I’m back after a summer break ! Plenty of updates this week on their way
China has been grabbing all the headlines at the moment, probably rightly so given the big tectonic shifts. Overall I’ve been more cautious than most although one can’t help but note that China Tech stocks are cheap and getting cheaper by the day.
An alternative take on this huge debate comes from Mark Sheppard who runs the Manchester and London investment trust. As a tech investor he’s bet big on China and perhaps unsurprisingly has a different take on how events might unfold. As he says the “core fear some are sensationalising is that China may be moving away from the New Era of Socialism towards Xi Jinping Thought which is shifting ever more Mao-ist in nature.”
I’m not sure that this is a sensationalizing read of events but Sheppard’s bigger point is that if the cynics are right, why hasn’t there been a wider impact on key developed market stocks. Names such as Burberry, HSBC, LVMH, Renishaw, SSAB, Kone are all businesses that should be impacted given their profits from China but don’t appear to have been so far. As Sheppard observes there are “numerous global growth favourites in the tables below that earn material parts of their earnings from China. Beware!”
Piecing this Chinese policy jigsaw together Sheppard offers up his own read on the next likely steps :
- China ensures strict discipline with the regulations
- Material monetary penalties will be levelled against miscreants and scapegoats will be welcomed.
- Business models will have to change and this will reduce returns but it will also create significant barriers to entry.
- The “new era of socialism with Chinese characteristics” will keep moving uncomfortably towards an autocratic and command economy but it will continue to shy away from adversely affecting the key goal of keeping the Economy growing and the people employed and satisfied.
- China will continue to invest in improving the productivity of its Economy with the aim that its economy surpasses and humbles the US.
- We will see further regulatory actions from the US against China and these dual superpowers growing ever more competitive.
- It will be a very uncomfortable and volatile ride for Western investors but there is a reasonable probability that the outturn provides these investors with material investment gains.
- Things could get worse before they get better
Well, so far the old adage about selling in May and coming back on St Ledgers day isn’t panning out again. After a few wobbles, the markets have taken the summer and Jackson Hole in their stride. The S&P 500 for instance is up +20.4% year to date and Euro Stoxx 50 at +19.2% (both local currency). Investors seem to be in a confident mood. investors appear to be bristling with confidence.
There are potentially lots and lots of reason for this confidence but one factor might be that share buybacks in the all important US market have been steadily increasing. Ironically though, according to Andy Lapthorne at SocGen, the rate of growth in buybacks hasn’t kept up with the rate of growth in share prices. Lapthorne reports that buybacks for the S&P 1500 non-financials have fallen by around 20% from pre-crisis levels but are once again growing year-on-year and in terms of cash flow represent the same payout as dividends at around 20%.
“However, given that US equity prices are also up 40% from end-2019, this 40% total distribution payout ratio still only equates to a total payout of 2.4%, near its all-time low, and to get back to pre-pandemic levels of distribution relative to price looks challenging. In these times of low yields, maybe 2.4% is acceptable, but given the importance of compounding in driving long-term equity returns, the difference between 2.4% and 4.8% is huge.”
Buybacks are of course only one piece of the valuation puzzle – the big question is whether the market confidence is bordering on bubble-ish behaviour. Lapthorne’s colleagues at SocGen, Arthur Van Slooten and Alain Bokobza run an in house proprietary risk model called the SG Multi Asset Risk Indicator (SG MARI) which attempts to give investors a quick snapshot of market confidence.
Curiously their model currently suggests that “investors are remarkably risk off (see chart below). Just three days before Jay Powell’s ‘tapering’ speech at Jackson Hole, SG MARI touched the lower bound of its normal trading range at -1.06, almost one standard deviation below its long-term average. “ The key point here is that this reading is very unusual – “ We have only seen such a low reading in just 9% of all observations since 2000. In the past, any drop below the current SG MARI level has been typically trigged by a major crisis such as the TMT bubble, the subprime crisis and the ‘taper tantrum’. The current level is below even the Covid-19 blighted March 2020 reading. Conversely, whenever SG MARI has bounced back from current levels, it has typically heralded the start of a more positive tone, which is good for risky assets such as equity and commodities but not for rates”.
So, time to panic ? Not quite the SG analysts conclude.
“We do not find the current low reading from our risk indicator SG MARI particularly worrying.
Rather, we take it is a sign of restraint on the part of investors on risky assets (equities, FX and
commodities) which is appropriate whenever market conditions are about to change. That said,
whatever the cause of potential future shocks, the fallout should be relatively mild – so no
pressing need for overly optimistic investors to square positions, at least for now. Without readily
identified major immediate threats, SG MARI’s low reading could still call for a more balanced
approach to risk.”
Charles Ekins is a well respected technical and fundamentals analyst who runs his own multi asset ETF for EkinsGuinness. Like everyone else he keeps tabs on the aggregate market valuations, using his own value/technical measures. His conclusion ? “World Equity absolute valuations are stretched historically but are not yet extreme. But Equities are still very cheap against artificially-expensive Bonds”. The chart below nicely sums up this cautious stance – his World Equity Value Yield measure (blue line) is at 3.3% which is lower than in 2007 before Global Financial Crisis, similar to pre-1987crash , but not as low at Tech Bubble in 2000. The second measure, the World Equity Dividend Yield (green line) is currently running at 1.9%. This is also low but is not extreme.