The Week in Review 31st March 2019
In this issue :
# Liquidity Triggers a Bond Binge and Lifts All Asset Classes
# Chinese Equities Lead the Global Equity Rally
# US Economy Slows more than anticipated
# Oil Caps a Strong Quarter but a Stealth Danger lies ahead
# The Long Awaited Palladium Collapse
Liquidity Triggers a Bond Binge and Lifts All Asset Classes
In November 2018, Donald Trump was criticizing the FED and its Chairman Jerome Powell for having raised interest rates and provoked the collapse in equities. Last week, he has been at it again, tweeting that the FED was maintaining too tight a policy and should lower interest rates.
Last week the FED actually surprised the markets by lowering its guidance for the year from one expected interest hike to none at all and the buzz word of the financial markets last week was “Yield Curve Inversion”.
Indeed, Bond markets have rallied considerably since the peak in interest rates in September 2018 and US 10-year Government bond yields fell by 25 % in the past three months, easing monetary conditions considerably.
Indeed, the dovish tome of the FED led bond investors to rush along the yield curve and extend maturities, not only in the US about also in Europe and Japan, and, indeed, Yield curves are now inverted at the middle range of maturities.
More importantly, In excess of US$ 10 trillion of bonds are now yielding negative nominal returns and most of the world bonds and yielding negative real returns ( i.e. deflated by inflation ).
Bond Investors ARE actually BEING PAID in nominal or real terms to lend money to Governments as far as 30 years down the road !
WOW ! That IS liquidity creation !
A Bloomberg index tracking negative-yielding debt has reached the highest level since September 2017 as 10-year bunds trade in negative territory and the U.S. yield curve flashes recession warnings.
With central banks in dovish mode, money managers face increasing pressure to reprise the yield-chasing mentality synonymous with quantitative easing.
The DEFLATION SCARE that we were predicting in OUR SEVEN INVESTMENT CALLS FOR 2019 is truly there.
Investors holding cash are moving along the maturity curve — or down the rating curve — to seek yield, which is once again becoming a scarce commodity, and are no longer worried about inflation, quite the contrary !
Bond investors are not stupid and THE ONLY RATIONALE FOR BUYING A NEGATIVE YIELDING BOND IS WHEN YOU EXPECT INFLATION TO PLUNGE IN TO NEGATIVE TERRITORY !
Fund flows underscore the lust for yield in this deflationary scenario.
The extraordinary abrupt end to central bank hiking cycle caused by the extraordinary economic slowdown caused by the extraordinary Trade Wars of Donald Trump are sending investors piling into long dated bonds, triggering negative real or nominal interest rates.
The charts below show the extent of the monetary easing induced by falling bond yields around the world
Sharply falling Bonds Yields around the world. ….
Triggered massive monetary creation with the usual time lag
Note how Broad money supply has jumped in the four largest economic region of the world in January and February
Interestingly enough, and maybe t outperformance of the Chinese equity market is not a coincidence, China is replay where money supply is exploding upwards…
The fact of the matter is that we have never seen monetary easing so long, so broad and so big in economic history.
In addition to lower bond yields, Europe and Japan are pumping extraordinary amounts of liquidity onto the system and China is doing the same.
As America stopped withdrawing liquidity, the tidal wave of money is in full force.
Extraordinary monetary conditions have been in place for almost a decade now and, as a result, asset prices are 1) extremely elevated, hence the sharp falls when liquidity is deemed to tighten and 2) highly addicted to liquidity !
The tide of liquidity lifts all assets …
and this is why there is no point in fighting the desire of equity markets to go higher and higher, after their big scare of the 4th quarter of 2018. We had been expecting a correction in equities markets in March or April, but it does not seem to be the case and the recent rally in bonds juts paves the way for more advances.
Let’s just take a simple case in point using Dr. JANSEENS, a Belgian dentist living in Antwerp.
Currently, interest rates in EUR are slightly negative. Inflation is at 1.3 %, meaning that if Dr. JANSEENS borrows EUROS, he is actually PAID 1.5 % per annum to get this free money.
If in turn he invests in SOCIETE GENERALE common stock which pays an 8.5 % dividend yield, he makes a quasi 10 % real return on borrowed money…. If he has no fears that rates are going up and that all the other alternatives pay negative returns, then he has no other option but to Buy stocks.
