Good Morning.. I think it is time that global equity markets realised that phase 2 of the US/China trade war is upon us as the US contemplates what punishment to level on HK and possibly its banks. Sanctions are possibly on the way and even talk of undermining the HK USD peg, which seems rather dangerous to me. But the US is aware that China needs US dollars and is why they are ramping up Chinese stocks to attract capital. But China is not just battling the US and IF these other nations all unite, then China could have a problem but so far, few are prepared to give up on such a huge buyer of goods and raw materials. But more action is coming and equity investors need to bear this in mind. Data is still not telling us much and need time to settle after such a dramatic shutdown and reopening but one gauge that can help is CapEx. It is the critical driver of growth in the future and it is being slashed and this on top of unemployment levels that are likely to remain high, especially in the US. Again, equity investors need to bear this in mind as earnings season is almost upon us. Wall St fell into the close even after Clarida comments reiterating the Fed has unlimited resources to hand. I still see the EUR higher over time and I just wonder if and when the EU pass this joint bond, whether China starts to diversify more into the EUR. It is very exposed to dollars. We have no data of note but Sunk is delivering his spending ideas at 12;30 London time and there is a meeting later to discuss the EU recovery fund hosted by von der Leyen and Merkel. Meanwhile Boris reiterates Britain is prepared to walk if EU fails to compromise;” art of the deal”? Maybe.
Keep the Faith..
Details 08/07/20
Forget history; these are unprecedented times; watch CapEx: Things could change radically.
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Economists and analysts revert back to what they always do in a crisis and take to the history books to see what can be taken from the past and applied today. Bear market rallies, overlaying of charts from previous crashes, deep technical analysis all is taken into account in an effort to forecast what is coming next. But to me, this is a total waste of time, because we have never had the global economy forced into a self-induced coma before, so how on earth can you look back for a reference? It is time these economists and bank analysts fessed-up to the fact that we are in unchartered waters and are flying blind. But they are paid far too much to accept that but in reality it is the case, as indeed it is for me and the Fed and all the central banks and governments trying to fight this thing. They make all sorts of claims about the fall and steep rise in stocks, the swiftness of the rebound, which, to be honest, caught many by surprise but now actively support it with claims of understanding why.
Stocks in 2020 have witnessed extremes to the upside and downside
The issue here is that the severity of the shutdown brought not only a dramatic seizure in the global economy but also brought about the biggest collective stimulus effort ever seen by some considerable margin and rules of the game have been thrown away, as central banks now monetise debt so that governments can spend with carefree abandon. Never before have we seen this at such extreme levels. Data is improving as we unlock but with that comes the problems of more infections and deaths and the biggest issue is still the absence of any vaccine. But not only that, the other massive issue still to be resolved is how long will the recovery take? The recovery is not going to look anything like that equity chart above and the longer it takes the harder governments will find it to sponsor the packages of support to the millions of unemployed and destroyed businesses. The governments, like the US cannot keep handing out $600 a month forever. The disconnect between US workers and businesses is far greater than it has been in the EU or UK as companies were encouraged to furlough and hold onto staff but not so in many cases in the US.
History is of no use to us in this crisis and it is difficult for many economists to model this. But on may occasions here, you have read about my views on the importance of CapEx. Nothing has changed and in fact it is possibly more important now than ever, as it is a gauge we CAN use with regards to the recovery in businesses, as CapEx is the critical driver of growth in the future. That is a fact but unfortunately companies globally are slashing capital spending this year as the virus-induced recession has forced management teams to rein in costs. They will shed staff and cut costs for quite some period in my view and neither are good for the US or the global economy. Refinitiv data (of nearly 4,000 firms) estimates 2020’s CapEx cut will be on average 12%, much larger than the 11.3% decline during the global financial crisis in 2008-09, or the largest in over a decade.
Investing in R&D at a time like this is not on the agenda and weaker business investments are typically associated with slower economic recovery. Refinitiv showed Exxon Mobil and BP Plc, have already told investors CapEx will be slashed by at least 20% this year. This all suggests the market is widely misinterpreting the shape of the economic recovery – as it appears a steep reduction in global CapEx could result in a 2H bounce that underwhelms, leading to levels of GDP and earnings in 2021 to be lower than hoped for. That on top of an expected 9%+ unemployment level by year end estimated by none other than the Fed.
We start earnings season in a week or so and I am wondering if the impact may already start to show. Zero rates will also weigh on financials. If you are wondering what to monitor, I would watch CapEx.
The recent head-fake/spike in the data was obvious as economies reopened but current data tells us very little about where we are headed; that may have to wait for a month or two before the data levels out as indeed it will in many cases. I am a fan of PMI data in a normal world but even that is sending mixed messages in the way that it is collated and focused on whether things seem better this month against last. This again is in danger of levelling off as is retail sales which spiked after the shops reopened in the US as one would expect. It is judgement that we need to fall back on and I fear that many have given up using it and still rely heavily on spreadsheets and financial modelling. Bond markets in the US tell us little now as the Fed footprint is all over them and they are actively involved now in the credit space. What are we to look at that is free to move for the right reasons now? This socialising of the markets is very worrying and I fear we may not get them back anytime soon. The dominance of the central banks has never been so great in the free world. Human behaviour or “animal spirits” are hard to model but that is part of the move higher in equities. The other part to the rally is the massive rise in global money supply.
