Mastering the Chinese Bull Market

In this issue :

Mastering the Chinese Bull Market
Who the heck is Buying US Stocks ?
Strong Earnings underpin Technology Stocks
The Worldwide Auto Market is Taking a Dive
Greece on the Recovery Path
The Week in Review

Chart of the Week

China’s CSI 300 Index is up 24.99 % since the beginning of the year after 8 straight weeks of positive performances and what looks like a vertical acceleration.

Is it the end or the beginning of something ?

As we expected at the end of last year, 2019 had to see China recovering from the depth of undervaluation and pessimism that prevailed in 2018. The rally started with little conviction in the first weeks of January but accelerated upwards since and domestic investors are now rushing to buy stocks before it is too late.

The main Chinese domestic indexes ended last week up +6 to +7 % with a very strong move on Friday.

As we argued many times, Chinese investors are far less sophisticated than their Western counterparts and the pension fund industry is still nascent there. As a result, Chinese equity markets have less depth and display more momentum characteristics than the Western markets as investors are less concerned with value than they are with stories and consensus.

The rally – and its recent acceleration upward -have been fueled by three factors :

1. Expectations for a positive outcome of the Trade Negotiations

Expectations for a positive outcome of the Trade Negotiations have been rising as Donald Trump postponed the March 1 deadline for additional sanctions and the negotiating teams seem to be working around the clock to word not one, but five different agreements.

As a result, the Chinese Yuan rose against the US dollar for the fourth consecutive week and the general consensus is now moving towards our initial call that the Trade War is all about forcing a substantial appreciation of the Chinese currency.

A gauge tracking the yuan against 24 other currencies also advanced this week, confirming that the rise in the Yuan was broad-based. The Bloomberg replica of the CFETS RMB Index climbed past 95 as it staged its longest winning streak since May 2018. The index had been fluctuating between 93 and 95 for most of this year.

The offshore yuan headed for a third consecutive weekly gain after the U.S. was said to be preparing a final trade deal with China.

Investors are coming to terms with the fact that a Yuan devaluation is no longer on the cards and that a structural appreciation of the currency is the only way to contain and ultimately reduce China’s structural trade surpluses.

Uncertainties over a trade war with the U.S. remain however.

U.S. Trade Representative Robert Lighthizer’s cautious stance suggests that a trade truce is not a done deal. Donald Trumps’ request today that China lift tariffs on agricultural products shows that he is still playing hardball.

An abrupt end to a summit between the U.S. President Donald Trump and North Korean Leader
Kim Jong Un raised speculation in Chinese media that it could be a signal that Trump, when he wants, can walk away from the negotiating table. Trump has indicated as much.

The truth is that investors’ mood has swayed from total pessimism about the Trade War in December to outright optimism today.

They could be disappointed in the coming weeks before a final agreement is reached at the end of March.

2. The Chinese economy seems to be finally responding to the policy stimulus of the past few months.

China’s Caixin manufacturing purchasing managers’ index showed a surprising — and strong –rebound in February. The Caixin manufacturing PMI posted a large rise of 1.6 to bring it to 49.9 — close to the 50 mark that separates expansion and contraction. This is considerably higher than the consensus forecast of 48.5.

The direction of improvement is consistent with the official PMI, which is considered to be less reliable because controlled by the Government. Similar to signals in the official PMI data, the forward looking element of new orders showed a strong rebound, and in fact returned to expansionary territory — suggesting the impact of China’s supportive macroeconomic policy.

One clear thing is that China’s major trading partners have continued to see their economies weaken, as reflected by further declines in their PMIs. Weaker demand has been dragging down exports of other countries such as Japan and South Korea.

On the positive side, the output sub-index rose back into expansionary territory. Paired with the increase in the new orders gauge, that suggests greenshoots are appearing in the economy.