Another indicator of that thirst for yields has been the performance of BBB bonds
The Bloomberg Barclays Investment Grade Corporate Bond Index has shot up considerably in the past few weeks as investors were scrambling for yield and went down the credit quality ladder.
In the week through March 20, investors parked $6.6 billion into BBB investment-grade funds, $3.2 billion into high-yield bonds and $1.2 billion into emerging-market debt, according to a Bank of America Corp. note citing EPFR data.
There was a period of time late last year when BBB rated bonds — those securities just above junk status — were anathema in the corporate debt market.
Investors, fearful that these bonds were about to get hit by a wave of credit-rating downgrades, dumped them day after day in November and December.
We actually recommended to BUY them in November and added some to our model portfolio.
But now, in a sudden and surprising turnaround, these securities have become one of the most popular slices of the corporate debt market, having handed investors gains of 5.8 percent this year.
And some of Wall Street’s bigger investors, including Loomis Sayles and T. Rowe Price, say there are still plenty of bargains to be had among the BBBs, as the Federal Reserves
signals it is dovish and working to ensure the U.S. economy keeps humming.
Bonds like equity are lifted by huge liquidity injection.
That is all well…. and for now liquidity will do the job as long as there are no signs of excessive speculation.
In fact, global equities are climbing the proverbial wall of worries !
But at some point, when economic momentum accelerates again and/or inflation re-accelerates, the markets will be in for a severe wake up call.
China is different though ….
In his closing address to the NPCC Congress that took place the week before last, Chinese Premier Li Keqiang said China’s domestic economy showed signs of stability amid targeted stimulus support, although new threats were arising from weakness in global demand.
“China’s sound economic performance is not a result of quantitative easing or massive stimulus,” Li said Thursday in a speech at the Boao Forum for Asia on the Chinese island of Hainan.
The Chinese government this month unveiled a record 2 trillion yuan ($297 billion) tax cut and has worked since last year to improve the supply of credit to small businesses and the private sector. This is showing in the massive increase in the bank’s lending to small and medium sized companies in their latest results.
While signs of stabilization in the local economy continue to appear, the U.S.-China trade war remains a major source of uncertainty. Negotiations continue in Beijing from Thursday and I. the US next week and it may take months before the two parties arrive o what they consider to be an acceptable agreement.
In the mean time the structurally undervalued Chinese equity market is flying and gives every sign that it wants to go higher.
Chinese Equities lead the Global Equity Rally
As we expected, Chinese Equities have led the global equity rally in the 1st quarter of 2019 delivering a strong 29 % performance after their dismal year in 2018. With 29 % returns, China’s main index beats the SP500 by more than 18 %.
The first leg of a powerful rally has been completed and the second leg is about to start, fueled by liquidity and inflows from foreign investors.
Based on liquidity and the stimulative policies enacted by the Government,domestic investors have embraced the rally, taking the domestic indexes higher than any other.
Foreign investors have been lagging behind, probably still in distrust as usual of China, its system and its financial markets.
And this is testified by the sharp performance of the foreign Chinese indexes such as the H-shares index of the FT 50 China Hong Kong Index in this 1st quarter rally.
The two equivalent HKD indexes underperformed the very SAME Indexes by a minimum of 10 % and the gap is particularly striking when it comes to the FT50 China Indexes traded in Shanghai and in Hong Kong.
The gap has nothing to do with Foreign exchange as both have been stable over the period and the above comparative is based on performance in the respective currencies of the indexes.
The best performing index since the beginning of the year is the less well-known Shenzhen Index where more small and mid-caps are listed. Small Caps are 10 % higher than large caps and – more importantly – the Shanghai index is probably underperforming because foreign investors and US hedge funds in. particular – Kyle Bass et al. – are shorting the domestic indexes future contracts
The observation is even more striking when it comes to individual shares.
Taking the case of China Life Co.
China Life Co. A-shares added 10 % more than the equivalent H_shares since the beginning of the year, and from February 14th to March 5th, the gap is even larger, standing at 17 % for the very same shares.
Taking a smaller capitalization stock such as SHANGHAI PHARMACEUTICAL HOLDING CO.
The gap since the beginning of the year or since the rally really started on January 31st 2019 is huge and amounts to 17 to 18 %.
Two obvious conclusions from the above :
You had to be invested in Domestic Shares to make real money since January.
There will be tremendous potential for a catch-up in H-shares and US Listed Chinese stocks once foreign investors take the measure of what is happening in China.
