Weekend Thoughts from the FT. China's Q3 GDP, Fed on bubbles, Covid, Value investing and more
ON LINE EDITION
Five things to watch for as China reports third-quarter GDP. Data due Monday will reveal if country’s post-pandemic recovery remains on track.
The IMF projects China will achieve 1.9% growth this year while US will contract 4.3% and India contract 10.3%. The article focuses on 5 questions.
1. How high can quarterly growth go? It fell 6.8% in Q1, rebounded 3.2% Q2. The article quotes Macquaire who expect Q3 @ 5% and Q4 at 5.5%. They then expect it to surge up to 15% in early 2021 due to the low base effect. Trading Economics has consensus at 5.2% and forecasts 5.1%.
2. Will Beijing continue to rein in real estate investment? Continuing the homes for living in not speculating theme. It notes the importance of the property sector but also the current policy of restricting credit to the developers. It will be a tough call; land sales are what finances local governments. But demand for property whilst high in the Tier 1 and 2 cities is good but outside those cities it is much more patchy. Also the size of the debt that some developers have run up is staggering. Last week Evergrande only achieved part of its placement objective so there are concerns. The fact that Chinese developers are so highly geared is a worry. They are highly geared and have large pre-sales; they are presuming that property prices continue to rise, seemingly forever. That is a worry. Made worse by the fact that they are expanding into lower tier cities where land prices are cheaper but there are questions over the demand side. There are also concerns about how covid has hurt migrant workers and the impact that may have on small Chinese landlords in the larger cities.
I think Beijing will continue to be cautious because the recovery has gone well so far with needed to relax on real estate.
3. Can consumers and infrastructure investment come to the rescue? Retail spending turned positive in China in August after seven months of falling. Chinese tend to be very cautious about spending in uncertain times. They will be watching the globally recovery and are still very aware of the impact of deteriorating relations with the US, India and Australia as a reason for concern. On infrastructure this has been a favourite path in the past but there are only so many roads, bridges and subway systems you can build that add value. The potential here is linked to the growth in urbanisation and housing and so I think we will see projects being brought forward but the scope to drive the economy is less than it was.
4.Will fixed-asset investment return to positive territory? Most expect that it will, not least because the PBOC said it would allow a temporary increase in overall debt levels and the September bank loans grew strongly.
5.Can China’s booming export sector continue its strong run? I think, yes in the short term because the latest figures showed strength in medical and electronics. With Europe and the US seeing a resurgence in covid cases the demand for medial exports will remain. Electronics is less certain as 'working from home' purchases are a one-off expenditure. Also the tariff war with the US also means that companies are looking to diversify their supply chains and that is likely to be a gradual but negative impact. Whether domestic consumption can make up the difference? Personally I think it is unlikely; Whilst there is a growing wealth in China from the middle class there are only so many TV’s they can buy. In large cities there are restrictions on additional cars and houses. At the other end of the scale there is a huge number of people that are still close to the poverty level and remember China’s definition of poverty is calculated differently from everyone else’s; which means the cut point is actually lower than for the rest of the world.
Lastly the weakening USD or strengthening renminbi is also likely to make it difficult for exporters and there is little that China can do about that. Last week it lowered capital requirements on FX trades to make it easier to short the renminbi but the reality is that it is more about the USD.
Overall I think Monday’s data will be positive following the good loans data last week. The markets will react positively. Then on Tuesday we get the Loan Prime Rate decision and House Price Index (covers the 70 major cities) which will continue to see rises. It is worth noting that in China there are over 100 cities with a population of over 1m people (12 cities with a population over 5m). Those are well established cities but what I think investors really need to watch is what is happening in the lower tier cities and rural areas for a better idea of the strength of the long term recovery within China. For investors the key remains; to stick to the well run companies with good balance sheets. E Commerce will continue to be a favourite as the Chinese people of all ages are willing adopters of the technology.
Federal Reserve debates tougher regulation to prevent asset bubbles Officials worry that low interest-rate policies could encourage excessive risk-taking.
A wise but difficult move. Having created the environment that encourages excessive risk taking; as investors are forced to take more risk in order to achieve the returns that in previous times they could have achieved by buying US T10 bonds. But it highlights that the Fed is aware that there are events out there that could have significant impact on the economy.
The problem is that the Fed doesn’t actually have a plan; Neel Kashkari is quoted '“I don’t know what the best policy solution is, but I know we can’t just keep doing what we’ve been doing,” he said. “As soon as there’s a risk that hits, everybody flees and the Federal Reserve has to step in and bail out that market, and that’s crazy. And we need to take a hard look at that.”’
The obvious way to prevent excessive risk taking is for interest rates to rise to a reasonable level so that the cost of money is the deterrent. With ultra low interest rates it is a much more difficult, if not an impossible objective. When money is free where is the risk?
Whilst the Fed can control the banks with higher capital requirements, the capping of dividends and buybacks it cannot realistically control investors. In fact those moves make it more likely to happen; as investors are denied a source of income and are forced to seek returns elsewhere.
