Weekly – Investment Adviser-09-01-20
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The devil is in the détails
Finally, a – trade – truce
The upcoming signature of a ¨phase 1 deal¨ between the US and China is good news. It will eventually spell the de-escalation of last two years’ trade war. It practically will mean a gradual unravelling of the ¨corrosive¨ tariffs imposed by Trump last Q2/3 2019, which – if implemented – would have nastily cascaded up to US consumers. Considering the late stage of the business cycle, such a burden would have provoked undesirable consequences.
It remains important to figure out the actual perimeter and nature of this deal. Indeed, Chinese purchases of US agriculture and other goods seem guaranteed. It also seems that Xi will ¨concede¨ on the currency front, i.e. stabilize the Yuan. Additional opening-up of the Chinese financial services might also take place. But for the rest of the pact, the jury is still out as of today!
Vanishing trade tensions should somewhat unleash capex / investment
But this will not be enough to restore a global trade buoyancy
However, trust is not restored
The US has been hastily erecting law and barriers against unfriendly foreign investments for a couple of years now. The most consequential actions were taken against ZTE and Huawei. Logically, Chinese capital flows reversed from their top in 2016. A sharp slowdown is visible in M&A, Direct Investments and venture capital.
Both government bureaucracies are going ahead with measures to curb what it sees as increasingly serious security risks from the other side. The drive to achieve at least a partial decoupling of the US and Chinese economies is particularly focused on technology. China is accelerating its restrictive security regulations on IT hardware, software and data flows. China’s Cybersecurity Law, which came into effect in June 2017, is the legal foundation for current efforts to achieve these goals.
Chinese inflows will continue decelerating
US M&A may be due for a cycle-end deceleration
The costs of doing business in China for foreign companies will rise
Arbitration and enforcement, the ultimate grains of sand
China’s accession to the WTO in 2001 fueled the set-up of a global and common level-playing field on trade’s (legal) framework. As a main beneficiary of globalization, Beijing has clearly become a growingly ardent advocate of Free Trade. As a corollary, international commercial arbitration has flourished, in line with the continuing development of cross-border trade and investment.
Ultimately, any court ruling in a specific country (US), region (Europe) or by a supranational organization (say WTO), should theoretically be a) acknowledged for and b) implemented by the concerned counterpart (say China). In practice, this is far from being the case yet. The growing mistrust of Trump administration for multilateral entities and processes has proved a (new) dampening factor.
Up to recently, the failure to sign a durable trade pact between Washington and Beijing was namely due to the US, attempting to impose US / Western system and courts for any dispute, where-ever it happened… Now, new discussions and explorations are underway regarding international arbitration, such as investor-state arbitration and third-party funding.
When it comes to enforcement, China made efforts in recent years to be align with internationally acceptable standards. This favorable approach accelerated since 2013, in order to facilitate its Belt and Road Initiative (BRI). In pursuit of this cause, China adopted nationwide applicable measures and made groundbreaking innovations within its Pilot Free Trade Zones. But still, the inertia and proportion of rejection by Chinese administrative tribunals remain significant.
The gap is important between under-average Chinese standards and a growingly protectionist US
It will take new and significant political initiatives / brakethroughs to forge durable bilateral pacts
- A successful ¨mid-cycle¨ economic adjustment, analog of 1995, 1998 and 2011 is becoming likelier
- But progress beyond trade (i.e. phase II / III) is unlikely before a new US Presidential cycle unfolds
- Divergences in technology sectors between China and the US, as well as Japan and Europe will increase. It should penalize the global sector’s margins
Fixed income. The oldest world central bank sets the tone
The Swedish central bank delivered what it promised and is, by the way, the first one to exit negative rates policy. It was one of the most expected moves ever. The Riksbank raised rates because of worries about the collateral damage and unintended consequences of an ultra-low interest rates regime.
By raising its key rate by 25 bps to 0.0%, Sweden exited a negative rate paradigm that was in place for the past 5 years. It came after officials expressed concerns that persistent negative yields adversely distort the behavior of households and companies.