But the Key question for investors is
WHAT IS HAPPENING IN CHINA ?
IS THIS SIMPLY A REBOUND IN A BEAR MARKET ?
IS IT A SIMPLE CYCLICAL BULL MARKET ?
or
IS THIS THE BEGINNING OF A MAJOR, MULTI-YEAR, SECULAR BULL MARKET ?
This is obviously a multi-trillion Dollar question and the THREE parameters to take into consideration, in our view, are the following :
China is counter-cyclical and ahead of the other economies of the world in the cycle.
As China’s Premier was highlighting, contrary to the other three major economic zone of the world, China has not resorted to EXCEPTIONAL monetary measures to stimulate or contain the slowdown of its economy in the past 10 years.
It has managed a highly delicate economic model transition from Export-led to consumer-led without creating any major hiccups or massive lay-offs. Legacy industries have been managed humanly and financial in a very gradual way, testifying of the efficiency of the China Political System of Governance ( think of the devastated Rust Belt in the US or the coal-mining industries in Europe and the UK )
China is actually PRECISELY at the THROUGH of this transition phenomenon if one looks at the economic data.
China’s economic slowdown deepened in the first two months of the year, pushing unemployment sharply higher and intensifying pressure on the government’s calibrated stimulus strategy.
With industrial output having its worst start to a year since 2009 and retail sales expanding at the slowest pace since 2012, the unemployment rate jumped to 5.3 percent in February from 4.9 percent in December, the highest level in two years.
Against the backdrop of slowing global demand and domestic weakness, the jump in joblessness comes just days after Premier Li Keqiang announced an “employment first” strategy as a key part of economic policy for the coming year. That will feed into policy makers’ calculations as to if and when further stimulus measures to shore up the world’s second-largest economy are needed.
The Yuan 2 Trillion tax cuts announced last month – without any degradation of the Public Finances – targets precisely these concerns and aims at boosting consumption and domestic oriented job creation.
The interesting part is that Donald Trump’s Trade War may have accelerated the economic model transition.
Indeed, when looking at the details of the employment figures, the increase in the unemployment rate shows rising pressure from the U.S.-China trade war on China’s jobs in the export sector with manufacturers of intermediate products used by foreign companies – screens, casings, low added-value electronics, furniture, toys, etc – being hit hardly.
Companies like AAC Technologies or Tongda Group, major suppliers of Apple Inc have seen their earnings collapse by 70 to 80 % in the past year and it is doubtful that they will ever allow themselves to become as dependent to exports as they were before.
Donald Trump’s Trade War has in fact accelerated the shift of focus from exports to the domestic market is a lasting and significant way over the past year.
On the positive side, fixed-asset investment has started to accelerate in China and property investment jumped, showing that the stinulative measure put in place in the second half of 2018 are starting to have an effect.
The re-acceleration of fixed-asset investment shows that China’s proactive fiscal policy is taking effect and there is a good chance that fixed-asset investment growth may have bottomed out.
As we highlighted in many of our articles, the sudden and relatively brutal economic slowdown the is hitting the world economy – the lowest growth rate projected since the financial crisis – has all to do with Donald Trump’s unexpected Trade Wars.
By creating uncertainty, it has caused a collapse in Investments that then fed into employment, consumption and ultimately growth and inflation.
Investments are always at the forefront of any economic cycle and China’s recovery in investments and fixed capital formation indicates that the China economy will pull out of its slowdown faster than the rest of the world.
AND that re-acceleration will favor the domestic market and consumption.
Without realizing it, by forcing China to react to its Trade War, Donald Trump has accelerated both the Chinese transition and the speed of its pulling out of its economic slowdown.
And the one thing that is constantly overlooked by foreign analysts and commentators is the SIZE and the POTENTIAL GROWTH of China’s domestic market.
To understand what is at stake, it is useful to go back to history and in particular the history of the US in the 1920s. Then, the world was dominated by the British Empire and America was an emerging market populated by Cowboys and capitalist adventurers with big cigars.
No one trusted the US currency and trade was done in Silver Sterling. Only small proportions of portfolios are invested in US equities, let alone American bonds.
Still, The 1920s is the decade when America’s economy grew 42 percent. Mass production spread new consumer goods into every household. The modern auto and airline industries were born.
The U.S. victory in World War I gave the country its first experience of being a global power. Soldiers returning home from Europe brought with them a new perspective, energy, and skills.