The virus has accelerated a few themes as we now have embraced technology that was availiable which has seen many prove that working from home is a viable option and that meetings may not need to be face to face. But it has also accelerated the global geopolitical tensions bubbling under the surface for the last few years. The divide between China and the west and the failure of US leadership of the west have both deepened. As the FT suggested; The western-led world order is in crisis. If the US re-elects Donald Trump, this will be terminal they say. That may or may not be the case but the risks are rising that a deeper and more widespread global trade war is developing. China has issues with not only the US but Oz, the EU, UK, India and many of it’s neighbours in Asia including of course Taiwan. This is not the time for the US to look inward, as indeed they seem to be doing; this is a time for unity, as I think China, Russia and N. Korea can smell the US reluctance/weakness to engage as true global leaders. This is far more important than economic data which at present is irrelevant. The timing of the security law in HK is no coincidence as China is very aware of the broken relationships in the west. We are weaker now than we have been for decades and has the US, as the global super-power, lost its way?
The US are considering actions against HK after the securty law was put in place and there is talk that they my hit HK banks and try an undermine the HK peg. The reason for that, which I will discus below, is that the US knows full well that HK brings in much needed USD capital inflows for China. The idea of striking against the Hong Kong dollar peg — perhaps by limiting the ability of Hong Kong banks to buy U.S. dollars — has been raised as part of broader discussions among advisers to Secretary of State Pompeo and hasn’t been elevated to the senior levels of the White House, suggesting that it hasn’t gained serious traction yet. HSBC slumped on the talk of resticting HK banks. Eddie Yue, chief executive of the HKMA, last month called any move to deny Hong Kong access to the U.S. dollar clearing system an “apocalyptic” scenario that “would also send shock waves across the global financial markets, including the U.S.” He is right. But this did not stop Chinese shares rising again last night. But it shows that more action against China from the US is coming. The next phase of the “real trade war” is about to open. “We’d love to preserve the freedom in Hong Kong,” Pompeo said. “But if we can’t, we’re going to hold the Chinese Communist Party accountable.” Game on!
But China has a problem as it is no longer a closed economy and has a need for US dollars and FDI. In barely two decades, China’s share of the $140tn pool of global liquidity (defined as total savings plus credit) leapt from about 6 per cent to well over 25 per cent. China invoices goods in US dollars, invests in US dollars and provides timely countercyclical boosts of fiscal and monetary policy for its dollar-hungry economy. It is trying to attract foreign investors to its stock markets to soak up more USD’s as we have seen the last few days. Data produced by Crossborder Capital, writing in the FT, suggests that the bulk of the near-30 per cent rise in the US currency since the mid-2000s and about three-quarters of the drop in US bond yields can be attributed to China effects! While it is not in the interest of China to dump Treasuries, they are reducinmg thier holdings.
Even a partial switch away from the US dollar should help the EUR, the number-two world currency. Bear in mind that a newly assertive European Central Bank is prepared to match the US Federal Reserve in balance sheet expansion through its pandemic relief programme. In that context, a clear catalyst to pull these disillusioned Chinese assets toward Europe could be behind the EU’s plans to issue €750bn of so-called eurobonds. Maybe this is what swayed Germany to end its culture of austerity and start offering a joint bond. The ECB’s strength now also questions whether the US Treasury markets are the best or safest harbour in the world; maybe we shall see the EU bond market steal some of that staus now. I think it could be the case if this joint bond is ever passed. I am keeping my bullish recommendation on the EUR and in fact will look to buy again if we come off as I see this as a macro trade worth keeping and bulding. The reason being that markets follow money. The coming flood of ECB liquidity and eurozone safe assets, alongside the pressing need for China to diversify, could cause a radical change in capital flows.
Meanwhile, EURGBP slipped yesterday and it seems yet again that GBP was in demand due to expected spending by Chancellor Sunak to be unveiled today. We saw a steep rally in GBP last week after Johnson announced plans for infrastructure spending a while back and again it seems spending is being rewarded; not punished. But we still need to consider the Brexit trade deal and apparently, Boris reiterated his stance to Merkel last night that Britain was prepared to walk if the EU is not prepared to compromise. Negotiations are stuck over questions including fishing rights, the future influence of EU courts in U.K. laws, and how far Britain will be able to loosen its rules and still enjoy access to the single market. If a deal is not formed by about the end of September; it may be too late.
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Strategy:
Macro:.
Long EUR @ 1.1210.. Stop at 1.1150
Long EURAUD @ 1.6250 stop at 1.6080
Brought to you by Maurice Pomery, Strategic Alpha Limited.
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