3. Morgan Stanley raised the proportion of Chinese shares in their indexes substantially on Friday.

MSCI will increase China’s weighting to 3.3 percent from 0.7 percent in three steps between May and November of 2019, the indexer said Thursday. 168 mid caps will be added at a 20 percent inclusion factor in November, an upside surprise versus the originally proposed timeline of May 2020.

Overall inclusion factor increase could usher in a potential $70 billion of net buying to A shares, with the flows likely skewed toward consumer, health care and a select group of “foreign favorites”.

The rising representation of A shares in global indexes could create active allocation demand; still, recent investor feedback suggests some asset managers are restrained/discouraged from
investing in China A directly for various regulatory, accessibility, legal and fundamental reasons.

This shows that China still has some work to do in opening the market, but as the “Wall of Worries” is being climbed, more and more money and more and more investors are likely to reach the Chinese equity markets shore.

Global portfolios are still extremely underweighted Chinese equities considering the size and growth of the Chinese economy and MSCI’s latest move is a confirmation that the trend is in place.

While the increase from 0.7 % to 3.3 % is a big gain, if the emerging-market gauge was to go by market-capitalization alone, Chinese stocks would account for more than 40 percent of the MSCI Emerging Market Index

MSCI Chief Executive Officer Henry Fernandez said the nation could win a greater allocation if the economy continues to open up to the outside world.

We have argued many times before, and again in our documents presenting our latest product, the EFG Global Yuan Portfolio Index Certificate ( click the link below ) that China is about to experience a massive secular bull market in its currency and equity markets similar to the one experienced by Japan in the 1980’s when Japan transitioned from an export-led economy to a consumption economy.
EFG Global Yuan Portfolio Index Certificate Presentation FINAL Download

It is yet too early to say for sure, but a once-in a lifetime Chinese secular bull market may have already started.

Who the Heck is Buying US Stocks ?

The US equity rally over the past two months has been truly something. Not just in terms of the thrusts, the incredible price gains with high persistency, and broad and sustained gains across a broad swath of stocks.

It’s also something because it’s hard to figure out who is doing the buying.

The latest Commitments of Traders report released by the CFTC showed that large speculators still aren’t jumping in

Interestingly enough, small speculators – as per the definition of the CFTC Commitment of Traders report – are not buying either

Equity hedge funds should be pouncing on this rally, but they don’t seem to be. If anything, equity hedge fund returns are becoming less correlated to moves in the S&P, instead of more. This is just as unusual as seeing speculators sell into a rally.

Finally, money is NOT pouring into ETFs and mutual funds as it should considering the strength and breadth of the rally

The logical conclusion would be that this is bullish as stock climb the “wall of worry.” That’s a false positive though, since bull markets need investors to become more positive, not less to power ahead.

For now, we have not really seen this before, and the only conclusion that can be drawn from the surveys is that individual investors are extremely busy buying individual stocks into their 401-K plans through their brokers.

And they are more optimistic than they were at the beginning of 2018

This is NOT a good sign …

Strong Earnings underpin Technology Stocks

Following last year’s FAANG meltdown that we predicted, this year’s longest surge in tech stocks since 2012 is remarkable.

The 2 1/2-month surge in the Nasdaq 100 qualifies as the longest in seven years and has lifted the gauge within 6.6 percent of its all-time high.

It is coming atop a profit foundation that has reduced valuations by 20 percent.

The truth is that profits for U.S. computer and software makers jumped 29 percent last year, turning extremes in valuations into relatively reasonable ones.

The narrowing in price-earnings ratios is making for an especially broad rebound in the group, in which an equal-weight version of the Nasdaq 100 is outpacing the normal index by the most since 2012.

Rapid earnings growth and falling equity prices have restored value in technology companies and the Nasdaq.

Despite some lackluster sessions, the Nasdaq 100 rose for 10 consecutive weeks and gained 21 percent since Christmas.

While the rebound has fattened price-earnings ratios to 22.7 after they hit a five-year low in December, the current valuation sits below the decade average. Valuations look relatively cheap when compared with a year ago, when they hovered above 28 times annual profits.