The United States produced nearly half the world’s output. That’s because World War I destroyed most of Europe. New construction and investments almost doubled, from $6.7 billion to $10.1 billion.
Average income rose from $6,460 to $8,016 per person. It is today circa $61’374.
The United States transformed from a traditional to free market economy. Farming declined from 18 percent to 12.4 percent of the economy. Taxes per acre rose 40 percent, while farm income fell 21 percent. At the same time, new inventions sent the manufacturing of consumer goods soaring.
At that time, and when compared to old Europe, America was comparatively more populated than any of the European economies and particularly the UK.
The “Roaring Twenties” they were called ! U.S. prosperity soared as the manufacturing of consumer goods increased. Washing machines, vacuum cleaners, and refrigerators became everyday household items. Sixty percent of families bought radios. By 1922, 60 radio stations broadcast everything from news to music to weather reports. Most of them used expanded credit offered by a booming banking industry.
The airline industry literally took off. In 1925, the Kelly Act authorized the Post Office to contract out airmail delivery. In 1926, the Air Commerce Act authorized commercial airlines. From 1926 to 1929, the number of people flying in planes increased from 6,000 to 173,000. In today’s China we count in hundreds of millions.
The auto industry also greatly expanded. That was due to Henry Ford’s mastery of the assembly line. That lowered Ford’s price 80 percent between 1909-1929. A Model T only cost $300. Also, more families could buy on credit. By the end of the decade, 26 million cars were registered. For the first time, women got behind the wheel.
Governments spent $1 billion to build new roads, bridges, and traffic lights. Gas stations, motels, and restaurants sprang up to service drivers who now covered longer distances. The insurance industry added expensive protection for the vehicles and their owners. Banks also profited by lending to new car owners.
Over the decade, US GDP grew 42 % from 688 Bln. to 977 Bln, a compounded rate of growth of LESS than 4 %. China is still growing at way above 5 %.
America was then Emerging economic super power, challenging the world dominant power, which it took over in 1949.
Interestingly enough, the economic and military dominant power of that time criticized and feared this new country and its political and social organization in exactly the same way America fears China today.
Ye Old British Empire could not understand and accept the superiority of the full democracy that was created in the USA, the first real experiment of a society were all citizens were totally equals and had equal rights, where were you were born did not matter providing you accepted The LAW, where aristocracy had no power and no importance and where there was no King and no Emperor to guarantee the continuity of the State.
Then, as is the case now, the infrastructure of the new country was newer, better and more efficient the. the one of the old dominant power because installed more recently and with the latest technology of the time.
REMINDS YOU OF SOMETHING ?
The one difference though is that America’s free-wheeling capitalism enticed every citizen to borrow to consumer and invest with our restriction, a trait of the US system that led first to the 1927 crash and Great Depression and again in 2007 to the 2008 finical crisis.
Another major difference is that only one-third of the nation’s 24,000 banks belonged to the Federal Reserve System. Non-members relied on each other to hold reserves. That was a significant weakness.
It meant they were vulnerable to the bank runs that occurred in the 1930s and again to the contagion effect of Lehman Bros and Bear Sterns in 2007. Another weakness was that banks held fictitious reserves. Checks were counted as reserves before they cleared. As a result, these checks were double-counted by the sending bank and the receiving bank.
By contrast China has much more controlled economy and these excesses are quickly tamed and managed to avoid letting them get out of control.
The fact of the matter is that China is EXACTLY where America was in the 1920s, without the free-wheeling excesses, and where Japan was in the 1970s without the Keiretsu system of cross-equity holdings.
A quick look at the following chart shows what will happen with China’s domestic Consumption market.
China’s Disposable Personal Income increased to 39251 CNY in 2018 ( US$ 5’858 ) from 36396.19 CNY in 2017. It has more than doubled over the past 10 years and is currently growing at 7.8 % per annum on average.
At this rate, in 20 years, China’s disposable personal income will have risen to 24’000 US$, to be applied to a population of 1.4 Billion people, or almost 5 times the size of the US population.
By then, China’s GDP will have grown to US$ 40 Trillion, almost TWICE the size of today’s US economy. By the middle of the century, it will have surpassed US$ 60 Trillion.
China’s consumer market will soon become the world’s main driver of growth and it may happen faster than most people think.
China’s Currency may be embarking on a secular phase of appreciation
It is perfectly clear that the ultimate strategic objective of Donald Trump’s Trade War is to force China to allow its currency to appreciate.
