Disclaimer: The following content is an archive of Substantive Research Discovery Trending Themes, as delivered as weekly insights to our paid subscribers. Links to gated content have been removed.
Quant Insight: Credit > Inflation. Regime shift for US equities? (Sept 12)
In some quarters, there are arguments that the inflation debate is losing significance. The bigger macro theme is the unfolding tightening of credit conditions. That is partly right. The slow motion credit crunch is indeed critical but it is premature to argue inflation’s importance has dwindled in any way. Qi’s macro factor sensitivity data can provide a real-time demonstration of what matters most. Inflation and credit are both critical, and it is Technology that is most reliant on a Goldilocks mix of reflation plus easy credit.
MRB: Don’t yield to the bond temptation (September 8)
Many investors are tempted to buy bonds on the prospect of the Fed et al nearing the end of the monetary tightening cycle and cutting interest rates down the road. Such a view is mistaken given a global economy that will remain sturdy, write MRB in this asset allocation piece. They expect stocks to modestly outperform bonds. Cash remains comparatively appealing, and MRB continue to recommend an overweight stance within a multi-asset portfolio. They favor investment-grade corporate and emerging market local-currency bonds within fixed-income portfolios, while in equities valuation multiples will come under pressure as bond yields rise, especially in the expensive U.S. market. Euro area, emerging market and Japanese stocks should benefit from firming domestic economic growth and warrant overweighting within a global equity portfolio, offset by an underweight in the U.S.
Goldman Sachs: Finding balance – remain Neutral and focused on carry/ relative value (September 13)
Asset Allocation: Goldman maintains a neutral stance in their asset allocation, with an overweight position in cash and no strong bias towards equities, credit, bonds, or commodities.
Risk Strategy: They are cautious about adding cyclical risk and are instead focused on identifying carry and relative value opportunities in the market.
Regional Imbalances: Goldman acknowledges ongoing regional imbalances in portfolios and bond markets that are still in the process of finding a new balance.
US Economic Outlook: They anticipate a soft landing for the US economy, with a reduced probability of a recession in the next 12 months (15% down from 20%). They also expect inflation to normalize by 2024.
Market Trends: The US yield curve has steepened, pushing longer-dated bond yields to post-pandemic and post-global financial crisis highs. Risk premia are low, but Goldman’s risk appetite indicator remains positive.
Asset Performance: Risky assets seem to struggle with rising interest rates, and markets are showing a trend where “good news is bad news” due to positive equity/bond correlations.
Changing Correlations: Goldman anticipates that as global growth slows and disinflation continues, equity/bond correlations will become less positive. They favor the middle section of yield curves (3-5 years).
Real Assets and Inflation Hedge: Real assets, particularly those related to energy, are seen as valuable diversifiers in portfolios due to upward pressure on oil prices. Shorter and longer-dated Treasury Inflation-Protected Securities (TIPS) are recommended to hedge inflation and stagnation risks.
Risk Hedging: Goldman looks for opportunities to hedge against growth and interest rate risks. They suggest selling short-term rate payers to buy long-term rate payers as a hedge. Additionally, they recommend downside hedges on European foreign exchange (FX) and consider equity volatility hedges, funded with credit and selective hybrid trades.
Macro Risk Advisors: The Petrodollar and why higher energy prices may not be inflationary (Sept 12)
MRA say the US dollar is now effectively the petrodollar. Given it is now the swing producer, rising energy prices lead to a stronger US dollar. The point of this short 5 min video explainer, is that while investors may fear that rising energy prices could be inflationary, MRA say this ignores the the second-order effects, as a result of the US running large goods deficits, and energy surpluses, among other things.
Clocktower Group: What if Americans Never Run Out of Excess Savings? (Sept 14)
The dominant narrative in the macro community has shifted away from “recession” to “soft-landing,” and now even to “re-acceleration.” However, bearish investors have expressed concerns over households’ excess savings, which – according to a recent San Francisco Fed paper – will likely be depleted as soon as Q3 this year. Without more excess savings to dip into, the argument goes that US consumers will be weakened, eventually leading to a slowdown of the US economy.
Clocktower have an out-of-consensus view. Most economists have likely got the debate wrong. When excess savings run out is a mathematical game depending primarily on how one defines “the pre-pandemic savings trend.” Ultimately, behavior change of consumers matters. If Clocktower’s view on the YOLO economy proves correct, not only are the US pandemic excess savings far from being depleted, but they are likely far larger than many investors believe. In fact, they may never run out!
MI2 Partners: Global Savings: Part I – The Savings Shortfall (Sept 7)
Julian Brigden has just published part 1 of a 2 part series looking at the global savings shortfall and why this may create significant problems for funding markets in the future. The piece outlines the changing dynamics of global sovereign debt markets. While all the big global economies have huge investment requirements for the foreseeable future, Brigden writes that it’s very hard to identify which countries will be natural ex–ante suppliers of the savings to finance all those projects. The market implications are going to be profound, which is what he will examine in Part II.
Renaissance Macro Research: The Timing of BoJ Exit from Negative Rates; timelines may slide (Sept 13)
What is the appropriate timing for YCC exit? Obviously the market wants to know, and Ueda has indicated that exit will occur between now and year-end. RenMac’s Howard Mason delves into the nuances of timing in this piece. Waiting too long risks inflation due to a weakening yen, while acting too soon could hinder wage inflation for a 2% target, says Mason. Expectations of no significant US rate cuts have already depreciated the yen, and the tear is still on a tear. Mason reckons Ueda’s suggested year-end policy change, but it may not be realistic. Japanese investors are reducing US Treasury holdings due to hedging costs, but wholesale liquidation is unlikely. The BoJ is likely to maintain yield control and bond purchases post-negative rates due to sensitivity.