There is no doubt that American technology companies make gargantuan sums of money. In 2018, members of the S&P 500 Information Technology Index earned a total of $210 billion, almost twice as much as the next biggest industry, health-care.

However, the key issue at hand is whether the earnings and valuation momentum of the past 10 years is over or not.

Indeed the 2018 results were at record highs, but several leading technology companies will remember that year as a turning point in their business model.

Apple Inc. had its worst run in a decade last year despite posting $261 billion in revenue. Facebook lost a quarter of its value even as net income rose 39 percent to $22 billion.

As we have argued several times, Technology giants are the most risk-on of the most risk-on stocks. They have been accumulated relentlessly by investors impressed by their earnings growth power, and valuations have been ignored for the past 10 years as investors were searching for growth.

Earnings growth in the sector will turn negative for the next three quarters, according to analyst estimates. When that happens, valuation will Strat increasing again and will no longer be in line with expected growth.

Logistic solutions company Xilinx Inc. and digital storage firm Western Digital Corp. – one of our US equity recommendation put in December – have been the biggest gainers in the Nasdaq 100 since their December low.

We have taken our profits in Western Digital and have increased our short positions in Technology stocks. We see the Nasdaq peaking soon.

The Worldwide Auto Market is Taking a Dive

It’s been a cruel winter for auto sales almost everywhere around the world.

From China, to Europe to the US, Auto sales have been falling sharply in the past two quarters precisely at a time where the whole industry is facing a costly reconversion towards Electric vehicles.

In China, the world’s largest car market, the second half of 2018 was an unprecedented disaster. Car sales fell almost 20 % to the lowest level since 2012. Never in the past decades has China’s car market slowed so brutally.

There are many explanations for the collapse but the main one is that China’s car market is maturing and that traffic and pollution are now making the Chinese less keen on using individual cars and more inclined to use public transportation and car-sharing services.

And the numbers are down everywhere :

Car sales in Britain declined 18.2% in January. It was the eighth successive month of decline.
Sales in Turkey declined 60%
Europe-wide, sales are down around 6%.

In the US, total car registrations have declined by about 10%.

The US National Automobile Dealers Association February report released last week shows a sharp contraction of sales as well as dire predictions for next year.

After several years of U.S. sales at or near record levels topping 17 million vehicles, the National Automobile Dealers Association forecasts 16.8 million deliveries in 2019. That would be down from about 17.3 million last year.

February’s figures showed slowing deliveries and the rapid onset of a widely expected downturn in U.S. new-car demand. The annualized industry sales rate slowed to 16.6 million, the worst reading in 18 months, according to researcher Autodata Corp., also missing expectations. Sales came in at 1.26 million for the worst reading in 18 months, that is a 2.8 % decline from the same month a year ago.

Even Jeep, the once-hot Fiat Chrysler Automobiles NV’s star SUV brand, suffered a second consecutive monthly decline, driving the carmaker to its first total sales retreat in a year.

Sales dropped 5.9 percent for Fiat Chrysler’s lucrative Jeep Wrangler, which entered February with inventory piling up at dealerships.

At Ford Motor Co., sales fell 4.4 percent, worse than analysts projected, due in part to a drop-off in sales of its top seller, the F-Series, according to a person familiar with the results.

Those companies joined Toyota Motor Corp., Honda Motor Co. and Nissan Motor Co. in trailing analysts’ estimates for February.

Toyota deliveries in February fell 5.2 percent, dragged down by weak demand for its RAV4. Sales fell 12.5 percent for the Japanese company’s compact SUV. Nissan’s Rogue crossover plunged 16 percent, pulling down the automaker’s overall monthly sales by 12 percent compared with a year ago.

Jeep’s rough patch after a yearlong growth spurt adds to signs the American SUV boom may have reached its limits. Rising interest rates and tighter credit are likely to make it more difficult to sustain a run-up in prices to record levels. That’s been fueled by consumers shift toward costlier pickups and other light trucks at the expense of sedans.

