FAST FACTS ABOUT TODAY’S ECONOMIC DATA:
* Australia is a China proxy that also happens to have its own debt problem.
* We have concerns about Australian exposure to China in trade and housing investment.
* New China “blue sky” environmental laws will hurt Aussie exports this winter.
* Meanwhile, Australia’s housing sector is already turning lower.
* We believe the time is right to short Australia.
AS CHINA DETERIORATES, AUSTRALIA BECOMES EXPOSED:
Frequent readers of our work are well aware that we have serious economic concerns about China in the year ahead. We believe that China is facing a significant debt bubble, weakening economic conditions, and is suffering from state-sponsored bloat throughout its industrial and commercial sectors. China has attempted to fight these issues by pushing even greater amounts of leverage into its economic and banking system.
We believe a prolonged trade war has begun and is the catalyst that begins a significant economic downturn in China. In fact, today the Wall Street Journal reported that The Trump administration has broadened its trade spat with China beyond tariffs, and will now include “export controls, indictments and other tools to counter the theft of intellectual property.”
This goes way beyond trade. At issue is that China is state-sponsoring a build-out of its semiconductor industry via its “Made in China 2025” blueprint: https://multimedia.scmp.com/news/china/article/2165504/china-2015-semiconductors/index.html
The Trump Administration sees China’s semiconductor policy as a serious threat. And with good reason as China’s startup semiconductor company, Fujian Jinhua Integrated Circuit Co., is backed by $5.7 billion in state funds. As such, the Commerce Department is going to bar exports and transfers of U.S.-origin technology to Fujian, in an attempt to destroy Fujian’s business.
In short, we see the China trade war as gathering steam and we believe that the trade war will tip China into recession. However, shorting China is problematic given that China has the means to distort data and control all facets of its economy, including capital flows, equity market investment, currency exchange, bank withdrawals, and even loan restructurings. In a sense, outside investors are at a significant disadvantage with China, as investors face asymmetric information on both the long and short side. As such, we believe the best means to short China is via China proxies, and this brings us to Australia.
EXPORTS TO CHINA IN DOWNTREND, AND CHINA’S TRADING PARTNERS ARE EXPOSED:
We continue to believe that the best means of tracking China’s economic activity is through what OTHER countries report about China (we don’t have confidence in China’s official data). Note that China’s major trading partners are all saying that exports to China are in a significant downward trend and some countries now have negative export growth to China. The one exception is Taiwan, as their exports to China accelerated to +9.3% Y/Y in October (+5.5% Y/Y prior) but this is well off the recent peak of +41.3% Y/Y in March. Note that Australian exports to China have slowed from +41% Y/Y in June to +13% Y/Y in September.
AUSTRALIAN EXPORTS TO CHINA REMAIN POSITIVE, BUT ARE EXPOSED TO CHINA:
Australia has been benefitting from a sizable trade surplus over the past few years…
…However, it is notable that China accounts for all of Australia’s trade surplus (and then some). 845% of Australia’s trade surplus since 2015 has come from Australia’s surplus with China:
AUSTRALIAN EXPORTS TO CHINA HAVE DOWNSIDE RISK:
Generally speaking, as goes China’s economic growth, as goes Australia’s trade surplus with China. However, Australia’s exposure to China has far more serious concerns given Australia’s exposure to China’s steel sector and overall commercial buildout. Note that some of Australia’s top exports to China are commodities, such as Iron Ore, Coal, Copper and Gold. With exception to Iron Ore and Coal, prices have turned negative.
We don’t believe that recent positive price improvements in Iron Ore and Coal are long-lasting. There are several negative factors at work for Australia’s exports 1) China’s overall economic slowdown, 2) China’s efforts to reduce overall steel supply, 3) China’s “blue sky” environmental initiative which seeks to cut steel production during winter months (November-March). China has a new three-year plan for production cuts across major steel producing regions during this time frame each year, beginning this month. You can read more about this here: https://www.mining-technology.com/comment/chinese-steel-policy-shifts-to-flatten-out-the-iron-ore-boom-by-2022/
So we have entered the new government-mandated seasonal dead zone for China Iron Ore and Coal imports, and the effect lands squarely on Australia.