S&P Global: The credit cycle has well and truly turned; Defaults highest since 2009 (Sept 12)
The global corporate default tally jumped to 107 as of Aug. 31, 2023, with 16 defaults in August, the highest August monthly tally since 2009, according to S&P in this report. They expect U.S. and European 12-month trailing speculative-grade default rates to continue to rise from current levels, to 4.5% and 3.75% respectively, by June 2024. Click here for that report. Also see ”Global Debt Growth Diverging By Credit Quality,” where S&P explain how global debt is diverging in credit quality, in that IG is growing and HYL is contracting.
J Capital Research: How advanced is China’s IC industry? (September 12)
You may have seen Gavekal’s piece today ”China Chips Watch—Beijing’s Story: Huawei Broke The Choke” In this piece from earlier this week J Cap look at China’s 7 nanometer chip and what it means, or doesn’t mean. SMIC is now producing a state-of-the-art 7 nm chip: This chip, reportedly used in a Huawei smartphone and as Geely SUV, challenges the U.S., which wants to keep high-end IC technology out of China. J Cap say that China has top-notch tech talent but is stymied at the company level. Despite nationalist rhetoric, the current government’s vigorous attempt to curb the private sector makes it less rather than more likely that China will compete at the 7 nm level, whether or not sanctions work, the note says. In the end, 7 nm chip may be more an advertisement for China’s tech development than a practical advance. But don’t dismiss it too quickly, say J Cap. Serious technologists have tested high-end chips being designed and fabricated in China and found them to be of high quality. Manufacturing at scale may be a problem, but small batches of tiny chips and densely layered 3D NAND are clearly within reach. Watch this space.
PRC Macro: Restocking Key to Debt Reflation: Energy Transition, Affordable Housing and Steel Exports
Last week we sent you this note from PRC Macro that looked to explain what was behind the resilience of China steel prices amid the slump in China real estate markets. This seemed counterintuitive and PRC provided evidence of how China was exporting steel to other markets. We wanted to provide some further depth to this issue this week from PRC, and how this fits into a broader policy by policymakers, in what PRC Macro describe as ”Energy is the New Property” as a growth driver. See the back end of this July report and in more detail also see this presentation from August.
But to summarize, PRC Macro’s view is that Chinese companies are going out into the global south, and they are convinced this has been under the auspices of the BRI /new GDI, which itself is being revamped from large mega infrastructure projects to leaner, smaller more profitable, commercially run projects like the energy transition etc., which will help Chinese producers export excess manufacturing capacity despite the domestic slowdown.
The perfect example is steel this year, and PRC think it is wrong to treat steel and iron ore demand strictly as a function of property new starts in China. The combination of China’s manufacturing upgrading and outbound investment in infrastructure, driven by smelters’ attempts to de-risk from weaker domestic demand and rising geopolitical tensions, will dictate future steel and iron ore demand. PRC called it “China new demand”, and they expect export demand will account for at least 8% of China’s total steel output, largely offset slacks from steel demand by domestic property slowdown.
Trivium China: Delivering a ”Slow Bull” equity market (September 13)
The team at Trivium provide a solid walkthrough on the playbook China policymakers will employ to boost the China equity market, or what has been termed a ”slow bull’ market. Will it work? As Trivium write, ”Given policymakers’ striking lack of available tools to otherwise boost business and household confidence – and thereby jolt consumer spending back to life – we expect they’ll give it a serious go over the coming weeks.”
Sino Auto Insights and Eurasia Group: China Auto’s European invasion (September 11)
Previously we’ve highlighted research on the expansion of China Automakers into global markets. This week we highlight this topic in regards to Europe. The always excellent Tu Le from Sino Auto Insights recently attended the IAA Mobility trade fair in Munich and he details his observations, where he observes ”China Auto Inc feels pretty welcome in Germany. Judging by the number of companies and CEOs that showed up to represent, I’d say that they see a tremendous opportunity for growth here.” That said, not all of the automakers will get traction, he writes. Furthermore, European policymakers will seek to protect their own auto industry. In this note, published yesterday, Eurasia Group provide some analysis on EU executive’s announcement yesterday to launch an anti-subsidy investigation into Chinese electric vehicle (EV) exports to the bloc.
CLSA: AI Superpowers; New frontier in China – US competition (Sept)
ChatGPT has sparked a global AI race with lucrative potential, and CLSA have produced this 172 page report that delves into China’s potential. While the USA is a strong leader, CLSA say China is putting up a fight and they believe it will become the world’s second-largest AI market with over 6% share of global US$1tn AI spending by 2026. They expect AI cloud to be an early beneficiary due to model-as-a-service (MaaS) and large language model (LLM) offerings, while services industries will be quick adopters. CLSA see Baidu, Alibaba and Tencent leading AI innovation in China and, as the cheapest global AI plays. Click here for the full report.
BCA: Will I Work For AI, Or Will AI Work For Me? (Sept 13)
We include this piece from BCA’s Dhaval Joshi on AI for general interest. Back in 2018, he delivered a speech at the London School of Economics titled: ‘Will I work for AI, or will AI work for me?’ Many of its themes were eerily prescient of this year’s explosion in interest and concerns about generative AI. This Special Report is a timely reprise of that speech, updated to incorporate the latest understandings and misunderstandings of generative AI, and the economic and societal implications for the coming decade.
Joshi writes that in neurological terms, generative AI has a ‘super-neocortex’ which means that it can thrash humans in abstract thinking, or IQ. But crucially, generative AI does not have a ‘limbic system’ which means that humans can thrash AI in emotional intelligence, or EQ.