Un vistazo a las bolsas

Mark Tinker, responsable de Framlington Equities (AXA IM) para Asia - Sabado, 28 de Mayo

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The latest Fed minutes have got the high frequency economists excited about higher US rates again. This is seen as the last opportunity this year, but is as much about the perceived health of the rest of the dollar zone, specifically emerging markets, as the US economy.
The dollar zone, the eurozone and the renminbi zone all have economies moving at very different speeds with varying levels of debt. Monetary policy is struggling to work within each zone while politics is threatening disruption of trade policies. All of this makes for bifurcated markets more appropriate for active rather than passive investing.
The Chinese authorities have announced a further round of tightening in the Chinese shadow banking system, this time targeting so called channel business where bank loans are effectively made via fund management companies. This could have implications for short term liquidity.

The latest Federal Reserve (Fed) minutes have swung the received wisdom amongst the noise traders back towards higher rates in the US which is leading to a firming of the US dollar again. The latest high frequency data from the US and to some extent Europe is likely to have a more positive tone, not least because (as I never tire of saying) surveys such as the Purchasing Managers’ Index (PMI) are about the first derivative, i.e. are things better or worse, higher or lower? Earlier this year, ironically influenced by just such a misunderstanding about Chinese PMIs, the noise traders had convinced themselves, and many others besides, that China was not slowing, but  about to collapse. It wasn’t, and it didn’t, so now surveys are likely to be more positive again. However, in my view it is the health of the emerging markets that will determine Fed funds, not the US economy. Despite saying that the path of Fed funds is ‘data dependent’, the Fed  stopped responding to short term US data a long time ago. If we were modelling US rates based on US economic data, then according to the Taylor rule, a model of US Fed data that reflects all of the issues economists say that the Fed watches, such as employment rates, inflation, output gaps and so on, rates should already be 3.25%. The fact that they are not means that the Fed are watching something else apart from the US economic data. Post the financial crisis they were clearly watching the health of the US financial system. Now, it seems to me at least, they are watching the health of the global financial system and more specifically the stability of the rest of the dollar zone, the emerging markets that have too much dollar debt. This is where the debt risk lies in my opinion (and I suspect theirs). Not in China.

 

The discussions on Fed funds are of most interest to the foreign exchange markets and it is worth noting that from a yield perspective, I read this week that the US now accounts for almost 75% of all sovereign G-10 debt with a positive yield in the 1-5 year range. For anything under a year, 90% of all positive yielding G-10 debt comes from the US. For the world’s largest pension funds and insurance companies desperate to match asset and liabilities with yield, there is almost nowhere else to go, unless of course you are prepared to invest in synthetic yields, which tends to suggest a limit to the downside for the long end of the US bond market. Of course, there is one country that offers much  higher yields - China. We notice this week that two of the Chinese policy banks are in the process of raising around $1bn from international investors with a spread over Treasuries estimated from 140 to 170bp. If we think about it, as a dollar bond there is no currency risk so that, not for the first time China appears to be offering a product of equal quality, but for half the price.

 

It is interesting to recollect that this time a year ago the Shanghai Composite Index was at 4900 and every man and his dog was speculating on the MSCI inclusion of China into its indices, a move speculators were assured would bring in a wave of money from the west. Well, it didn’t happen of course and now, even if the index does get included next month on a 5% weighting there is little or no speculation ahead of it and no perception of forced buyers. This is not to say that investors can continue to ignore China, either as a market or as an economy. As the old expression about economics says – you can ignore it, but it won’t ignore you.

 

I suspect part of the reason for the ongoing negativity about China is that, especially after last year it is in the ‘too hard’ box and without any weighting and indexation issues, global institutional investors are quite happy that it stays down and goes nowhere. As such all negative news is welcome. As predicted last week, the western press has been full of discussions about the apparent conflict between Mr Xi Jinping and Mr Li Keqiang and the ‘confusion’ about the direction of economic reform and George Soros and Kyle Bass have popped up again to pronounce on debt and recession. The notion of a systemic collapse due to debt to GDP ratios being high remains the constant theme of the bears and as I commented last week, either they complain growth is too fast (as in March) or that it is too slow (as in April). Equally the political narrative swings from the fact that either Xi is being too authoritarian (bad) or that he is not being authoritarian enough and there are splits (also bad).You can’t blame the bears for trying to spin everything to suit their narrative, but it helps to recognise that they have such a narrative.

