Happy new year !!! Apologies for the radio silence over the last few festive weeks but I’m sure my Adventurous readers had much more interesting stuff to read than my rantings over the last few days!
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Monday Macro: China
I have no idea what will happen in 2022 but of one thing I am reasonably sure – all eyes will be on China. What happens in the land of the CCP increasingly matters to all of us and frankly any macro takes on investing that avoids discussing what happens to Chinese consumers and exports is missing the point entirely. My gut tells me that China is in big trouble in 2022 and because what happens to China matters to the rest of us, those travails will affect all of us.
First of all, though, let’s disabuse readers of one thing: that globalization is over and everyone is re-shoring. It isn’t and very few are. The first chart below is from the excellent Robin Brooks at the IIF, the global association of the financial industry and a former strategist and economist with Goldman Sachs and the IMF. The chart below shows China’s export values from Jan to Nov each year by key regional market. As you can see the US and European exports have steadily increased but the real quantum of increase has been in exports to the ASEAN countries and beyond. China is still an export powerhouse. That chart below gives me no confidence that China will not dominate global exports for the rest of this decade.
Now, that exporting strength might have one immediate consequence. Cue the second chart from Robin Brooks which shows how the trade weighted value of RMB has been steadily strengthening over time. Put simply China needs to devalue, as it has done in the past, and aggressively so. If that happens we can expect a wave of turbulence in the global markets as investors work out what that means for other emerging markets – especially South Korea, and Vietnam.
If this particular dog doesn’t bark, then I think we can identify another possible source of disorder and concern: Covid. I’ve been sounding like a broken record player on the subject of Zero Covid for months now, but it seems to me all but impossible to keep Covid out of China in the medium term. Sure dramatic local lockdowns will dampen down the impact but until 80 to 90% of the population is triple vaccinated with mRNA vaccines, then at some stage the dreaded virus will sneak back in unless China intends to shut down for the next decade. The winter Olympics could be the turning point but hey, the virus is essentially unpredictable when it comes to where it might appear 9or mutate) next.
When Covid makes contact with the domestic population, the carnage will be spectacular and inevitably crush local consumer demand and knock the global economy off balance. But don’t just take my word for it. The political consultancy Eurasia has just released its annual Top Risks for 2022 Overview and up at number one is No Zero Covid. Here’s their basic summary which I agree wholeheartedly with:
“China is in the most difficult situation because of a zero-Covid policy that looked incredibly successful in 2020, but now has become a fight against a much more transmissible variant with broader lockdowns and vaccines with limited effectiveness. And the population has virtually no antibodies against Omicron. Keeping the country locked down for two years has now made it more risky to open it back up. It’s the opposite of where Xi wants his country to be in the run-up to his third term, but there’s nothing he can do about it: The initial success of zero Covid and Xi’s personal attachment to it makes it impossible to change course. “
To repeat: when Covid rips through China, Chinese consumer demand will crater, and that will have a knock-on impact on the rest of the world, dulling down inflationary pressures.
China pressures on inflation and trade
Another way of understanding China’s oversized impact on the rest of the world – including us in the UK and the US – is to read the economic historian Adam Tooze’s excellent summary of the causes of the energy crisis HERE. Tooze carefully maps out how local decisions around energy usage have had a massive knock-on impact on the rest of us, fuelling very rapid energy price inflation here in the UK.
Now, on the energy space, I would expect that the impact of my Zero Covid Retreat to have a massive impact on energy demand from China – demand will suddenly fall off a cliff as the realisation sets in on the energy markets that China will hit the wall. That should be good news at some point for all of us.
But the capacity constraints around China’s export machine aren’t going away. On this theme I thoroughly recommend a deep dive into the logistics nightmare across the pacific with Ryan Peterson, founder and CEO of Flexport via Noah Smith’s excellent Substack HERE.
It’s a great analysis which lays much of the blame at the door of the US government and its lack of infrastructure coordination and investment. But the changes needed are going to take months and years to have any impact and in the meantime, as this chart below shows, it’s all going to make 2022 another bumper year for shipping companies (and funds : Tufton and Taylor Maritime in the UK). The chart is from Flexport and shows that that the trend is still only heading in one direction.
What’s much more interesting is the scenario planning that Flexport have outlined which suggests that 2022 could get even worse.