This is a big policy move for Sweden, but from a too small country to directly impact other economies. By increasing interest rate differentials with the rest of Europe, it could strengthen the currency. However, higher domestic borrowing cost can hurt the economy. It is a risk the Riksbank will monitor closely. Rates will stay unchanged at zero until early 2022.
The loud message to other central banks is that not being the only one to do so for too long can make them not just ineffective but also counterproductive. Even if Sweden can hold out as the monetary policy outlier in Europe, this could well be looked back at as the beginning of the end of a historic policy experiment, one that worked initially but was then undermined by the failure of politicians to pivot to a more comprehensive pro-growth policy response.
The ECB may consider downgrading, or jettisoning, a key element of the Bundesbank legacy, according to officials. The amount of money growth in circulation, one of its two pillars to assess the economy, has proven to be a poor guide to inflation. Focusing on credit, or the impact of monetary policy on financial stability, might be more appropriate. The debate highlights how the President Lagarde strategy review will turn. It will evaluate the inflation goal, its primary mandate, and how to reach it, along with broader issues such as climate change and digital currencies. This review will likely be formally agreed by the Governing Council in January. No decisions have been made yet on how the exercise will be structured. A panel of ECB and European central bankers should lead it.
Ditching or downgrading monetary analysis would be a major technical change. It would also be a symbolic overhaul, cutting one of the longest-lasting ties to the Bundesbank model. The underlying principle is that the buildup of money in the economy (notes and coins, bank deposits and short-term money-market instruments) affects future prices. The faster money supply grows, the greater the risk of accelerating inflation.
The usefulness of that principle has been doubted by central bankers for a long time. Euro money supply climbed in 2001 even as inflation weakened in the aftermath of the dotcom bust. Since 2014, the ECB has managed to bolster money supply growth by adding massive amounts of liquidity into the economy with its QE program, long-term loans, and negative interest rates. Yet inflation has remained stubbornly subdued. However, there are still some defenders like the Bundesbank president, Weidmann, who declared that monetary and credit aggregates are good indicators of financial imbalances.
- Towards a monetary policy repricing in Europe
Currencies. The waltz of the central bankers continues … not always for the best
When Carney was appointed at the Bank of England in 2012, the news was surprising. He was described as a rockstar central banker. His successor Andrew Bailey came without stardust and will take over the reins on March 16th. He has never been an interest rates setter. So, it is tricky to judge how he will set the Bank tone. He is another noneconomist to take the lead at a major central bank. He is a Cambridge doctorate holder in economic history and has years of experience in dealing with monetary-policy issues.
Bailey is likely to focus on the Bank core responsibilities of monetary and financial policies. Nonetheless, changes in leadership at the Fed and the ECB have been coupled with framework reviews on monetary policy operating in a low inflation and rates area. The BoE could do something similar in 2020.
Carney has recently moved in a relatively hawkish direction compared to the other board members. Years ago, it would have been almost impossible to find a more dovish boss, but nowadays the Bailey pragmatic approach may take the MPC into a slightly softer direction than the most recent Carney stance. Given that he was running the regulatory office, he should be initially viewed as a slightly hawkish choice. However, he will bring continuity and competence.
- Risk/reward still favors a dovish BoE tilt. Favor UK duration.
- Now that Johnson’s exit deal is fully priced in, markets will start to discount the weak UK data again
Equities. Markets should digest the rise in the 4th quarter of 2019 short-term
We remain positive on equities for 2020, but in the shortterm, the stock markets should consolidate and digest the strong increase in indices, which occurred in the 4th quarter of 2019. Investor sentiment indicators are extremely high (see Fear & Greed Index) and we need a trigger; could it be the increase in tensions in the Middle East with the assassination of one of the highest Iran commanders (the regime’s number 3)?
Following the assassination of Qassem Soleimani, the traditional safe-assets were actively sought: gold, US Treasury bonds, the yen and the Swiss franc.
In 2020, the US Federal Reserve will remain a powerful support for equities. Regarding profits, bottom-up analysts expect an increase close to 10%, thanks to rebound in profits in Energy, Industry, Materials and Discretionary sectors. Unlike 2019, US profits growth in 2020 should come from companies that generate more than 50% of revenue outside the United States.
