Weekly – Investment Adviser
|MSCI World||+22.2%||CHF Corp||+2.9%|
|S&P 500||+25.8%||US Govt||+7.9%|
|Stoxx 600||+21.1%||US Corp||+14.2%|
¨Those who do not move, do not notice their chains¨
South-East Asian dragons are blunt
The notion of South-East Asia ¨Dragons¨ encompasses Hong Kong, Taiwan, Singapore, plus South-Korea. These resilient dragons are seriously impacted by the major reshuffling of the global pack.
Beyond trade tensions and de-globalization, politics and sovereignty have lately become obsessive topics for two of them. Indeed, they are directly concerned by the controverted concept of Great China, which refers to the geographic area sharing ties (trade and cultural) dominated by Chinese Han. It encompasses mainland China, Hong Kong, Macau, Taiwan and Singapore. Ultimately, China communist party expects all of them to integrate mainland China.
Hong Kong is experiencing the most acute crisis
The former British colony has never been so close to insurrection / civil war, since the 1997 handover. Two recent developments are tentatively explosive. First, the announcement of the standing committee that China’s National People’s Congress – and not Hong Kong’s courts – has the authority to rule on the constitutionality of Hong Kong legislation. Second, the Hong Kong Human Rights and Democracy Act just passed by the US Congress. In this context, HK district councils’ elections morphed into a referendum on both the government and the student rebels. The big turnout is a confirmation of the importance of this ballot. There are fears that the big support for the pro-democracy/student affiliated parties would cause political and economic uncertainty. Carrie Lam, the Chief Executive of Hong Kong, is probably a convenient fuse following the ballot. Shanghai and Shenzhen are not yet able to replace Hong Kong as China financial hub.
Following the pro-democracy vote, Beijing is likely to opt for further patience
A Trump veto of the HRDA would help a trade deal, but add fuel to the political fire
Politics irremediably impacts on business
Taiwan situation is very complex and barely more positive. In the first semester, Beijing sent its aircrafts circling the island, and ramped up efforts to internationally isolate Taiwan. This muscle-flexing is reminiscent of the 1995-6 crisis, when China disrupted commercial air and sea traffic by firing missiles near Taiwan and the US sent two carrier groups in response. Taiwanese President Tsai Ing-wen has steadfastly resisted integration with the mainland. Donald Trump broke precedent by speaking with Tsai on the phone after his election, then threatening to deny the one-China policy. The decades-long but always uneasy truce in the Taiwan Strait has become less stable. To the great displeasure of Xi, Tsai is well ahead in poll regarding 2020 presidential elections.
When it comes to business, Taiwan is between a rock and a hard place. Taiwan is indeed very dependent on mainland China, but also from the US. For instance, Taiwan has a comfortable technological edge in the highly strategic field of high-end semi-conductors. For example, TSMC is the reference manufacturer of Huawei… When it comes to the smartphone market, Taiwan has become growingly vulnerable to Chinese competition. And Taiwan’s contract manufacturers of electronics, under pressure from US tariffs and rising Chinese wages, have started to relocate some of their operation’s outside mainland China. Hong Hai (Foxconn) and Pegatron are important employers of (more than a million) Chinese workers. This may become a politically sensitive issue if the delocalization intensifies.
The latest vibrancy of Taiwanese exports should be considered with a pinch of salt
It is far from clear whether the country would ultimately benefit from the showdown of China and the US
US applies a basic, accounting, logic to its allies
In the past years, Seoul has not stopped showing its allegiance to Washington. It revisited a bilateral trade agreement distinctly to its disadvantage. It complied to Trump’s will and hectic strategy, when addressing North-Korean threat. It quietly accepted an 8% rise for 2019, regarding the cost of US military protection i.e. maintaining about 30’000 soldiers on the ground. Last week, the US administration presented the ¨new¨ bill for 2020, by multiplying 2019 amount 5 times! This humiliating decision is infuriating South-Korean politicians, without exceptions. It reached such a climax, that Seoul announced security talks with… China to discuss regional stability.
Relations between South-Korea and Japan deteriorated markedly over last summer. A ruling by the Seoul supreme court (on compensations relating to WWII) ignited an administrative showdown, followed by reciprocal exports restrictions and threats of embargo. This is not good news for the Korean chaebols that are dependent on high tech (electronic components) from Japan.
Trump and his administration’s policy are a source of high instability
It spillovers to the whole region
Singapore has been, so far, the exception, i.e. the only immunized dragon. It is even indirectly benefiting from some precautionary capital inflows.
- The indisputable victory of pro-democracy candidates confirms the rejection by HK society of mainland’s authoritarianism
- Be careful and selective when investing in Greater China, as storms are gathering over it
- Economic prosperity and resilient markets’ performance are not a given over next years
- We favor the Vontobel China Leaders fund
Fixed income. Fed is happy with its current policy stance, but stands ready to do more
The latest FOMC meeting saw the 3rd consecutive 25bps Fed Funds cut since July. The Fed will now merely assess the appropriate path for Fed Funds. This, together with the cautious Powell tone, is a clear signal that the Fed wants to take time. Minutes reinforce this message, as most members are viewing the economic outlook as positive. They pointed out the solid job market and consumer spending while trade tensions and geopolitical risks have eased somewhat. Nonetheless, economics risks remain tilted to the downside. They remain cautious about financial risks, highlighting imbalances in the corporate debt market. Generally, the FOMC appears to be more worried about external than domestic factors. Interestingly, some participants who were supportive of a rate cut, felt it was a close call between a cut and a hold. However, investors were left disappointed with preconditions of what a new rate cut would require. The minutes show that officials judged the current policy stance now wellcalibrated. The Fed job is done for now, unless something does not go as planned. This echoes Powell and Clarida recent comments.
