Weekly Market Review 18 th April 2019

In this Issue

  • CHINA’S RECOVERY
  • GLOBAL ECONOMIC SLOWDOWN
  • A NEW EMPEROR IN JAPAN !
  • THE WEEK IN REVIEW


CHINA’S RECOVERY

The one thing that has become clear in the past few weeks is that the Chinese economy is back on a growth path.

Almost every economic indicator points to a recovery in the world’s second largest economy, from real estate sales and prices, to credit growth to Money supply growth and even auto sales.

China’s GDP for the first quarter surprised analysts with a 6.4% Annual growth rate.

The strong rebound in China’s Industrial Production shows that the stimulus measures put in place in the past few months are starting to work and that the impact of the US tariffs on Chinese-made products is starting to fade away.

At first glance, momentum appears strong going into Q2. Growth in industrial value-added jumped to a five-year high in March. However, the strong pick-up in March

Demand indicators for March were a tad less upbeat. Fixed investment only edged up slightly, as a further decline in manufacturing investment was outweighed by a pick-up in infrastructure spending.

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was partly due to seasonal effects related to the shift in the timing of Chinese New Year. A build-up in inventories ahead of a scheduled change to the VAT tax rate may also have played a role. Growth in electricity production and construction activity both picked up in March too.

China’s policy to privilege baby steps and targeted measures rather than resorting to massive monetary stimulus seems to be bearing fruits

China is be poised to take more stimulus steps to drive an expansion showing renewed signs of health.

China’s leaders are stepping up attempts to support consumption and mitigate threats posed by trade tensions with the U.S.

Officials are drafting measures to bolster sales of cars and electronics, according to people familiar with the matter. Speculation over the stimulus swirled in the markets last week, pushing up shares of domestic automobile carmakers, but it also pushed automakers in Europe and the U.S higher.


An ambitious tax reduction program is seeing some early signs of bearing fruit: retail sales expanded 8.7 percent in March to beat expectations.

The proposals include subsidies for new-energy vehicles, smartphones and home appliances, and are at a consultation stage with other government branches, with no guarantee that they’ll be approved. However, history shows that when this kind of news is being leaked, the consultation is well-advanced.

More specifically, the proposal is said to include an increase in the number of automobile licenses, subsidies for people who exchange vehicles that are 10-years old or more for electric, hybrid or hydrogen fuel-cell vehicles, encouraging banks to increase auto loans in tier 3 cities, deducting auto purchases from personal income tax and exemption of value added taxes for used car transactions until 2020.

Existing car ownership restrictions have hindered the growth of car sales last year.

In Beijing and Shanghai, for example, drivers wanting a license plate for a gasoline-powered car must enter a years-long lottery or pay as much as 90,000 yuan. The restrictions came at a time where the Government has made air pollution one of its main political objective.

Any relaxation of the restriction would be medium-term supportive but also a reflection of how weak the current environment is. If all the cities were to relax the curbs by 15 percent to 20 percent, then we could see a one-time boost of around 1 percent in Chinese auto demand.

At the same time, incentives on Electric Vehicles may be re-instated to favor the switch of car sales from Internal combustion engines to EVs.

Another form of incentive came with the Government’s plans to make it easier for rural migrants in small cities to acquire urban residency permits, boosting real estate sales.

For a slowing global economy — on display Wednesday with Germany’s government cutting its 2019 growth estimate — China’s stabilization and the prospect of stimulus is a relief. 

It’s also a sharp reversal from as recently as January when key readings were pointing to a pronounced downturn, a factor U.S. officials have touted as leverage in their push for a trade agreement.

President Trump and other U.S. officials spent much of last year saying that China’s slowdown was making Beijing desperate for a deal. 

Now that China’s growth is recovering, Trump and team will be getting more questions from pundits and the media about whether his leverage is slipping away.

In fact, China has less and less incentives to yield to US demands, but on the other hand, the strength of its economy may also entice it to re-direct the talks towards allowing its currency to rise faster than the market expects.