The news coming out of the talks mention it regularly but the real factor is that China’s Trade surplus with the US and the rest of the world is structural in nature and comes from a pro-active Chinese policy to keep the Yuan undervalued for years by not recycling its trade and financial surpluses in Yuan.
This all coming to an end.
Whatever its outcome, Donald Trump’s Trade War will not allow the Yuan to depreciate markedly from here and as soon as China feels comfortable that its economy is rebounding again, it will allow its currency to rise structurally in a controlled way.
This will enable it to reduce its stock of foreign exchange reserves gradually, it will increase the relative purchasing power of its consumers and corporations, it will favor an increase in the volume of imported goods and the outsourcing of low-added value products an components from cheaper Asian manufacturing centers and finally keep a lid on what has always proven to be China’s Achilles heel, food inflation.
A strong currency will entice foreign capital to invest in Chinese domestic bonds and equities, keeping interest lows and providing equity capital for Chinese corporations and favor investments.
And this is already happening !
The imminent arrival of a new group of investors in China’s domestic bonds is set to trigger significant demand for the Chinese currency.
The fresh impetus comes from the phased inclusion of Chinese sovereign bonds and debt sold by three key state-owned policy banks into the Bloomberg Barclays Global Aggregate Index, starting in April 1.
Strategists see US $100 billion or more flowing in in 2019 and for years to come. That
will make the foreign investor community an increasingly significant stakeholder in China’s financial system. Their share of the domestic market will climb significantly from little more than 2 percent today.
Ultimately, we estimate that Trillions of US Dollars are bound to flow into Chinese bonds and equities over the coming decade, triggering a continuous rise in the value of the currency.
Contrary to common perception, a strong currency is not at all contradictory with a strong export sector. Japan, Switzerland and Germany are the world largest exporters in terms of percentage of their export sector to GDP and they ALL are strong currency economies.
China just needs to be re-assured that its economy is not going to tank and unemployment to rise if it allows its currency to rise. Consumption and domestic investments have to build a momentum that counters the fall in exports and the recycling of non-competitive export industries.
Until now, America have been benefitting form the privilege of the world reserve currency, in exactly the same way Sterling Pound had this privilege in the 19th century.
As the most powerful economy and military power, it is the debtor of last resort and pays no risk premium on its debt or issuance of currency. Investors are not questioning and even less pricing the geometric growth of US public debt – the largest in the world – and of America’s total debt.
The future inability to repay the debt or contain public deficits that will have exploded by the combination of tax cuts and higher interest rates will one day hit the markets.
Global investors – many Asian as their savings ratios are multiples of the American ratios – will suddenly question the creditworthiness of America and demand a risk premium t hold its debt and currency.
The US Dollar will move into a freefall and US interest rates will rise substantially.
We expect the big secular bear market in the US dollar to start as early as next year.
In the mean time, China is working hard on making its currency a significant trading and reserve currency. It is actively encouraging its corporations to trade in the Yuan for their exports and imports, it has set-up the Asian Bank for Investments and Infrastructure that provides loans in Yuan, it is financing its Belt and Road initiative in Yuan, the latest move of which is at the heart of Europe and it is developing access to its massive bond and equity markets.
The resolution of the Trade War will mark the secular peak of the US dollar and the start of a secular and lasting phase of appreciation of the Yuan.
From here, the downside in the Chinese currency is limited while the upside is anything from 100 % to 200 %.
The following chart depicts the 200-year journey of the exchange rate between the British Pound and the US Dollar . After a fixed rate that lasted for decades though a peg, the US dollar, currency of the rising super power rose from 5 to the British Pound to 1.30 today, or from 0.2 pence to 1 US dollar to 0.77 pence to 1 US Dollar, a 384 % incresase in value.
Interestingly enough, the same applies to the Japanese Yen to the US dollar in the 1980s when the Japanese economy morphed from an export-led economy to a consumer-led economy.
A brief history of the evolution of the Japanese Yen is interesting to look at :
1949 – After World War Two the dollar’s fixed rate is set at 360 yen via the Bretton Woods system, partly to help stabilize prices in the Japanese economy.
1959 – The dollar/yen exchange rate is liberalized and the margin of fluctuation is set at 0.5 percent on either side of its dollar parity.