CHINA ASIDE, AUSSIE HOUSING IS ALREADY IN SERIOUS DOWNTREND, AND DEBTS ARE BLOATED:
Australian Home Loans have declined for the second consecutive month down (-0.97% M/M and -9.65% Y/Y) in September. Moreover, in Aussie Dollar terms, total loans outstanding declined -3.77% M/M and -11.48% Y/Y to $29.12 billion (versus -10.37% Y/Y prior). Whereas the Aussie consumer debt is in a serious uptrend. As of the end of Q2, Household Debt to Income in Australia increased to a record high 190.5%.
WE BELIEVE THE TIME IS RIGHT TO ADD AUSTRALIA SHORT EXPOSURE:
Our concerns about China can be represented by shorting Australian equities. We believe Australia provides a fair proxy on China, while also averting China manipulation. We believe factors are working against Australia that go beyond China exposure, as described above. With China’s economy slowing, we expect to soon see meaningful slowdown in Australia’s economic data as well. And Australia won’t be able to fudge the data, like China can.
INDIAN INDUSTRIAL PRODUCTION SLOWED +4.5% Y/Y IN SEPTEMBER:
The Ministry of Statistics and Programme Implementation reported today that Indian Industrial Production increased +0.63% M/M in the month of September (not seasonally adjusted). However, Industrial Production slowed to +4.47% Y/Y (versus +4.67% Y/Y prior), which is the slowest pace since May. In the month, Manufacturing output (comprises 75% percent of industrial production) slowed to +4.62% Y/Y (+5.08% Y/Y prior); however, Mining output increased +0.21% Y/Y (-0.54% Y/Y prior) and Electricity output increased +8.24% Y/Y (+7.59% Y/Y prior).
INDIAN CPI SLOWED TO +3.3% Y/Y IN OCTOBER:
According to the Ministry of Statistics and Programme Implementation, Indian CPI increased +0.29% M/M in October. In fact, this is the seventh monthly increase in the past eight months; however, on a year over year basis, CPI slowed to +3.31% Y/Y (versus +3.70% Y/Y prior). In the month, Food & Beverage prices declined -0.36% M/M and Clothing prices declined -0.48% M/M,; however, Fuel prices increased +0.84% M/M, Housing prices increased +0.69% M/M, and Miscellaneous prices increased +1.19% M/M.
ITALIAN INDUSTRIAL PRODUCTION SLIPPED -0.2% M/M IN SEPTEMBER:
According to iStat, Italian Industrial Production slipped -0.19% M/M in the month of September (+1.71% prior). Nonetheless, total output is now up +1.26% Y/Y when adjusted for working days (versus -0.83% Y/Y prior). In the month, Consumer Goods output increased +0.29% M/M and Intermediate Goods output increased +1.13% M/M; however, Investment Goods output fell -1.64% M/M and Energy output fell -0.10% M/M.
U.S. GDP: Our GDP model sees 3%+ Real GDP growth through Q1 2019, but as higher oil and interest rates flow through the system, our model sees slower growth thereafter (Note that the Atlanta Fed’s preliminary estimate for Q4 GDP came in at 2.6% today). Our model doesn’t factor in the stimulus from the recent tax cut, so the reversal in 2019 could be more pronounced than our model appreciates (it is presumed that 2018 will be better than our model due to the tax cut, whereas the delta for 2019 would be worse than our model predicts).
U.S. Inflation: U.S. inflation appears to have hit a peak two months ago and with oil prices down and the dollar index up, we believe inflation has peaked (for now).
U.S. Federal Reserve: The Fed is signaling that rates will be 100 bps higher by the end of 2019, and with inflation peaking, they’re wrong. We don’t even think they should hike in December at this point. We believe the U.S. Dollar will continue to strengthen given interest rate parity and overall relative economic strength in the U.S., and this has now become a headwind for inflation (and potentially growth). We think a Fed pause is coming faster than the market currently appreciates (but a December hike is still on the table for now).