GLOBAL ECONOMIC SLOWDOWN

Hopes for an imminent revival of global growth were brought back down to earth last week by the latest batch of surveys.

Falls in the US and euro-zone composite PMIs suggest that it is way too soon to call a global recovery.

Markit publishes flash composite PMIs for the US and the euro-zone but only a flash manufacturing PMI for Japan.

A weighted average of the composite PMIs fell in April and suggests that GDP growth in advanced economies may have dropped below 1% annualized at the start of Q2.

The US composite PMI dropped sharply from 54.6 to a 31-month low of 52.8 in April, due to a big fall in the services index.

The MNI Chicago Business Barometer for the US fell to 58.7 in March of 2019 from 64.7 in February. The March fall was led by three of the five components. Production and new orders pulled back from last month and the prices paid indicator saw the biggest fall in 17 months, hitting the lowest level since August 2017.

We have been expecting GDP growth in the US to fall below trend in the second half of this year. If this latest PMI reading is anything to go by, after a resilient first quarter the US economy may be losing momentum faster than even we’ve been anticipating.

The euro-zone PMIs disappointed expectations of a proper rebound and suggest that the European economy is still growing at a sluggish pace. Admittedly, the German and French composite PMIs both edged up, but remain below their average levels from Q4 last year. The overall euro-zone PMI fell, indicating that economic conditions deteriorated in the peripheral economies.

The manufacturing PMIs suggest that German industry is still in a deep recession.

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German industrial orders dropped unexpectedly by 4.2 percent month-over-month in February 2019, missing market expectations of a 0.3 percent rise. 

This was the second straight month of decline in factory orders and the steepest since January 2017, amid decreases in both domestic orders (-1.6 percent) and foreign demand (-6.0 percent). 

New orders from the Euro Area shrank 2.9 percent and those from third countries plummeted 7.9 percent

Having dropped sharply in January and February, Japan’s manufacturing PMI ticked up last month and again in April but is still consistent with industrial output falling at the start of Q2.

With the economy struggling to regain momentum, export demand set to stay subdued and spending to be hit by the upcoming sales tax hike, we expect Japanese GDP to stagnate in 2019.

A NEW EMPEROR IN JAPAN !

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Emperor Akihito of Japan is set to abdicate on 30 April 2019, which will make him the first Japanese Emperor to do so in over two hundred years.

The Emperor of Japan is the head of the Imperial Family and the head of state of Japan. Under the 1947 constitution, he is defined as “the symbol of the State and of the unity of the people.” Historically, he was also the highest authority of the Shinto religion.

Numerous festivities will mark the accession of his successor, Crown Prince Naruhito. The enthronement ceremony will likely happen on 22 October
2019.

He will become the 126th emperor of the world’s oldest monarchy. 
He will also become Japan’s first emperor who was born after World War II.

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Naruhito was born on 23 February 1960 in the Imperial Household Agency Hospital in Tokyo Imperial Palace. His mother, Empress Michiko, is a convert to Shinto from Roman Catholicism, a specificity that drew a lot of criticism at the time of her mariage.

Naruhito’s childhood was reported to be happy, and he enjoyed such diverse hobbies as music, mountain climbing, and riding.

Naruhito graduated from Gakushuin University in March 1982 with a Bachelor of Letters degree in History. In July of the next year he entered a three-month intensive English course before entering Merton College, Oxford University, in the United Kingdom.

Naruhito first met his wife Masako Owada at a tea for Infanta Elena, Duchess of Lugo in November 1986 during her studies at the University of Tokyo. The prince was immediately captivated by her, and arranged for them to meet several times over the next few weeks. Because of this, they were pursued relentlessly by the press throughout 1987.

Despite the Imperial Household Agency’s disapproval of Masako, and her attending Balliol College, Oxford, for the next two years, Naruhito remained interested in Masako. 

The Imperial Palace announced their engagement on 19 January 1993. The wedding took place on 9 June 1993 at the Imperial Shinto Hall in Tokyo before 800 invited guests, including many of Europe’s heads of state and royalty, and an estimated media audience of 500 million people around the world.