 

The reality is that the government, financial and corporate balance sheets are all overlapping in China as it builds its financial system and combined with the fact that the debt is internal, not external, to the system (and thus the usual emerging market comparisons do not apply) means that while China does have issues, an emerging market style crisis or a 2008 style financial collapse are not likely to be one of them. Perhaps the key lesson is that analysis of China is not suited to the type of high frequency data crunching that has become the norm in the west. This is not just about the quality of the data (western data is far from accurate as frequent revisions attest) but also policy. Chinese policy makers are not in the habit of making short term changes in response to monthly data points not least because it is structural reform that is the key driver, as emerged from the ‘Xi versus Li’ discussions last week.

 

Apparently without irony, one western editorial last week declared that the problem for China was that “Free market reform requires tolerating periodic recessions and easing up on the political allocation of capital” while at the same time the paper was highlighting US Treasury backing for an aggressive International Monetary Fund’s (IMF) deal on Greece. A deal that is primarily aimed exactly at preventing  a recession and in my mind amounts to an extremely political allocation of capital. So it seems that, not for the first time, China is being held to a standard of economic purity far higher than the west holds for itself. This is not to defend China, but rather to illustrate that compared to parts of Europe its problems are not as extreme as some like to paint them. 

 

Elsewhere,  there was a big ‘One Belt, One Road’ conference here in Hong Kong last week which, aside from the traffic congestion associated with heightened security helped focus Hong Kong’s role as a finance hub where ‘the rest of the country meets the rest of the world’.  The usual roster of Hong Kong tycoons were reported as looking less happy than usual at the event, suggesting that it may not be the profits bonanza they have become used to, but that is probably because this is more about Chinese foreign policy and trade than anything else. One example, the new President Duterte of the Philippines in a statement to China declared  “Build us a railway just like the ones you built in Africa and let’s set aside disagreements for a while” which suggests a rather more pragmatic approach to bilateral talks with China and one that is clearly upsetting some US military strategists. The US pivot to Asia so far appears to be about constructing military alliances in the face of a declared threat from China and to subsequently trade within those alliance, much as NATO did in the post-World War ll period and the visit by President Obama to Vietnam this week certainly appears to fit this model. However, just as US attempts to stifle the Asian Infrastructure Investment Bank (AIIB) were thwarted  by the Europeans keen to engage in trade with China, it may be that the ‘One Belt, One Road’ strategy will deliver China the soft power it seeks in South East Asia and hopefully enable it to disengage from an arms race. The previous Philippine government was keen to allow US bases, the new one seemingly less so. Governments change as they say. Equally last week we saw the new President Tsai Ing-wen of Taiwan say that Taiwan would play a responsible role in Asia and be a staunch guardian of peace and say that regarding problems in the East China and  South China seas they “propose setting aside disputes so as to enable joint development”. It shall be interesting to watch how China responds. In this vein we know that Donald Trump advocates a far less interventionist US foreign policy and has also said that he would be open to talks with Kim Jong-il of North Korea and Vladimir Putin, while Hillary Clinton is in this sense a hawk. It may well be that under all the rhetoric, this will be the real issue affecting Asia arising from the US presidential election.

 

The other issue of course is free trade. Donald Trump has stoked populist calls for tariffs against China and last week President Obama beat him to it as the US announced huge (522%) tariffs on certain Chinese cold rolled steel exports. The benefits of free trade and comparative advantage are one of the few things that almost all economists agree on and yet politicians appealing to specific groups of workers are either ignorant of this or choose to ignore it. Raising steel prices in the US may be good for workers at US steel, but far less so for all the users of steel in America such as car manufacturers and ultimately the consumers. It will certainly raise prices more easily than QE appears to be doing, but perhaps then we might ask the question, “why are higher prices a good thing?” It is such an orthodoxy that the world’s central banks need to target inflation that nobody seems to be asking why it is good for the consumer (who after all are the people of the country) to have higher prices. I can understand exactly why government wants it – they are the biggest borrowers and their ‘income’ is a function of nominal GDP – but, if protectionism leads to higher prices, voter discontent will rise yet further. ‘Careful what you wish for,’ as they say.