U.S. Treasuries: Although recent inflation data has been cooling, the job market remains tight and Real GDP trending is still trending well above +3.0%. With that in mind, we still believe the yield on the 10-year U.S. Treasury will trend higher. We expect to see yields approach 3.50% by year end 2018, particularly if the market sniffs out a coming Fed pause (as that’s ultimately reflationary).
U.S. Equities and Earnings: S&P 500 operating earnings are rising materially, but the question remains, will the market put a 20 P/E multiple on forward earnings? We think a 20 forward multiple is aggressive, but 18.5 may not be. Our SPX target is for an 18.5x P/E on 2019 forward earnings of $165, bringing our 2018 SPX target to 3,050. We prefer financials given expectations for economic growth and an improving (steepening) yield curve. We also have a positive bias on the Technology and Health Care sectors.
Argentina: The macro looks abysmal in Argentina, and they have IMF involvement, but there is a silver lining here in that Q2 GDP was so bad that it might be hard for Q3 to be negative! Overall, Argentina’s economic condition appears to have weakened in 2018. Inflation is at a lofty 39.5%, Industrial Production is down -5.6% Y/Y, Exports are down -4.8% Y/Y, Consumer Confidence has deteriorated since January, the Economic Activity Index collapsed in May, and Unemployment jumped to 9.6% in Q2 (7.2% in Q4 2017).
Brazil: Overall, Brazil’s data has weakened in 2018, but the political situation has now moved a step toward economic liberalization, and we are encouraged. Currently, GDP is up just 1% Y/Y and Unemployment continues to be elevated (11.9% in September, which is an improvement); however, Retail Sales are now up +4.1% Y/Y, Consumer Confidence improved once again in October, and the Composite PMI rebounded into positive territory in October.
Canada: Canada’s housing market has been weak, as building starts and permits have gone negative, Retail Sales slipped in August, and home prices are slowing (Toronto area is now negative). Note that Canada’s monthly Real GDP has been in a slowing trend since October (3.5% in October, but now down to 2.5%), while monthly Nominal GDP has slowed from +6.5% in June 2017 to +4.1% Y/Y in Q2 … remember, nominal pays the bills.
Mexico: Overall, Mexico’s macro data looks to be improving, but inflation is also turning up. GDP is up 2.6% Y/Y, PMI’s have been steady, and Consumer Confidence jumped in Q3. However, Unemployment increased to 3.6% in September and Retail Sales slowed to +3.9% Y/Y.
Venezuela: Remains uninvestable.
United Kingdom: If you look at the GBP, you’d think BREXIT is a major economic problem. However, when you look at the macro data, you don’t see any meaningful deterioration. Inflation has been in a slowing trend in 2018, unemployment has been declining, wages have been turning up, and PMI’s have been steady. Even the big macro risk, housing, hasn’t shown much weakness. In fact, home prices improved slightly in August on a Y/Y basis.
European Union: Although Unemployment continues to trend lower, Industrial Production is now up +0.9% Y/Y, and Retail Sales are now up +1.8% Y/Y, Economic Sentiment is turning lower, and PMI’s have turned back from recent highs, and the political situation has gotten so bad that Merkel isn’t going to run again. The events in Italy foreshadow possible macro risks for Europe, as monetary accommodation is removed. We still believe Europe is uninvestible.
European Central Banks: The ECB is slowly removing accommodation and has reiterated its claim that bond buying is over in December. But Mario Draghi hasn’t given a timeline for raising rates and the recent decline in CPI will give them even further pause for doing so.
Eastern Europe: As we saw earlier in the year with Italy, nations with high debt levels can rapidly become front-burner macro items. The same can be said for Eastern Europe, given high Debt/GDP levels, most notably Cyprus (104%), Croatia (88%, up from 66% at the end of 2013), and Slovenia (81%). Yet, economic data have been robust this year across most of Eastern Europe.