“Health: Significantly worse SARS-CoV-2 variants lead to return of lock-down culture globally, resulting in significant manufacturing and port/airport interruptions. Policy Actions: Significant fiscal stimulus, continued monetary stimulus, stricter public health policies also known as zero-COVID. Demand: Consumer durables demand remains robust, consumer non-durables demand surges as a result of return to hoarding, spending on services collapses. Other Factors: Interruptions pop up in global shipping and airfreight lanes, either through accidents or geopolitical tensions. Union disputes at major U.S. West Coast seaports. Worsening COVID-19 conditions, combined with zero-COVID policies in Asia could lead to a continuation of frequent port and factory closures. Goods demand will likely remain high as services spending remains unavailable and hoarding of consumer non-durables returns. If demand remains elevated or climbs even further, then the logistics industry’s susceptibility to cascading problems caused by exogenous events increases. Indeed, if demand remains at elevated levels the level of congestion measured by the OTI may climb further. Aside from the evergreen risks from geopolitical tensions which could have a global impact, there are union negotiations on the U.S. West Coast due later in the year. “
“Figure 4 shows the impact on seasonal imports to the ports of Los Angeles and Long Beach during the strike of early 2015. Clearing the backlog created in January and February pushed imports in March up by 48% year over year, or around 240,000 TEUs. Similar disruptions in 2022 may take longer to clear given the ports have been operating at around 850,000 to 900,000 TEUs per month, potentially close to capacity, on the back of existing demand. Continued West Coast disruptions may lead companies to start to consider permanent strategies such as using the Panama Canal or shipping via Mexico, raising both costs and delivery times.”
US Interest rates
I want to finish my Monday Macro roundup with a quick guessing game about where US interest rates might finish up. This exercise matters a great deal because these rates help anchor a whole set of expectations about implied value throughout the financial system. In simple terms the higher the end point, the more dramatic (and negative) the impact. My own (cold) finger in the air suggests that Us interest rates will end up around 1.5 to 2.25% with a likely 2% peak. But the risk is that I’m wrong and on this score its worth taking note of the comments below from BlackRock which come from their Global Outlook for 2022.
“Central banks could revert to previous policy responses in the face of persistent inflation pressures. The Bank of England (BoE) – which in December became the first major DM central bank to raise rates since the pandemic struck – has made the most noise about responding more aggressively to inflation, leading markets to expect repeated rate hikes. The BoE may serve as a test case of a DM central bank coming closer to hitting the brakes, prompting the market to price in a risk of a policy reversal on rates by 2024. And inflation expectations could become unanchored from policy targets in the post-Covid confusion, forcing central banks to react aggressively.” [my emphasis added]
This signals, correctly in my view, that one major risk is that central banks are too aggressive in their rates policy which negative implications for equity investors. On which score I thought I’d also include the chart that goes with the BlackRock prediction. The markets are pricing 1.5%, the Fed’s December dot plotting says 2% but if central banks conform to historical precedents, then it could be closer to 3%…OR MORE. Needless to say if the stockmarket thinks 3% or more is on its way, we can expect very significant market volatility.
This is my new dashboard of key measures. There’s no special science in this but it’s just the range of measures I use to work out whether markets look cheap, or overpriced or anything in between. In the second box below I’ve given some of the explanations behind the measures used in the table.
My overall view: US equities (and thus the rest of the developed world) still look bullish
|The Govie Spread
|S&P 500 20/200 MA Above
|FTSE 100 20/200 MA Above
|Gold 20/200 MA Above
|Vix 20/200 MA Above
|Deutsche Equity Positioning
|S&P 500 Div Yield
|S&P 500 2021 PE
|Note 1: FAANG valuations – using TTM (historic, actual) earnings per share versus share price. source Yahoo Finance
Note 2: The Govie Spread – from YCharts “The 10-2 Treasury Yield Spread is the difference between the 10 year treasury rate and the 2 year treasury rate. A 10-2 treasury spread that approaches 0 signifies a “flattening” yield curve. A negative 10-2 yield spread has historically been viewed as a precursor to a recessionary period. A negative 10-2 spread has predicted every recession from 1955 to 2018, but has occurred 6-24 months before the recession occurring, and is thus seen as a far-leading indicator. The 10-2 spread reached a high of 2.91% in 2011, and went as low as -2.41% in 1980.”
Note 3 : Simple technicals. If a market is trading above its 20 and 200 day moving average this is viewed as bullish, below bearish. a crossover (the market ducking below or above the 20 and/or 200 day MA) is regarded as significant
Note 4 : Volatility regime. I use a simple quartile system for the Vix measure of turbulence in the S&P 500 index. The long term average is around 19. The third quartile is at around 21.50 and the first 1uartile is at around 13. Anything below 13 is regarded as very low volatility, anything between 13 and 19 low volatility, anything between 19 and 21.5 medium volatility and anything above 21.5 as high volatility.
Note 5: Equity positioning. Based on Deutsche Bank internal consolidated equity positioning which is in turn based on fund flow indicators.
Note 6: Simple fundamentals. These measure the market wide dividend yield and current 2021 price to earnings ratio of the S&P 500. The last two measure the Robert Shiller long term CAPE measure of the S&P 500, available at http://www.econ.yale.edu/~shiller/data.htm. This is a smoothed out and adjusted long term average for the S&P 500. There is also an alternative version which includes changes in corporate payout policy.