So, one of the great advantages I have is that I get a constant stream of not only tactical ideas and research but deeper, more strategic discussion. Three in particular stand out over the last week, all with some really big ideas worth contemplating for the long weekend ahead of us.
The first is from the excellent Michael Pettis via his wonderful Global Source Partners newsletter www.globalsourcepartners.com.
Michael is an American economist based in Beijing and wonderfully erudite. His regular newsletters are a great source of insight into the long standing structural issues facing everyone’s favourite Communist Party.
So, this week he has a smidgen of good news namely that it is now six to seven weeks after Beijing went into lockdown, and that conditions are ”changing for the better”.
Michael also says that there is a big internal debate raging about where the top line numbers on economic growth might land in China this year, with the most notable intervention being that of China International Capital Corporation , a large brokerage, which s downgrading its 2020 forecast to 2.6%.
Yep, that low. And my hunch is that the real number might be even lower than 2.6%.
This lowball number prompts many of us to think that the Chinese state and central bank might turn on the taps and flood the economy with extra money, in line with their Western counterparts.
Michael isn’t so sure. He thinks we shouldn’t rely on monetary or fiscal stimulus for four reasons
- Its consumption imbalance is the worst in the world and must be reversed by raising the household share of GDP
- The banking system is insolvent
- Debt levels are among the highest in the world – at well over 300% of GDP according to the Institute of International Finance, are now among the highest for a developing country
- China’s exchange rate policy prevents significant monetary expansion because of important monetary constraints that did not exist in 2009-10
In his view China no longer has the monetary space to really binge on the corporate national credit card,. More pertinently if the bosses were tempted to go crazy, it would be sending the wrong signals to an economy and society that needs to transition to a new growth model that is less debt fuelled and more consumption based. Or as Michael puts it “ if Beijing insists on forcing the economy to generate a 2020 GDP growth rate close to Beijing’s “social and economic goals”, we should be very worried.
Next up we have everyone’s favourite perma bear Albert Edwards over at SocGen who is back with his grim reaper style predictions in a paper called Transitioning from The Ice Age to the Great Melt. That title for the paper might imply maybe some cautious optimism from Albert , where we transition from deep pessimism to guarded optimism.
Albert is sticking with his pessimism and reckons at some stage we’ll see a retest of the 666 low of March 2009 for the S&P. He also echoes Raoul Paul’s call of 6000 for the Dow Jones, an 80% retrenchment. Personally I think those are both extreme outlier projections but lets hope they’re not right.
What is more interesting is that Albert then proceeds to spend a few pages of his report quoting at length from an article by Ambrose Evans Pritchard about the existential crisis for the eurozone as the Latin countries – the Latin front – stage an open revolt in the Eurozone.
He also quotes an article by the excellent economic historian Adam Tooze which headlines with this : “ The only thing that would be worse for them [emerging markets] than the dollar surging would be the dollar surging and the renminbi falling at the same time”. Which is precisely what Albert thinks could happen very soon.
Last but by no means least its worth digging out an excellent short paper on the RoboGlobal index website by their strategic advisor Louis Vincent Gave, founder of Gavekal.
You can download it for free at – https://www2.roboglobal.com/e/309251/OGLOBAL-CORONA-MELTDOWN-P2-pdf/23qfk4/160152787?h=0s3cHeu5znXbzvULqrQmVVA4-ZwDX_31_igv4cz6NIg
It’s always worth listening to Gave especially for his views on macro economic policy and the rise of Asia. One immediate observation on Asia shines through – according to Gave this is the “first time in my career that a) Asian equities have massively outperformed as markets collapse and b) have actually shown a lower volatility than the US equity markets in the midst of a downturn”.
Turning to the global picture, Gave reminds us that we are now living through the sixth big equity market meltdown in just 100 years – he thinks this is a perfect storm with three factors powering events
- “We are currently living through fears that a global pandemic will devastate global economic activity.”
- “There are genuine concerns from investors that the past decade’s worth of large capital expenditures in the energy sector could turn out to be worth very little”. That said Gave pointedly reminds us that at the moment, investors seem to be pricing in a complete meltdown in the energy sector. This might not be the case.
“Take ‘big oil’ share prices as an example: historically, share price performances have been driven by the price of oil and long-term interest rates. As things stand, it seems that the market has fully discounted the ‘forever’ nature of low oil prices, without simultaneously discounting the ‘forever’ nature of low interest rates. Meanwhile, of the two, we would argue that low interest rates are more likely to be ‘more’ permanent than low oil prices”. If oil prices do start rising again, a large amount of money might be made in the energy sector.
- A liquidity crisis of unprecedented proportions is unfolding at a rapid pace. Numerous examples are cited :
- One of the largest surges in the gold/silver ratio on record
- Municipal bonds have just sold off by almost -14% at a time when it seems almost guaranteed that the US federal government will open the taps to ensure that no local authorities go under
- A number of developed market currencies have been behaving worse than emerging market currencies eg – the NOK has fallen -22% this month and its RSI is a tall 10, or below the level reached in the depths of the 1992 Scandinavian Banking crisis
- the unforeseen spread between ETFs and their underlying benchmarks. Spread on Vanguard BND ETF has reached 3%
So, what’s Gave’s thoughts on what investors might want to do next?
He’s careful not to say too much but I think the chart below probably points in one direction. The table below shows the 50-day moving averages for each time the S&P 500 fell by 25% or more.
“For investors who were willing to project themselves out two years or more, buying the S&P 500 after such declines was almost always a good idea, the exception being in 1929 at the start of the Great Depression. Of course, back then, policymakers followed policies that were 180 degrees from the path they seem to be embracing today.”
For Gave we are about to enter a new normal where one thing seems obvious –
“the cost of capital will remain very low. This will encourage companies to continue to bolster their human workforces (which are susceptible to COVID-19 and future illnesses) with robots. Conversely, the low cost of capital may encourage a higher unemployment rate. If we are indeed moving to a world where UBI is funded by the proverbial ‘magic money tree’, aren’t cash and bonds the very worst places to keep one’s savings?”