South Africa: We remain highly negative on South Africa, but we have noticed recent efforts by the ANF to walk back some of the rhetoric. The ANF is now trying to reengage with foreign capital and wants to liberalize some of the rules around mining investment. Politics aside, the macro picture is getting bleaker by the day as Business Confidence is rolling over, GDP is negative, Inflation has turned up, Retail Sales are barely positive, and PMI’s are bouncing around the ‘50’ level. None of this will help unemployment (27.2% in Q2). In our view, the mere risk of having assets appropriated will grind foreign capital commitments and new business investment to a screeching halt, and more time is going to need to pass in order for foreign investors to feel any degree of confidence. Our best guess is that more downside exists for South Africa’s economy and we believe the currency and equity market will suffer as a result.
Turkey: Remains uninvestable.
ASIA / PACIFIC:
Australia: The Australian data remain mixed but we have serious concerns about the decline in building approvals and new home loans. So far, the Unemployment Rate appears to be ticking lower (to +5.0% in September), Real GDP accelerated to +3.8% Y/Y in Q2, Exports are up +15.9% Y/Y, Wages are up +2.1% Y/Y, Retail Sales accelerated to +3.7% Y/Y in September, and Consumer Sentiment has ticked slightly higher recently. However, consumer credit remains elevated and the value and number of home loan approvals and permits have turned negative, which is a bad sign as home prices have turned negative as well. We remain neutral on Australia at this time but increased concerns about China could push us into the negative.
China: It’s officially a trade war and Jack Ma thinks we’ve got 20 more years to go. We have the under on 20 years, but the over on 1 year as China isn’t even interested in meeting with the Trump Administration at this time (although there is a token Xi/Trump meeting on the calendar). China claims it’s going to pull out all the stops, is going to ‘encourage’ institutions to buy stocks, and there is talk of cutting taxes. We doubt any of this will work to plug the large liability problem in China’s banking system.
We continue to believe that trade talks aren’t going to get better for quite some time and China will use every tool in its arsenal, which includes Renminbi depreciation. It is notable that China is already working to stimulate its banking sector by lowering reserve requirements and encouraging banks to do “debt for equity’ swaps. Note that PMI’s continue to indicate slow growth, Industrial Production is slowing, and now China may have an inflation problem.
India: Indian economic activity appears strong, which runs counter to worries about shadow banking issues. Commercial Credit accelerated to +14.4% Y/Y in October, Industrial production has been strong, M3 money growth has been steady at 10%, and PMI’s still show growth (albeit slower). We are watching to see if any deterioration happens, but so far the only meaningful deterioration was confined to a drop in exports in September.
Indonesia: Indonesia had gone four years without raising rates, but now rates have been hiked +125bps since Mid-April. Indonesia’s GDP and Private Consumption Expenditures are up over +5% Y/Y, Consumer Confidence has been stable, Manufacturing PMI had been stable in the 49-51 range for a year and slowed to 50.5 in October, Industrial Production rebounded +9.0% Y/Y. However, Retail Sales slowed slightly to +3.7% Y/Y and Exports slowed to +1.7%. If there’s one emerging market that we’d be inclined to be bullish, this would be it, but we’d need to see the free-fall in the currency come to an end first.
Japan: Overall, the economic data have been mixed but we are encouraged by Prime Minister Abe’s promise to fix social security, immigration, and workforce participation. We are slowly becoming positively biased.
Russia: As we stated recently, the sanctions are beginning to have an impact on Russia. And it is never a good thing when officials talk about their ability to cushion “crashes”. We find Russia uninvestible at this time.
South Korea: Overall, the economic data have been mixed. While the world looks forward to peace on the Korean Peninsula, we are keeping an eye on trade data into China, which increased +17.7% Y/Y in October. Also, GDP increased +2.0% Y/Y in Q3, Income is up +4.2% Y/Y, Industrial Production increased +0.9% Y/Y, and the Unemployment Rate improved to 4.0% in September. Conversely, Retail Sales slowed to +3.0% Y/Y.
MACRO TRADE IDEAS:
GLOBAL CENTRAL BANK SCORECARD:
WEEK IN REVIEW – BEST & WORST PERFORMERS:
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