China tried to stop people borrowing money from the banks to put into the stock market by making it illegal. People taking out loans had to provide receipts showing what they had spent the money on and sign a declaration that the money would not go into stocks. But soon found out that people took out loans, for cars or other purchases, found a retailer who was prepared to give a false receipt or do a real transaction but then allow the goods to be returned and cash refunded. The money still ended up in the stock market; investors will always find a way.
The key is when peoples savings in the bank don’t earn interest they are forced to find alternative riskier investments. These days just finding a reasonable return is difficult and that is without being greedy. So when ‘good’ opportunities arise people tend to rush in and create bubbles.
It will be interesting to see what plan the Fed comes up with.
EU seeks data amid Covid drug concern. WHO says it divulged findings of medicine’s few benefits ahead of deal.The WHO is in hot water again. It announced that its remdesivir trial showed the treatment to have no substantial effect on rates of survival from covid. That announcement came out after the EU had agreed a deal with Gilead Sciences, to supply 500,000 treatment courses of the drug, worth more than €1bn. It has been revealed that the WHO knew that the drug and three others had little impact in September. Two weeks before the EU deal was signed. It must also put Gilead’s management in an award position not least because the drug was subsequently used on President Trump. Also there may be questions over the disclosure of material information that could impact the stock price. To say nothing of the honesty of the negotiations.
Europe reimposes curbs to fight second wave. Resurgence of virus is blow for continent that had succeeded in lowering infection rates. The resurgence of cases as Europe goes into the winter will be of concern. Officials had already warned of the combined impact with influenza; which is frighteningly coming true. The response of the governments is to increase social distancing measure but trying to avoid comprehensive lockdowns on economies that are already struggling to recover.
See also the Editorial A second wave of coronavirus has broken. England’s regional restrictions may not be enough to slow the spread.
For Asian investors the concern will be over the impact on exports and the global recovery
US retail sales accelerate in spite of stimulus uncertainty. It was a strong number but concerns remain over how long it can continue without a new stimulus programme from Washington. Many feel that being locked down has allowed households to build up savings. Areas that continue to do well include home improvements; which should be another positive for Techtronics (669 HK) along with garden equipment makers (may see a boost to Best Way (3358 HK)). Part of the strength may also have been ‘back to school’ purchases only now being made as schools delayed re-opening.
I think the key thing to remember is that those with jobs and able to work from home certainly still have the spending power and are using it. Those in the lower skilled areas that have suffered layoffs are suffering. They are the ones for whom the stimulus package is essential but their spending will be on essentials. That said it was interesting to see that retail groups like GAP and SIMON’S PROPERTY and even VF Corp (makers of North Face) after good results, sold down after the data came out. So whilst the number was good for general sentiment investor remain cautious on the outlook.
EU backs further talks despite UK gloom. Barnier authorised to keep negotiating after Johnson warns businesses of no-deal. Looks at the stand off between the EU and the UK over Brexit. It is interesting that 'French president Emmanuel Macron put the situation bluntly yesterday: the UK still needs a post-Brexit trade deal more than the EU does.’
The actual reality is that both sides really need a deal and no one really has any idea of what life without a deal will look like.
The UK obviously wants as good a deal as it can get. The EU is in a much more difficult position. It’s a collection of counties all with different agenda's. It is aware that there are other countries within the EU that are watching the negotiations and if the deal is seen to be ‘attractive’ could also seek to exit the EU.
The real losers will be the citizens of both the EU and UK unless a reasonable compromise can be achieved.
Fukushima contaminated water set for ocean release. Decision time is approaching as TEPCO the operator says it will run of space by 2022 to store contaminated water. It is seeking government approval to be allowed to release water contaminated with radioactive nuclides. It faces both local and international opposition. I don’t really know anything about radioactive nuclides but TEPCO is saying tritium-contaminated water is regularly released by working reactors.
But I would imagine not on the scale being considered here. It will be interesting to see what reports are made public about the possible implications. Rather like covid there are still so many things that have implications onto our lives that we know so little about.
Value drought claims big victim as trendy stocks power ahead. Slow and steady investing in overlooked groups hit by worst performance in a century. A reflection on value investing as AJO Partners announces it will shut and return money to investors.
Tries to find a reason why value investing has done so badly. Notes that often after underperforming the sector rebounds; bad during the Dotcom era but successful as the docoms blew up. But there is no clear reason as to why only observations on what has happened. With bond yields not helping value investors.
'SocGen reckons that the root cause is cheap stocks are now staying cheap — or becoming even cheaper — because they tend to be found in more economically sensitive sectors and, broadly speaking, global growth has been anaemic since the financial crisis of 2008.’
Others outdated ways of measuring value; using book value without including intangible assets.
Some think the passing of AJO might indicate a revival could come soon, maybe with the coming of a covid vaccine which could kick bond yields higher? A similar thing happened back in 1999-2000 when big value managers capitulated.
For me I think the main reason value investing is not working is because cash is mispriced. Ever since we brought in QE and flooded the system with cash, then value cannot operate. If your competitor has access to cheap money then there is no value in efficiency, or quality. Companies in sectors operate on the basis of the worst run and still in business because they have the pricing power. Only when we value money properly will value investing have a chance. I said it before but as they say 'never argue with an idiot, they bring you down to their level and then beat you with experience’; its the same in business good companies cannot compete with badly run ones when money if free.
