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Editor's Note:

Irrational exuberance is yesterday’s news and that is being demonstrated as the saga over the indebtedness of Chinese property developer Evergrande continues. As TS Lombard points out in today’s briefing, it has huge implications for all Chinese developers and their bankers, but perhaps more significantly, says Quiddity Advisors, it may mark the point where the global “bezzle” is discovered and the search for previously overlooked off-balance sheet liabilities goes mainstream and arrives in a sector near you. Of course, China’s decades long real estate boom has underpinned demand for commodities, and Longview Economics highlights the recent dramatic rise in correlation in commodity prices and equities. Meanwhile, Liberum explains why analysts, and hence stock markets, are too optimistic over the discovery of a vaccine and a return to normalcy for corporate earnings. They point out that the so-called anti-vaxxer movement acts as impediment to take up of using a vaccine, when they are eventually rolled out, and that in itself, curtails the successful eradication of the virus. As the big data firm PreData points out in this note, online anti-vaccine engagement is building which they say is threatening adoption. Finally, in our ESG segment this week Citi introduces the concept of the “net zero” club, explaining how firms driving climate change initiatives across supply chains can increase margins and market share – and which sectors are most likely to benefit.  
  1. China real estate Evergrande High-yield credit TS Lombard

    1. Evergrande: A confidence trick

    Andrew Lawrence at TS Lombard has published a note explaining why the letter that Chinese property developer Evergrande purportedly sent to the Guandong local authorities begging for government support for a corporate reorganisation is so damaging. Confidence, he says, is the main currency for those whose creditworthiness relies on the kindness of capital markets, and the company’s share price, particularly since 2017 when retail investors were able to join the party, personifies something of a confidence trick. The peak for the stock came in early 2018 when the company issued convertible bonds. Lawrence says that a credit structuring, if required, would likely wipe out Evergrande’s equity and off-shore bond holders. In China, says Lawrence, debt defaults are a political decision and the mainland authorities will have to decide if Evergrande is really ‘too big to fail’ and how committed they really are to their ‘Three Red Lines’ developer deleveraging policy. What Beijing ultimately decides will have significant implications not only for Evergrande but for all Chinese developers and their mainland and Hong Kong bankers, he says.
  2. China real estate corporate liquidity Evergrande Quiddity Advisors

    2. Evergrande – discovering the “bezzle”

    Travis Lundy at Quiddity Advisors has issued a note in the wake of the turmoil surrounding Chinese property developer Evergrande, whose shares have been gyrating after reports of a huge funding problem at the company – which it has strenuously denied. He says there may well be a specific problem at Evergrande – and indeed recommends selling the shares – but the episode points to a bigger issue coming into play for investors at this current point in the economic cycle, namely  the discovery of the “bezzle”.  The term “bezzle” was first coined by John Galbraith in his 1929 book “The Great Crash” and relates to the amount of undiscovered embezzlement at any one time in a country’s businesses or banks. As Lundy explains in good times people are relaxed, trusting, and money is plentiful, and under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the “bezzle” increases rapidly. In depression all this is reversed. To be clear, says Lundy, this is not a story of criminal embezzlement as much as it is a story of wealth-building during the good times. It is possible, he says, with banks being told not to lend more and companies being told not to borrow more that investors are on the cusp of a moment more generally – a time when the “bezzle” is discovered. In other words, off-balance sheet liabilities are making their way on to the front pages and investors should expect the rate of discovery to increase. Quiddity published their research on the SmartKarma platform.
  3. COVID vaccines earnings forecasts Equities Liberum

    3. Vaxxers versus anti vaxxers and why analysts earning forecasts are too optimistic

    The silver bullet for the coronavirus pandemic is the arrival of a vaccine that is reliable and can be rolled out to large parts of the population, but realistically that is unlikely to happen until the end of 2021 at the earliest according to Joachim Klement at Liberum. Even then, he says, the growing number of anti-vaxxers threatens to thwart efforts to stem the spread of the virus and keep the pandemic going. Social distancing measures of some sort throughout 2021 and probably well into 2022 are therefore likely, according to Klement, which naturally has significant implications for financial markets.   He points to a study from Harrison Hong and his colleagues that looks at the average analyst expectations for a return to normalcy in corporate earnings, which showed the average time to arrival of a vaccine implied by their forecasts was May 2021. Except for the most pessimistic analysts, says Klement, everyone at the moment has far too optimistic expectations for when we get control over this pandemic, and this is a recipe for much more subdued equity market returns over the next 12 months. Click here to contact the provider for the full report.
  4. Asset correlations Commodities precious metals Longview Economics

    4. Commodities and extreme correlations

    Asset prices this year have been highly correlated across the risk spectrum, and commodities are no different, writes Brad Waddington at Longview Economics. He says in this risk on/risk off dominated year, most key commodity prices have tracked the broader market movements of equities, of each other and of other risk assets. Reflecting that, Waddington notes cross commodity correlations, measured across 14 individual commodities, have averaged 76% so far this year (compared to just 7% in 2019). Moreover, he says the correlation of the S&P500 and commodity indices have also been at high levels, with, for example, the GSCI low oil weighted index correlation with stocks reaching 96.4% earlier this month, the highest since the final part of the Euro crisis in 2012. Waddington says that high correlation has been particularly marked across industrial (and precious) metals, many of which are heavily influenced by liquidity and speculative activity, while oil appears to be less correlated.
  5. ESG global supply chains net zero targets Citibank

    5. The “net zero” club – when sustainability meets margins and supply chains

    The recent creation of the “net zero” club could be the catalyst for sustainability to be seen as a positive for corporate pricing and margins instead of a cost argues Jason Channell at Citi. He says with an increasing number of corporate, city, sovereign and supranational targets based on being “net zero” by a certain date, the drive to follow up these targets with tangible strategies and business plans is growing. Even more impressive, according to Channell, is the drive for Scope 3 “net zero” targets, which refer not only to direct emissions, but indirect emissions through the whole supply chain. Indeed, he says a “net zero” club of suppliers and counterparties with similar targets is starting to come together and members in the club could see increased market share and expanded margins.

    To that end, Channell has analysed which industries are demonstrating broad ambitions for “net zero” and which are not, and within each, which companies are showing leadership – and where a lack of leadership highlights an enormous opportunity for the largest players to step in. He finds that Food & Beverage and Household, Personal & Leisure goods industries are the ones that stand out for the widespread range of ambition alongside similar strong levels of leadership shown by the largest companies, while Autos, Oil & Gas, and Pharmaceuticals are behind the curve. Interestingly, Channell finds in Banks, Technology and Business Services there is significant ambition shown by the industry, but it is not being reflected widely among the largest companies, implying there is significant scope for companies in those sectors to step up and seize the initiative.