1963 – The margin of fluctuation is widened to 0.75 percent. 1971 – United States abandons gold standard, bringing an end to the Bretton Woods system of fixed exchange rates and forcing a realignment of world currencies.
December 1971 – Under the Smithsonian Agreement, the dollar/yen exchange rate is set at 308 yen and is allowed to fluctuate in a wider band between 301.07 yen and 314.93 yen.
1973 – Japanese monetary authorities decide to let the yen float freely against the dollar, and the yen appreciates as far as 263 to the dollar.
1978 – The yen pushes through 200 to the dollar for the first time, strengthening as far as 177.
1980 to 1989 – The yen’s appreciation accelerates to 71 and partially reverses despite Japan’s big structural trade surpluses.
The following chart shows the evolution of the Japanese Yen form 1971 to 2015
From 1971 to 1989, the Japanese Yen appreciated from 360 to 71, a FIVEFOLD increase in the value of the Japanese currency was needed to stabilize and reduce Japan’s structural trade surpluses.
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Chinese Equities are Cheap and should benefit from inflow of funds
Whichever way one looks at it, Chinese equities are amongst the cheapest in the world, particularly the ones trading in Hong-Kong or outside of China.
The current valuation ratios 1 time Price to Book Value , 9 x Cyclically adjusted Price Earnings ratios, Dividend yields and Price to cash for are NOT in tune with an economy that is already the second largest in the world and corporations that are for most already much larger than any of their western counterpart.
Warren Buffett’s preferred valuation tool : Market Capitalization over GDP tells the magnitude of the valuation gap between the US equity market and the Chinese equity market. America trees at 3x while China trades at 0.5 x.
Over the past ten years, China’s GDP rose from US$ 5.1 Trillion to US$ 12.3 Trillion.
During the same period, Chinese stocks have gone up and down but are still trading at the same level they were at in 2009.
Global investors – mainly Americans today – globally distrust China and China bashing is everywhere in the western press as well as in the power circles of the USA and now even in Europe.
Suffice to highlight the difference of treatment between the fears of espionage lingering on HuaWei telecom equipment and the Western silence over the activities of the US NSA or the collecting of personal data by Google, Facebook, Amazon, Apple and any large US software company.
Governments and investors are fearful of the rise of China’s might ad do not really understand the reality of the Chinese Public Governance and organization of society.
Most of them do not realize that China’s political system and public Governance is actually much closer to our Western Private corporation governance than to our public Governance and as such is much more efficient.
In exactly the same way the Old British Empire fared and bashed the cowboys of America’s democracy at the end of the 19th century, America and the West are bashing China today .
But one day they will realize that China has been a success for the past 40 years for these very reasons and that it will continue to be one in the next 40 years for the very same reasons.
Public Governance is always at the heart of success of failure of Nations.
And when that reality starts filtering through and the Yuan starts appreciating, then Chinese stocks are to experience a massive re-rating.
Bull markets are always driven by two factors :
. An increase in corporate earnings, and
. An increase in valuations.
The 2009 – 2018 rally in US equities delivered 300 % returns and was driven by both.
Over the past 10 years, the P/E ratio of the US market rose from 12x to 23 x. The correction of the 4th Quarter of 2018 has restored valuation somewhat and the P/E ratio fell form 23x to 16x and back to 18.6x
Over the same period, the Price to Book ratio of the SP 500 rose from 1.8x to 3.5 times and is still hovering at 3.35x.
Over the same period, the Chinese CSI 300 saw both its P/E and P/B ratio fell considerably. Its P/E and is still hovering at 14x, a level equivalent to the one that prevailed in 2010.
Its Price to Book ratio is even more compelling at 1.8x , still well below the average of the past 10 years.
Things are even more striking when looking at the Chinese Shares lists in Hong Kong and quoted in HKD, the HSCEI Index
A 9.38 x, the HSCEI P/E ratio is one of the lowest of all equity markets in the world
and at 1.17x, its P/B ratio gives very little value to the future corporate earnings of Chinese corporations, let alone their potential growth
A quick and intuitive look at the above charts leaves the clear impression that the rally is not over.
If history is any guide, a significant shift in portfolio flows could start happening very soon.
Chinese shares were just increased to 3.4 % of the MSCI Emerging Market Index and they still represent less than 1 % of the MSCI World Equity Index despite China being the second largest economy of the world.