At the start of each year, we are entitled to all kind of statistics, such as when the first 5 trading days of the year are positive, then the S&P 500 recorded a positive performance 82% of the time since 1950.
Equity markets appreciate Donald Trump. The S&P 500 has grown more than 50% since the president was elected, more than the double of the average of 23% for the other Presidents after 3 years in office. The index rose 28% in 2019, well above the average of 12.8% in year 3 for the other presidents. If history is a guide, since World War II, year 4 should be positive with a probability of 78% for an average increase of 6.3%.
For 2020, let’s review our investment convictions: gold, Green New Deal, 5G, Energy sector and semiconductors:
Gold. For the past year, we have been positive about yellow metal. Global debts, the de-dollarization of world trade and foreign reserves from central banks of emerging countries and military tensions in the Persian Gulf are factors that favor gold.
The Green New Deal. The infrastructure programs linked to the decarbonization of the economy will require public private spending calculated in billions of dollars or euros over the next few years, necessary to save our planet and revive our economies. This will affect many sectors such as electricity production, energy storage, energy efficiency, smart networks/cities/homes, sustainable transport.
5G. In 2020, the development of 5G will accelerate with the arrival on the market of 5G smartphones from all manufacturers. But the US-China technological war will also accelerate the establishment of infrastructure. Analysts believe that smartphone manufacturers should revive a Supercycle thanks to 5G. But we can never repeat it enough: 5G does not only concern smartphones, but also the Green New Deal, smart networks/cities/homes, connected objects (IoT), autonomous cars, telemedicine. The main concern comes from the multiplication of relay antennas emitting electromagnetic waves, because the high frequency waves (for more data transfer), used by 5G, have much shorter wavelengths, therefore easily stopped by obstacles like constructions or plants.
Oil. By far, the Energy sector recorded the worst sector performance in 2019. Probably, the fault of an average price of a barrel of Brent in 2019 at $62, lower than in 2018 at $72, because of fears of recession, a slowdown in demand and US production constantly increasing, with +10% in 2019 to 12.7 million barrels/day and doubling in 10 years. The OPEC+ deal has supported prices, with a reduction of 2.1 million b/d since 2018, mainly from Saudi Arabia. Prices could rise with tensions in the Persian Gulf, better-than-expected global growth and doubts about the ability of the United States to maintain its current production rate.
The International Energy Agency estimates an increase in US production of 1.1 million b/d in 2020 compared to 1.6 in 2019. A few factors are favorable to crude prices: 1) according to the IEA, inventories should fall these next 2 years, see graph below, 2) US production should slow down, 3) US sanctions against Iran and Venezuela will not be lifted for a while, 4) non-OPEC non-US production, which accounts for 48% of global production, is no longer increasing, 5) the implementation of IMO-2020 standards from January 1st, 2020 for maritime transport should translate into an increase in oil demand by 500,000 b/d, while considerably reducing CO2 emissions.
Semiconductors. Most analysts missed the semiconductor segment in 2019 because of the risk of recession and the US-China trade/technology war. And yet, the Philadelphia Semiconductor index rose 65%!
At the beginning of December, analysts and semiconductor companies gave a positive message: demand is accelerating and prices for DRAMs (dynamic random access memories, computer storage memories, volatile memories are lost when they are no longer supplied) and NAND (flash memory, retaining data) seems to rebound due to higher spending by data center operators, cloud expansion and a better supply/demand balance.
In short, analysts believe that the bottom of the cycle was reached in the second half of 2019, which the stock market seems to have anticipated. Manufacturers Samsung, Micron, SK Hynix, among others, predict a 40% price increase in 2020 for NANDs and 30% for DRAMs. The accelerated deployment of 5G will increase demand for semiconductors (5G smartphones, IoT, emerging technologies, storage, improved connectivity, artificial intelligence).
- Gold. Favor physical gold with Swisscanto ETF Precious Metal Physical Gold (CH0044781141/ JBGOUA SW)
- The Green New Deal. Vast thematic to invest preferably through actively managed vehicles
- 5G. Apple, Samsung, Nokia, Ericsson
- Oil. Total, Exxon, Halliburton, Schlumberger
- Semiconductors. Micron, AMD, Western Digital, NXP and AMS
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