China; A String Start to 2018, but How Sustainable is it?

The US+BS China Economics team write that China has had a strong start to 2018. China’s Jan-Feb activity surprised to the upside, led by 24%y/y growth in exports, a rebound in real estate and infrastructure investment, and solid retail sales. The ongoing environment-related production cuts in northern China and tightening of local government financing do not seem to have had as big of an impact on industrial production as expected (IP up 7.2%y/y), the UBS report says. In the real estate sector, property sales and new starts softened, but despite Jan-Feb’s weaker sales and starts, property investment surprisingly rebounded by almost 10%y/y. Together, they suggest faster actual construction in the sector, as inventory levels are low, say UBS. However, the report goes onto say, there key headwinds for 2018 that remain intact. Amid recent strong activity numbers, property sales and credit growth continued to soften alongside the ongoing deleveraging campaign, pointing to moderating activities ahead. On balance, given usual CNY seasonal distortions and the overall mixed set of data, markets would need full Q1 data set to better assess the true underlying strength of the economy. To be clear, UBS are not expecting China’s growth data to soften more visibly until well into Q2 and therefore they retain their forecast for GDP to slow modestly to 6.6% in 2018E. UBS clients can view the full note on UBS Neo.

Tillerson’s Departure Signals End of Iran Nuclear Deal & Higher Oil Prices

Hedgeye’s Joe McMonigle is an astute follower of Middle East politics and energy markets policy. In a note yesterday  following Trump’s decision to replace Rex Tillerson he says that this surely signals the end of the Iran nuclear deal.  While a reluctant Trump issued another waiver of Iran oil sanctions in January, he warned that it was the last waiver unless the agreement is changed to address his concerns. This looks to set up a showdown at the next waiver deadline on May 12.  McMonigle says that Tillerson was pursuing a separate side agreement with the EU to address Iran’s ballistic missile program but there was little sign of progress and unlikely that Iran would agree.  French President Emmanuel Macron will make a state visit to Washington in late April just in time to lobby Trump to renew the oil sanctions waiver and preserve the nuclear deal. In Hedgeye’s view, it is unlikely that Congress or the Europeans will take any meaningful action to modify the agreement. As a result, there is significant risk of snap-back US oil sanctions on Iran on May 12, and the nuclear deal remains on life support. Re-imposing US oil sanctions on Iran would put as much as one million barrels a day of Iranian crude exports at risk of being removed from global markets.  Such a move would inject significant geopolitical instability in oil markets and likely send oil prices higher, the report says. If you’d like to read the full report, and other analysis on this issue from McMonigle, click below to request trial access from Hedgeye directly.

Trade Wars: Impacts of Tariffs

In March 2017, Ned Davis Research assessed which countries would be most impacted by broad based US protectionism. They looked at those countries with the most export exposure to the US by product and then factored in the import price and import substitutabliity elasticity by product. They concluded that along with Mexico, Canada and Ireland, large portions of emerging Asia (Vietnam, HK, Malaysia, Taiwan, Thailand, South Korea, China) would be hit hardest. A year later, in light of Trump’s proposed steel and aluminium tariffs, they assess the potential economic impact on the US economy of increased protectionism. The tariffs will result in higher prices and could lead to slower GDP and payrolls growth in the very likely event trading partners retaliate. While primary metals will benefit, the rest of manufacturing will face higher costs and margin pressure. Potential employment gains in primary metals could be more than offset by losses in other industries. Finally, they note, protectionism does not increase GDP and could actually widen the trade deficit.  Chief Strategist Tim Hayes also last week published a note on the Trump trade and tariff wars, where he argues that Long-term trends intact despite recent moves, and that Trade war potential does not warrant changes. Therefore he is remaining overweight equities, underweight bonds, bullish on gold, bearish on the dollar and overweight EM. Click below to request trial access to view any of the above mentioned notes.

CAD Caught in the Line of Fire; Valuation Still Cheap

While the Yen has been the best performing G10 currency in 2018, CAD has been the worst, even as the USD has continued to weaken broadly. BOTM’s FX forecasts for 2018 were bullish on CAD, but the currency has been caught in the line of fire of NAFTA negotiations and US tariffs, which have put the currency under pressure. This has also coincided with slowing economic momentum as well. This isn’t a good combination, and BOTM’s bullish view would be seriously challenged by a breach of the 1.3200-level, which represents the next important technical resistance level beyond 1.3000. However, BOTM say that their long-term valuation models now estimate that the Canadian dollar has moved back to between 5%-10% undervalued against the US dollar. Indeed, their valuation model based on the higher price of oil alone suggests that USD/CAD should currently be trading closer to the 1.2000-level rather than the 1.3000-level. Click below to request access to this piece from BoTM UFJ directly.