April 30th 2019 will mark the end of the Heisei period ( 30 Years ) and the beginning of a new era, the “Reiwa” period. 

The abdication and enthronement are both traditionally national holidays so the Japanese Government has consolidated the 2019 Golden week holidays into a special ten day block lasting from April 27 to May 6 2019.

As our readers know, we have been underweighted Japan in past 12 months as the second leg of the secular bull market that started in 2012 paused. 

Time may have come to take a more positive stance on Japan.

Japanese equities have been underperforming the world major stock markets so far this year and this may be coming to and end. 

Three positive things may trigger the second phase of the second leg of the secular bull market in the Nikkei 225.

Firstthe celebration of the Emperor’s abdication and the birth of the new Reiwa era will attract International attention and boost Japanese consumption.

In our view, the VAT hike expected in October will be less negative than the market expects and we believe the Abe administration’s active economic stimulus package of JPY 2–3 trn will support domestic household consumption.

The Tokyo 2020 Olympic Games should also support the domestic economy next year, triggering investments and attracting visitors from all over the world.

International investors, who account for 60–70% of the Japanese stock market’s trading volume have been largely absent lately and are still not net buyers of Japanese stocks. 

The lack of international investors’ interest could end once the 10-day holiday period in early May is over.

Second, positive developments regarding the US-China trade talks, and a recovery in the Chinese economy are positive factors for the Japanese economy which derives a significant portion of its GDP from Exports. China is today Japan’s main trading partner and any resumption of Chinese consumption is a strong positive for China. 

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Moreover, Japanese equities have always had an inverse correlation with the vale of the Japanese currency and as we expect a significant bout of strength of the US dollar in the months to come, Japanese equities should perform well.

As the two charts below show, an important break of the JPYUSD above 112 is imminent with a target at 120. When that happens Japanese stocks will be flying.

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Third, Japanese Corporate earnings are set to recover markedly after a weak 18 months.

Japanese companies’ March quarter earnings are expected to be worse than originally anticipated but the worst may be behind us. We expect Japanese corporate earnings to fall 6% for the full FY18 and rise 3% in FY19.

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Japanese corporate earnings growth should improve year-on-year for the next four quarters.

Despite a significant drop in the quarterly earnings, the stock market’s reaction has been limited and investors are starting to anticipate better results ahead.

Japanese stocks are moderately undervalued.

TOPIX is trading at around 13x P/E based on 12-month forward EPS and the dividend ratio is 2.3%, which is relatively high compared to history. 

Japanese equities are below their future earnings trend, but we think the gap will narrow once international investors return to Japan after the massive selling in 2018.

Some Japanese companies with strong operating exposure to China are undervalued in our view

Increase Exposure to Japanese Equities.

THE WEEK IN REVIEW

CURRENCIES

The US Dollar had a strong week closing higher against almost every currency. As expected,Swiss francs weakened the most and broke out of the long term triangle that we highlighted in our previous posts.A

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COMMODITIES

Another weak week for GOLD as the US dollar is pushing higher. We are nearing levels where BUYING Gold starts making sensePalladium had a strong rebound while Natural Gas has one of its weakest showing in months.

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EQUITIES

Global equity markets are losing momentum as the SP500 hovers at 2’900 and the Dow Joins Industrial nears its September all-time high.

It rarely gets more optimistic than that ! Dumb Money Confidence has been climbing steadily for a month, and stocks have so far shrugged off that extreme optimism.

Now it has reached its highest level in a decade, though, and every date that saw this high of a reading in the past 20 years sported a negative return in the S&P 500 at some point in the weeks and months ahead.

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On the other side of the spectrum, the McClellan Oscillator for the Shanghai Composite has dropped back to -75 while the index is holding above its 50 day average. According to the Backtest Engine, this has only happened a few times, all leading to further gains for the Shanghai Composite Index.

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BONDS

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