In the 1980s, when Japan competed its transition from an export-led economy to a consumer economy and the Japanese Yen rose form 250 to 120, the Nikkei 224 rose from 4’000 to 40’000 and the market P/E rose to 40x earnings.
This happened as global investors increased their proportion of Chinese equities from almost zero to 22 % of their portfolios at the 1989 peak.
The same is likely to happen in China over the coming decade.
It is obviously impossible to say for sure that the Great Chinese Bull Market has started,
But what is clear to us is that there is a limited downside if it has not and massive upside if it has.
For choice, Investors should be Invested !
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The US Economy Slows more than anticipated
U.S. economic growth cooled by more than initially reported in the last quarter of 2018 on revisions to consumer and government spending, signaling mounting challenges to the expansion as it nears a record duration.
Gross domestic product grew at a 2.2 percent annualized rate, Commerce Department data showed Thursday, significantly less than the initial 2.6 percent reading. Consumer spending, biggest part of the economy, grew at a downwardly revised 2.5 percent pace that also missed projections.
The less-robust reading — which followed 3.4 percent growth in the third quarter — reflected broad revisions to spending on consumer goods, including recreational goods and vehicles. State and local government spending was downwardly revised on investment in structures, while business fixed investment was reduced on software spending.
Last week’s surprise decision by the FED to revise down its interest rate path for 2019 to no-increase was certainly taken with knowledge of these numbers.
While the expansion is poised to become the nation’s longest on record at midyear, the downward revision indicates that the economy had weaker momentum heading into 2019, when various indicators in housing and manufacturing have been showing signs of cooling.
After the collapse in Investments in the past two quarters, Consumers have started to be affected and the sharp fall in equity markets did little good to consumer confidence in a country where every household watches its 401-k on a daily basis.
U.S. consumer spending in January was also short of projections, an early read on the economy in the first quarter that may add to concerns about the outlook.
Purchases, which account for about 70 percent of the economy, rose 0.1 percent from the prior month after a downwardly revised 0.6 percent drop, according to a Commerce Department report Friday.
Personal income rose 0.2 percent in February, also less than forecast.
The spending figures, which reflected weaker sales of new autos, signals first-quarter growth faces additional headwinds, though surveys show consumers remain generally upbeat despite projections for slower expansion.
When the two main cylinders of any economy – Investments and Consumption – are on a roll, then there is not much positive to expect.
We do not see the slowdown to abate any time soon and project that growth in GDP will slow to 1.5 percent in the first quarter, the slowest pace in two years.
Deflation Scare
At the same time, tame inflation reinforces Fed projections for no interest-rate hikes
this year.
The Fed’s preferred price gauge — tied to consumption — fell 0.1 percent in January from the previous month and was up 1.4 percent from a year earlier, the slowest reading since late 2016.
Excluding food and energy, so-called core prices rose 0.1 percent, less than estimated. The index was up 1.8 percent from January 2018, also below forecasts, after an upwardly revised 2 percent gain.
The downward revision still keeps intact a milestone that President Donald Trump has boasted about, as the Republican-backed tax cuts helped bring 2018 full-year growth to 3 percent, as measured on a fourth-quarter-over-fourth-quarter basis.
That still is the fastest since 2005 but the rapidity at which the effects of the tax cuts are fading is worrying.
Meanwhile, there are clear signs that Trump’s tariffs could weigh on future growth. Net exports remained a drag on the expansion.
Unknowingly certainly, Donald Trump has boosted the US economy through his massive tax cuts – the price of which will be paid for later on – but he has triggered the fastest global economic slowdown on record through his trade wars.
The world economy was in a great shape at the beginning of 2018 and it is certainly not the very mild increase in interest rates by the FED that caused the goal slowdown from China to Switzerland, Germany, Korea, Canada and the US.
US Monetary policy never became restrictive and Japan and Europe were still pumping massive liquidity into the system.
The report also gave the first read on business earnings in the fourth quarter. Pretax corporate profits fell 0.4 percent from the prior quarter for the first decline since early 2017, though profits still rose 7.4 percent from a year earlier.
While the expansion has moderated, the labor market has remained in generally solid shape despite some recent gyrations. Payrolls grew by an average of 186,000 over the past three months as the unemployment held around the lowest levels in a half century.
A separate report from the Labor Department Thursday showed filings for unemployment benefits fell to a two-month low. Jobless claims decreased to 211,000 in the week ended March 23, below what economists had forecast.