Glencore’s Glasenberg rules out coal divestment. An interesting read, basically makes the point that if responsible firms are forced to sell their mines they will be bought by less responsible operators; Ivan Glasenberg said Chinese companies would be the most likely buyers of coal mines and would be able to operate them under less environmental scrutiny, increasing the total amount of CO2 emitted.
Interesting on the back of President Xi claim last week to cut emissions. But without details of how China intended to do that or how it calculated emission. So Glasenberg might have a point.
OKEx halts customer withdrawals after China probe and digital key concerns. It seems the company has lost contact with a employee who is ‘helping' with a Chinese government investigation. Highlights the problem with China’s legal system for companies; that if an employee is ‘helping in an investigation’ they are not contactable. In this case the official is the holder of the exchange’s so-called private keys, which enable the authentication of cryptocurrency transactions.
If China really wants to be an international business centre then it needs to review how it treats people who are being investigated.
Apartments look like trouble spot for property investors. Looks at the potential for defaults to hit the US commercial property market; especially CMBS deals. Suggests that whilst the market pricing is not currently reflecting concerns, those concerns are there nevertheless. One reason they are not so apparent is that falling interest rates mean that it is easier for people to borrow and to an extent; to refinance their current mortgages at a lower rate. The current low rates have also pushed up the value of existing bonds. Currently bonds issued by Fannie Mae last October with a 2.5% coupon are trading at 110 cents in the dollar. So widespread defaults would cause a problem; with funds only getting back 100 cents in the dollar.
It seems that at present widespread defaults are not expected but that could change, especially if there isn’t another stimulus package shortly. Other factors at play are the moratorium on landlords evicting tenants, which could be ‘hiding’ the scale of the problem.
An interesting read and as I have written before this could have a significant impact when it happens. Just like in the film 'The Big Short', just because most people seem to think that it will not happen; that doesn’t mean it will not.
US fracking could be an unlikely beneficiary of Democrat ‘blue wave’. An interesting read that suggests the US natural gas sector could be a big beneficiary of Joe Biden winning the election; especially those with existing production and preferably not on Federal land. In addition to the companies the other beneficiaries are likely to the ‘well completion specialists’ those that actually do the fracking. The losers it says will be 'Any E&P company that wasted its time sucking up to the Trump administration’s Bureau of Land Management for leases in western states, particularly New Mexico, Wyoming and Colorado.'
FT BIG READ. GLOBAL ECONOMY. The week that austerity was officially buried
Stern warnings to reduce deficits after the financial crisis led to a decade of budget cuts as governments struggled to balance their books. But now they are being urged to spend their way out of the pandemic. An interesting look at the policies being advocated in response to the global slow down due to covid. Basically the reverse of the policies advocated in the 2010’s. Well for rich countries that can issue their own debt. Makes the point that the IMF still enforces austerity on the smaller countries that seek loans from it; which does seem to indicate that this is not a one policy fits all solution.
Well worth a read. Read also the Editorial The death of austerity should not be mourned Governments must spend wisely to rebuild their economies. It makes the point that governments need to outline a plan of how they will reduce extraordinary spending when economies return to strength.
Mind you having a plan is one thing; getting politicians, especially ones that come later and were not involved in drawing up the plan, is a completely different affair.
Obituary. Modest aristocrat who restored lustre of Barings Lord Ashburton Banker 1928-2020. It notes 'Ashburton’s success reflected his quality of judgment, integrity and discretion, and his caution, paralleled by imperviousness to any business idea that he did not think was of sufficiently high quality.’ Qualities that all of us who have the privilege to work in Financial services should aspire to attain.
He had left Baring by the time that Nick Leeson’s fraud brought the company down. But having set up the Baring Foundation in 1966, a grant giving charity, which used dividends from Baring to support a range of artist and charitable activities. When the bank collapsed he stepped in to try and protect the charities it was supporting.
Whilst the era in which he lived may have moved on the standards that he adopted remain as important today as then… if not more so.
Ignore the noise when placing bets after US election. Sets out that whoever wins the election there are unlikely to be any immediate radical changes so as it says 'Ignore the short-term market noise and stick with equities and other assets that will benefit from the secular forces driving the economy and the business cycle into the next presidential term and beyond.’
Sets up the market stats; S&P up 53% under Trump vs 71% Obama and 61% Clinton. But notes the real driver for the returns under Trump has been the Fed.
Then outlines which sector will benefit and which be hurt
-VE Energy, Financial Services, Healthcare and Big Tech
+VE Within Healthcare hospitals could be winners. Also Infrastructure plays; Construction and renewable energy.
An interesting read.
Will America tear itself apart?
The constitution has long been treated as a sacred document. Now Supreme Court politics and fears of a contested election are prompting many in the US to question their founding creed, writes Edward Luce
Looks at what the constitution was designed to do, how the balance of the Supreme court matters and looks at some different scenarios of what might happen post election day.