Xi and Trump Policy Priorities Imply US Inflation to Diverge from Chinese Growth

Investors underestimate both Washington’s determination to confront China on trade and Beijing’s determination to curtail excessive growth. In combination, these would send shock waves through consensus portfolio positioning over the next few months, says Entext’s Sean Maher. The only obvious threat to Xi Jinping is a systemic financial crisis, which is why the consensus has underestimated Beijing’s determination to finally purge speculative excesses and duration mismatches in credit markets. Simultaneous deleveraging in China and protectionism/fiscal expansion in the US would change the long-standing correlation between US inflation and Chinese growth expectations. Click below to request trial access to view this report.

Overweighting EM Equities

MRB have been overweight EM Asia for the last two years and in a report out at the beginning of March they have increased this position to include global EM equities. Expanding trade volumes, increasing bank earnings and undemanding valuations are the main reasons. However, within Asia, they have moved to a downgrade bias on the neutral weight for China. They are bearish towards Chinese financial stocks and to Indonesia as a whole, due to a lack of economic growth momentum and stalled structural reforms. They also make the point that global trade growth is on a tear, and this includes commodity exporters. The weak dollar is offsetting the fall in Chinese demand for commodities to supply its old industrial strategy. There will be winners and losers in this scenario and so they break it down country by country in this report. Click below to request trial access to read this report.

US – China Trade Catalysts: Section 301

In last week’s edition of Asia Views, Goldman Sachs refer to a report by Alec Philips and Andrew Tilton in late January that highlights the Trump Administration’s Section 301 investigation into China’s industrial policies and technology transfer practices. They believe this investigation poses the biggest risk (for Asia) of a further escalation of trade conflict with a large economic impact – and which is not fully appreciated by many market participants. Should the US enact more substantial and broad-based barriers to Chinese trade or investment than seen to date, the current dispute could reach beyond trade by affecting investment and regulation. China could respond with retaliatory trade sanctions, actions against US companies operating in China, exchange rate depreciation, sales of US assets or shifts in posture on key geopolitical issues such as North Korea. Of these, Philips and Tilton think targeted trade sanctions against US exports of agricultural products or transportation equipment seem most likely. The USTR report is due in August but news reports suggest it will be released sooner. Goldman have been covering this topic extensively, and yesterday published another piece entitled: Global Economics Analyst: Trade Wars: The Big Picture. GS clients can read all of these notes on Goldman 360.

Who’s Afraid of Falling GDP

JCap’s Anne Stevenson-Yang expects China’s growth to decline sharply this year as the country stops building empty cities (which are sometimes torn down, so they can be rebuilt to fuel growth again). But she thinks this reduction in investment-led growth could have less impact on the world economy than many expect. The losers will be heavy industry and commodities suppliers seeing declining demand from China. If there is a sudden adjustment causing a financial crisis in China, all bets are off and the impact could be felt across international bond and equity markets, currencies and trade and investment flows. GDP growth has been the engine of remuneration of China’s vast bureaucracy so the ascension to permanent power of Xi Jinping is consistent with the expectation that the growth era is over and there will be less cash generated for political supporters. Click below to request trial access to read the full report.

Fiscal Policy, Inflation and Real Assets

QMA is the quantitative and multi asset division of Prudential’s PGIM business. In this note from early this month, they look at investing during periods of inflation. They make the important point that no two periods of inflation are alike. And the factors behind the increase in inflation can have very different impacts on different asset classes, include the catch-all term of real assets. They look at the historical returns of eight different real asset classes and show that different asset classes do well when different causes of inflation are in play. Therefore, they recommend finding a way to diversify tactically between different real asset classes through various, liquid holdings. Click below for the full report.



Portfolio Strategy for an Inflationary World

In Gavekal’s Strategy Monthly Report for February, they argue that there is a secular shift from a disinflationary to an inflationary world and as a result, investors need to change the defensive part of their portfolio. They use a four-quadrant model between inflation boom and bust, and disinflationary boom and bust, with asset recommendations for each quadrant. They believe that inflation is coming back due to four reasons: less excess capacity from Asia; higher oil prices; higher US budget deficits; and less QE. To hedge against this, Gavekal recommend investors increase exposure to short dated assets such as gold, commodities, value stocks, energy, financials and cash. Click below to request trial access to read this report.