Despite slowing sales, most automakers are showing discount discipline. They’ve been dialing down the deals after year-end blowout sales such as a GM’s December promotion promising “employee pricing for everyone.” February incentives averaged $3,721 per vehicle, down $161 from the same month last year, researcher LMC Automotive estimated earlier this week.

The Lyft IPO may be signaling a major shift in the auto industry.

The founders of the ride-sharing app Lyft filed their IPO papers last week, and their vision for the company is dramatic. Lyft is not just about getting you from A to B, they say.

Rather, founders Logan Green and John Zimmer believe that car ownership is in permanent decline and they want to help it die, they write in their S-1 filing.

“We believe that the world is at the beginning of a shift away from car ownership to Transportation-as-a-Service, or TaaS.

Lyft is at the forefront ofthis massive societal change,” they told investors. “Car ownership has economically burdened consumers.

US households spend more on transportationthan on any expenditure other than housing. … On a per household basis, the average annual spend on transportation is over $9,500, with the substantial majority spent on car ownership and operation.”

Cars create “inequality,” they argue. “The average cost of a new vehicle in the United States has increased to over $33,000, which most American households cannot afford,” the IPO says. “We estimate over 300,000 Lyft riders have given up their personal cars because of Lyft.”

We have ourselves in cities like Paris, London and New York where owning a car has become a burden instead of being an added-value.

The development of services such as UBER, LYFT, LIME ( electric scooters ) is changing considerably the way people go around and will ultimately reduce congestion, pollution and oil consumption.

Transportation-as -a-Service coupled with Electric Vehicles and Autonomous vehicles means that much fewer vehicles, costing far less than conventional ICE cars will transport far more people wit less traffic congestion, less pollution, less parking problems and less maintenance issues.

The Auto industry is going through a major revolution that will see only a few brands remain.

Autonomous Vehicles and Electric Vehicles will phase out the traditional economic model of Internal Combustion Engine vehicles owned by individuals, leading to lower numbers of vehicles in circulation and far less people employed in the industry.

Greece on the Recovery Path

Greece’s sovereign credit rating was raised two levels by Moody’s Investors Service last week , helping the government’s plan to sell new debt as soon as this month.

The country’s long-term foreign currency debt was upgraded to B1 with a stable outlook from B3, Moody’s said in a statement on Friday. The new ranking remains four levels below investment grade.

“The ongoing reform effort is slowly starting to bear fruit in the economy,” Moody’s said. “While progress has been halting at times, with targets delayed or missed, the reform momentum appears to be increasingly entrenched, with good prospects for further progress and low risk of reversal.”

Greece exited its international bailout last summer, though foot-dragging on some key economic reforms is raising creditor concern and putting at risk a planned debt relief measure this month.

The government is planning to tap the markets once again, after a successful sale of five-year bonds in January, most probably with a new 10-year bond this month, given that appetite for Greek risk among investors remains strong.

The yield on benchmark 10-year bonds is now below 3.7 percent, compared with a peak of about 37 percent at the height of the debt crisis in 2012, when Greece defaulted on its debt to private-sector creditors.

The country’s stocks and bonds have risen this year, with the Athens Stock Exchange index up about 16 percent since the start of 2019.

We had been expecting this change of macro-economic trend and have accumulated Greek stocks in our portfolios.

“The most politically painful measures have already been enacted, with the economy finally showing signs of recovery, reducing the incentives for any future government to jeopardize the hard-won gains,” the rating company said. “The stable outlook balances the relatively low risk of policy or fiscal reversal against the limited upside to Greece’s credit profile.”

The upgrade is the first time in more than a year that Moody’s has changed Greece’s rating. Fitch Ratings upgraded the country to BB- in August, while S&P Global Ratings rates the country B+. Each is below the junk threshold.

Nevertheless, the trend is up and Greece’s economic fortunes should improve markedly over the next few years. We expect its economy to deliver superior growth rates and its public finances to improve sharply in the comoing five years.