It is a hawkish signal, which could spell the end of this midcycle adjustment. No more cut is to be expected this year
Markets appear to be slightly doubtful of the Fed thinking. Another 25bps rate cut is already discounted by mid-2020 with a 40% chance of another one by yearend. There has been hope that a phase one trade deal with China could lift some of the gloom and offer a better backdrop for the global economy, but this is taking longer. While a recession is not the most probable scenario, we will certainly experience a sub-potential GDP growth. The consensus is forecasting 1.8% for 2020 vs. 2.3% for 2019 and with inflation set to remain close to the Fed target around 2.0%.
There is still a strong chance of another rate cuts in Q1 2020
Trump mentioned he had discussed negative interest rates with Powell. The Fed once again ruled it out as an option. While other countries have done it, there are differences between the US financial system and the other ones. Foreign experiences do not provide a useful guide in assessing whether negative rates would be effective. If things were to turn really bad, the Fed is more likely to drive long-dated yields down towards zero through QE, which would allow government to fund broad infrastructure projects at low cost.
- The bar for another rate cut would require a material reassessment of the Fed outlook
- Short-term bonds stay expensive
Currencies. Lagarde aware of side-effects
The ECB President Lagarde spoke on “The future of the euro area economy”. Firstly, she confirmed that the accommodative stance of monetary policy will remain in place, but the ECB will continuously monitor the side effects of its policy. Secondly, monetary policy will undergo a strategic review due to begin soon. So, she had no new monetary policy signals to offer but left the impression of a dovish ECB.
She does not sound like setting the stage for more easing. The next easing package will not be discussed before March at the earliest and only if core inflation remains too low.
The Euro-area growth prospects continued to be very weak in November. The composite PMI declined from 50.6 in October to 50.3 in November. Those levels indicate positive but very slow growth in Q4 2019. However, some leading indicators are at least stabilizing if not improving. This can feed a net short speculative positioning unwinding. For the time being, they have not reacted to improvement of the economic surprise index.
Equities. Consolidation in the year-end rally
Some technical indicators suggested a consolidation of equities; that’s what happened last week. But the target remains the 3,200 on the S&P 500, as this level corresponds to the top of the corridor of the bull market, started more than 10 years ago. For the Euro Stoxx, it is 3,830, the SPI 13,000 and the MSCI World 2,400. Overall gain potential is between 4% and 6%. The strength of equities comes from the rise in US dollar liquidity (Fed) and the improvement in PMI Manufacturing indicators, while remaining in a contraction phase (PMI below 50) in Germany, US and China.
In the short-term, factors that could support equities are a trade agreement between the United States and China (also depending of the content of the deal), and good year-end sales with Black Friday (November 29), Cyber Monday (December 2) and Christmas. Record sales on the Alibaba platform ($30 billion) on Singles Day alone (11.11) showed the resilience of household consumption in a phase of global economic slowdown.
However, as we approach the top of the bull market corridor of the S&P 500, analysts point to the risk of a more pronounced correction due to some unfavourable indicators, such as a positive correlation between the S&P 500 and the VIX, or the weak correlation between the largest capitalizations of the S&P 500. Citigroup analysts have established that the 50 largest stocks of the S&P 500 offer a very low correlation between them, reflecting a favorable environment for stock pickings and a high level of complacency on macroeconomic risk. If the Atlanta Fed model is right, US GDP growth in the fourth quarter should be only 0.4%!
- The S&P 500 upside potential is limited to 3.5%:breaking the 3,200-3,220 resistance on the S&P 500 will be difficult
- We are aware of the situation and are participating to this rebound only from a tactical stand point. We remain vigilant and ready to protect portfolios
Equities. The good performance of cement companies
In 2019, the share prices of Lafargeholcim, Heidelberg, Martin Marietta and Vulcan increased by 28%, 28%, 52% and 42% respectively.
Cement companies operate in a favorable environment:
- Energy costs are relatively low.
- Ability to create value through asset sales and / or acquisitions.
- Positive financial conditions.
- Increase in the coming years of conventional and environmental infrastructure spending (Green New Deal) in developed countries to support the economy and respond to the demands of the green political wave (Europe).
- Urbanization in emerging countries.
- Cement prices rise due to demand and the disappearance of overcapacity in China. “China has become one of the most profitable cement markets in the world,” notes UBS. In 2018, prices rose by 22%”. Lafargeholcim holds a 42% stake in the Chinese Huaxin.
- Stabilization of emerging currencies. In 2018, Heidelberg had suffered with its Turkish subsidiary company.
In ecology, cement will have its place: efficient houses, drinking water networks, resilient infrastructures. Since 1990, the cement industry has reduced its CO2 emissions by 18% per ton of cement produced. But it remains one of the biggest polluters in terms of CO2 emissions, due to manufacturing clinker, a constituent of cement.
According to the International Energy Agency, cement production will increase between 12% and 23% by 2050.
Expansion multiples also explain the good equity performances.
- We prefer Lafargeholcim which has a diversified and defensive profile with a valuation of CHF 56 per share
- Despite generous valuations, Sika remains a value of choice in the specialty chemicals for construction and building (cement additives, concrete admixtures, admixtures for dry mortar and gypsum, waterproofing systems, repair, bonding). We value the action at CHF 190
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