 

From an equity investor point of view this shifts pricing power and margin pressure and could be a key threat to business models. The benefits of globalisation in terms of greater choice and lower prices are less obviously visible than the costs in terms of unemployment and thus lobby groups can sometimes redirect the winners from the many back to the few. It also raises questions about attempts by various emerging economies to grow their way out of debt. India for example, with an already heavily indebted steel industry and facing a global surplus is nevertheless planning to increase domestic capacity by 34% in the next few years and Prime Minister Modi apparently wants to triple the size of the industry over the next decade, reflecting a “made in India” campaign that predates the slump in prices. It is all very well planning to invest and expand a domestic steel industry when supply is tight and prices are rising, but when there is huge overcapacity and record levels of Chinese exports, the fact that Mr Modi is still seeking to increase Indian steel production from 110 million tonnes to 300 million tonnes by 2025 suggests that supply and demand are not likely to come back into balance any time soon.

 

The oil market also remains constrained by excess supply despite the recent rally in oil prices and with reports of US and Canadian output picking up again, the prospect of a ceiling on oil prices is appearing.  This remains good for the customer – although the base effect will soon start to drop out of the inflation data – but bad for the producer and with the inventory  levels at close to record highs in the US pricing power looks like it remains to the consumer. One place where this is hurting is Saudi Arabia. Earlier this year I said that those worrying about the renminbi (RMB) peg breaking should look instead at the Saudi Riyal and once again this week the peg came under pressure amid stories of contractors being paid with tradable IOUs. Budget issues are not new for Saudi Arabia, although the market appears to have temporarily overlooked them as oil rallied, but there is a risk of a vicious circle; weak oil prices put budget under pressure, which forces increased output and in turn puts further downward pressure on prices.

 

There is also the prospect of a sharp jump in the US dollar, but even with only a marginally stronger dollar, sterling weakened on Friday and implied volatility jumped as the certainty that the financial markets appeared to be taking from UK bookmakers about the possibility of the UK leaving the EU (they put it as low as 20%) switched towards something more like the polls themselves where the situation is much closer. From a trading, Fibonacci, perspective, sterling dollar executed a near exact 38.2% retracement of its rally from the February lows to the early May peak before bouncing again. On this measure 1.448 is now a key support. Doubtless this volatility will continue for the next month until the referendum.

 

Chart 1. Sterling Fibonacci says watch 1.448

Source: Bloomberg

 

The Chinese authorities continue to build a financial service infrastructure which means allowing the shadow banking system to expand and then regulating it to bring it into the official system. This week the Chinese Regulator, China Securities Regulatory Commission (CSRC), announced some important  draft rules for the regulation of fund management company subsidiaries. Without getting too complex, this is basically a proposal to restrict an aspect of the shadow banking system that  is known as channel business. In effect banks rather than lending have been buying specially created products from the subsidiaries of fund management companies (FMCS) who in turn ‘invest’ with the businesses requiring a loan. Almost 70% of the business is done by the top twenty FMCs and around half of the top 20 of these asset managers are actually controlled by banks. This has led to extremely rapid growth in this channel and, as has happened elsewhere with shadow banking the authorities allow two steps forward before requiring one step back. Over the last 3.5 years, 79 of these target asset management companies have been set up and assets have grown from around RMB 1trn in 2013 to almost RMB 10trn by Q1 2016. This then is aimed at slowing down the growth of leverage in the system. The draft proposals would require much higher levels of capital to be held by the fund management company subsidiaries if they want to maintain their current level of channel business, the idea seemingly being to push FMCs to lower risk and less capital intensive business. There are parallels with the restrictions in the past on trust businesses and while this might not be as onerous, there is a risk that closing off this channel of credit could put some short term pressure elsewhere in the system.

 

Finally, some perspective on the size of China and its cities ahead of a trip to London to speak at our China Symposium. Last week I showed a map of China superimposed over Europe, partly to show its geographic and climate diversity but also to make the point that when we refer to ‘local government debt in China it can reflect areas many times larger than a European sovereign. It is also true of the financials. This week with the ‘One Belt, One Road’ conference in Hong Kong there was talk about the integration of the nearby Pearl River Delta. We know Hong Kong is a reasonable size economy with a GDP of around $322bn (putting it 34 on the IMF ranking), but the city of Guangzhou just on the mainland in the Pearl River Delta comes in at $258bn which makes it bigger than Greece, Portugal or Ireland. Provinces such as Hunan ($445bn), Sichuan  ($461bn) and Fujian ($398bn) are all larger than Hong Kong and ahead of other European countries such as Denmark, Norway, Austria, and Belgium. Guangdong province – the whole Pearl River Delta region - has a GDP of $1.17bn, which makes it twice the size of Switzerland and ranks it larger than Russia, Indonesia, Mexico or Spain and the same size as Australia.

                                                                                              

Mark Tinker

Head of AXA IM Framlington Equities Asia

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