Morning Note: Market news and our thoughts on China.
Market News
US wholesale inflation ticked higher in September. The core PPI index, seen as a lead indicator of consumer price inflation, rose by 2.8%. However, consumer sentiment fell by more than expected, with the University of Michigan index slipping to 68.9, versus a forecast of 70.8. Fed futures now price 87% chance of 25 basis points cut at the FOMC meeting on 7 November. The equity market ended the week on a positive note (S&P 500, +0.6%; Nasdaq, +0.3%) as JPMorgan and Wells Fargo posted solid results.
Chinese shares fluctuated this morning in a volatile session after a Finance Ministry briefing at the weekend underwhelmed investors and a drop in factory prices reinforced concerns about the economy. Officials promised more aid for the slumping property sector and indebted local governments, without giving a headline monetary figure that investors sought. Onshore equities (Shanghai Composite, +2.0%) swung between gains and losses while Hong Kong shares dropped (Hang Seng, -0.6%). China’s yuan weakened. Japan was closed for a holiday.
Geopolitical tension remains high in the Middle East. The US is said to expect Israel to strike Iranian military and energy sites. US officials have concluded that Israel has a shortlist of military and energy sites it will target in response to Iran’s missile attack, NBC News reported Saturday. Gold moved higher and currently trades at $2,662 an ounce, although oil slipped below $78 a barrel.
The UK business and trade secretary signalled on Sky News that the government may increase payroll taxes for businesses by raising their national insurance contributions. UK inflation is out this week and is tipped to fall below the Bank of England’s target for the first time in more than three years. Sterling trades at $1.3070 and €1.1960, while the FTSE 100 is currently trading 0.2% at 8,260.
Germany is suffering a mild recession and output across the whole year will be flat, according to a Bloomberg survey. “There’s no clear catalyst for a turnaround,” said Rabobank’s Erik-Jan van Harn. “A bottoming out is the best-case scenario for now.” The ECB’s François Villeroy speaks today.
Source: Bloomberg
Market View – Chinese Equities
Source: Bloomberg
The Chinese economy has been in the doldrums ever since its Covid policy response. However, this pales compared to the financial markets and asset prices more broadly. It depends upon which market or region you look at but broadly speaking Chinese property is down 30% and Chinese shares were down 60%. This compares to the US where the stock market is at all-time highs and property is buoyant. Until now, Chinese policy has not been shifted to address these issues. While Western Governments were handing out money willy nilly in response to Covid, China not only enforced the most stringent lockdowns, but they also left the population to deal with the financial consequences on their own.
On 24 September, the People’s Bank of China (PBOC) cut interest rates, lowered banks’ reserve requirements and took steps to reduce mortgage payments. More critically, the central bank will help firms buy back their own shares by refinancing bank loans used for that purpose. It will also help securities companies, insurers and other institutional investors raise funds, making their balance sheets more robust. Two days later the Chinese Communist Party (CCP) resolved to address the property market’s decline and implement aggressive counter-cyclical policies.
Chinese equities which had been significantly under-performing both developed and other emerging market equity markets took off like a rocket, with major indices rallying 30% in a matter of a few days. When Chinese equities were under-performing, the job of a global equity portfolio manager was simple. Avoid Chinese stocks like the plague. The evolution of the “great power conflict” between the US (and Western democracies more broadly) and China, combined with the terrible performance has earned China the moniker “uninvestable”. The often-cited example as the reason for this is what happened to Russian assets in the wake of the Ukraine invasion. However, now there is a genuine catalyst that will cause investors to question whether this is the right position to take. It’s much easier to look down your nose at something that is going down.
As you might expect there is no consensus on what this means. For example, legendary investor David Tepper of Appaloosa Management, a hedge fund, in an interview with CNBC was asked what he would buy, he replied, “Everything. Every. Thing.” Others have been much more circumspect. The argument of the naysayers is broadly split into two categories. First, you can’t trust the property rights in China and even if you think you own something, eventually if will be taken away. Second, the economy is terminally in decline due to structural factors such as debt, demographics and fundamental problems with the communist model and the stimulus will never be enough to change that.
Whilst we have sympathy with both these lines of argument, our retort would be that “that doesn’t mean Chinese shares can’t go up a lot in the meantime”. It doesn’t mean that policy announcements won’t disappoint along the way – this weekend’s Finance Ministry briefing did – and that Chinese shares won’t sell-off dramatically as a result. They will. However, we do think that the recent announcements represent a line in the sand or “policy bottom” where the CCP now actively wants shares to go up whereas in the past they wanted them to go down. We also sense the government wants the market to avoid the kind of volatility it endured in 2015, and would rather see a smoother progression, while providing support on the downside.
If the agenda at the latest Politburo meeting is 1. Make shares go up. AOB, we think there is a good chance that over time they will get their wish. They have plenty of levers to pull and the fact they have not pulled them until now has been a choice. To those who say this won’t help the economy, we say you may be absolutely correct. However, we think the policy to stimulate the economy is via higher asset prices not the other way around.
This is a much tougher trade for investors to get right than piling into US tech names when judged against a global benchmark. Valuations in the most efficient industrial economy in the world are on their knees and global investor positioning could not be more bearish. The pain trade is higher.