smith was with Mitchell Hutchins Asset Management, Inc. as managing director of taxable fixed income (1988-1991); Provident Capital Management, Inc. as senior vice president overseeing taxable fixed income (1984-1988); Munsch & Smith Management as a founding partner (1980-1984); and First Pennsylvania Bank as vice president and portfolio manager in the fixed income division (1976-1980). He earned a B.S. in economics and business administration from Xavier University, where he chairs the university's foundation and is a member of the board of trustees. Mr. Smith also serves on the board of trustees at St. Mary's Villa for Children and Families, a provider of services for abused and neglected children, and Winterthur Museum & Country Estate, a nonprofit educational institution.

About Brandywine Global

Founded in 1986, Brandywine Global Investment Management offers a broad array of fixed income, equity, and balanced strategies that invest across global markets. As of March 31, 2015, Brandywine Global manages $66.5 billion in assets. The firm is a wholly owned, independently operated subsidiary of Legg Mason, Inc. (NYSE: LM), and is headquartered in Philadelphia with an office in San Francisco. Brandywine Global also operates two affiliated companies with offices in Singapore1 and London2.

1. Brandywine Global Investment Management (Asia) Pte. Ltd.;
2. Brandywine Global Investment Management (Europe) Limited is authorized and regulated by the Financial Conduct Authority (the "FCA"). (FRN 472774). Registered in England and Wales, No. 06324517

About Legg Mason

Legg Mason is a global asset management firm with $707 billion in assets under management as of May 31, 2015. The Company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).

All investments involve risk, including loss of principal. Past performance is no guarantee of future results.

Fixed income securities are subject to interest rate and credit risk, which is a possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. As interest rates rise, the price of fixed income securities falls. International investments are subject to special risks including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Asset-backed, mortgage- backed or mortgage-related securities are subject to prepayment and extension risks. Risks of high-yield securities include greater price volatility, illiquidity and possibility of default.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

The views expressed are those of the portfolio manager as of June 3, 2015 and are subject to change based on market and other conditions. These views may differ from other portfolio managers or the firm as a whole, and are not intended to be a forecast of future events, a guarantee of future results or investment advice.


©2015 Legg Mason Investor Services, LLC, member FINRA, SIPC. Brandywine Global Investment Management, LLC and Legg Mason Investor Services, LLC, are subsidiaries of Legg Mason, Inc.



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