The question that this slowdown begs to raise is whether the weakness will bring the FED to lower interest rates in 2019 or 2020.
We do not think so !
Monetary policy is still accommodative and inflation is not about to fall significantly either.
Rising stock markets will boost consumer confidence and a resolution of the Trade War – now deeply wanted by Donald Trump should pave the way for a resumption of investments>
Oil Caps a Strong Quarter But a Stealth Danger Lies ahead
Oil prices closed above US$ 60 for the first time this quarter capping a rally that has seen prices rise by 32.4 % since the year end, the best quarter since 2009.
Bullishness is prevailing and Hedge funds are leaning big into crude’s biggest
rally in a decade.
Their wagers on rising benchmark oil prices in New York and London have jumped to the highest levels since October, according to data released Friday for the week ended March 26.
The net-long WTI position — the difference between bets on higher prices and wagers on a decline — climbed 12 percent to 238,205 futures and options contracts, according to U.S. Commodity Futures Trading Commission data. Long positions increased by almost 7 percent, while shorts slid 16 percent.
These are exactly the kind of situation that we wait for to start considering shorting again, something we have refrained to do for weeks now.
Among the reasons supporting the optimism, Saudi Arabia orchestrated global production cuts and drilling slowed in America’s shale patch.
However, we see the supply-demand equation still and decidedly tilted towards the downside.
From the rapid evolution towards Solar and Wind energy in electricity production to the fats shift towards electric vehicles, to the sharp global economic slowdown of the current quarters to sharp increase in permitting in the Permian shale basin that points
to another big acceleration in production.
As always, the Oil market is highly speculative and manipulated and we are just waiting for a clear technical signal to re-instate our Strategic short oil positions.
And this may come from a totally unexpected Stealth Buyer of Oil that has been at work for years and is now re-considering its strategy.
China is the world second largest Oil consumer after the USA with in excess of 13 million Barrels per day of actual buying in the market out of the 99.8 Million sold in the world.
However, a significant chunk of that buying was destined to build Chinas Strategic Oil Reserves between 2016 and 2018 with a stated target of 100 days of consumption, despite the very discreet attitude of China vis a vis its strategic reserves.
It is today estimated that China holds anything between 400 and 600 million barrels of strategic reserves and that as it has set it strategic priorities on clean energies, Wind, Solar, Nuclear and Electric Vehicles, the pace of Oil buying for the Strategic reserves could fade away quickly.
The Long Awaited Palladium Collapse
Palladium is heading for the biggest weekly decline in more than three years as investors’ focus turned to demand amid concerns over slowing global growth.
The metal used in auto catalysts to curb emissions sank for the three days through Thursday before paring losses, putting it on course for an 11 percent weekly drop.
The metal hit an all-time high on March 21 after a massive rally that spurred predictions a reversal was inevitable.
We started selling Palladium Short at the end of February and added to our short position the week before last/
Palladium is down 10 percent in March, but still heading for a fourth quarterly gain after prices hit an all-time high of $1,614.88 last week.
With the palladium market expected to be in deficit for an eighth year, manufacturers of gasoline vehicles have scrambled to get hold of supplies to meet stricter standards for pollution control.
Much of palladium’s doubling in price over the last eight months was driven by supply concerns, and these are well-known and well-explored.
Naturally the momentum attracted speculative as well as trade support in the form of inventory building. But final demand is far from being assured.
For one, Palladium can technically be replaced by Platinum, a much cheaper precious metal that is now trading at. multi year lows.
Two, the ongoing contraction in China car manufacturing and a recent string of weaker macro data has shifted focus to the demand side of palladium markets.
Now that inventories have ben but and that speculators are massively long the metal, where will the additional demand will come from ?
Prices entered a sharp decline on Wednesday, shortly after Anglo American Plc Chief Executive Officer Mark Cutifani told the FT Commodities Summit that the platinum market was in a bubble.
After this week’s slump, some analysts are predicting a rebound.
However, if history is any guide, when a turning point materializes in an otherwise speculative market, Selling begets selling and there is no end to the bear phase until speculative positions have been unwound.
We have seen and traded it in Lumber last year, in Oil many times since 2008 and the next big casualty on the horizon is Palladium.
More than 80 percent of palladium comes as a byproduct from nickel mining in Russia and platinum mining in South Africa from producers including MMC Norilsk Nickel PJSC and Impala Platinum Holdings Ltd.
The Week in Review 31st March 2019
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