15th June 2023
Dear Investor,
We’ll start with a quick tour of the globe to see how our themes are doing.
Japanese equities have continued to do very well as the year progresses. We have been positive all year and our initial worries regarding a move away from very low interest rates and yield curve control having a short-term detrimental impact on the stock market there have dissipated as the new Bank of Japan Governor shows no signs of changing the status quo.
You can see our original January commentary on why we like Japan in the archives (#2) and it mainly all holds true. BUT there are signs of froth in the market in the short term and “everyone” now seems to be talking about Japan. There are vertical moves in semiconductor equipment stocks, like Advantest below, as the AI/NVIDIA mania goes global:
And we always worry when we see headlines like the below from Bloomberg this week:
BlackRock’s Japan ETF Lures $1 Billion as Nikkei Rally Powers On
- EWJ ETF has pulled nearly $1 billion in net inflows in June
- Above-trend growth and inflation sends Nikkei to 33-year high
Having said that, the below article caught our eye as it captures some of what we discussed in our initial commentary regarding a generation of investors conditioned to buy bonds and sell equities as deflation was their only experience. As you know, we believe inflation is more structural than many people think, and the Japanese equity market was one way of playing this. The longer-term story is still intact for us.
FT 3rd June
Japan inflation will drive savers back to the stock market, says exchange chief
Inflation is pushing Japan into a new era that could lift equities by spurring more households to move savings out of low-yielding bank deposits, the head of the country’s stock exchange operator has said.
Hiromi Yamaji….said he expected many Japanese to stop sitting on so much cash — the country’s households have amassed ¥1 quadrillion ($7tn) in bank savings — and look to stock markets for better returns in response to rising living costs.
Many Japanese have been deeply sceptical of holding equities since the bursting of the country’s economic bubble more than three decades ago, while years of stagnant prices meant households could overlook the fact that bank deposits were earning almost no returns.
“They did not care about it, even if it did not generate any returns,” Yamaji said. “But once inflation starts . . . they have to be prepared to hedge against inflation and it’s very obvious that deposits do not give you a good enough return to hedge.”
At the same time Japan’s stock markets have returned to levels not seen in 33 years. The broad Topix index has risen 14.5 per cent this year, which investors say is partly due to efforts by JPX under Yamaji to push companies harder on improving their capital efficiency and raising their corporate value.
However, the increase has been driven mainly by foreign funds, while domestic Japanese investors — particularly retail — have been far more cautious.
The Japanese economy is doing well though in contrast to a lot of the world, despite all the negativity around China and the well anticipated recession in the US, and the fact is, that this kind of performance will continue to attract global funds who had previously pretty much consigned Japan to history. The next big move up in Japan which will last much longer is when domestic institutions turn to net buyers of stocks rather than sellers.
Japan’s service activity expands at record pace in May
TOKYO, June 5 (Reuters) – Japan’s service sector activity expanded at a record pace in May, a private-sector survey showed on Monday, thanks to a recovery in overseas demand and a surge of foreign tourists as pandemic restrictions were eased further.
The number of foreign visitors to Japan climbed to a post-pandemic high of nearly 2 million in April.
The subindex measuring outstanding business rose at the fastest pace on record as disruptions caused by the pandemic continued to wane.
Service sector companies hired more workers for the fourth month in a row, with the rate of job creation the second fastest since September 2007.
We will look to add more Japan on any weakness and once the Chinese really start travelling again, the economy will pick up more steam. Most of the Chinese consumption spending after the opening has been kept in Greater China as after 3 years of lockdowns passports need to be renewed and planes need to be bought back online. The chart below shows that international capacity is only at 42% of pre covid capacity.
Next, let us turn to China which continues to underwhelm investors with hardly any interest shown in the market, maybe because it doesn’t have many ways to play AI!
Caixin 10th June
China’s Consumers Are Flush With Cash, So Why Does the Recovery Have the Wobbles?
Ominous signs that China’s economic recovery may be slowing from an initial surge fueled by pent-up demand among consumers has analysts and bankers alike pondering whether continued loose monetary policy can underpin the revival, as a rise in risk aversion leads people to save more and shy away from borrowing.
The article basically states what we discussed in a commentary earlier in the year. We repeat it below:
“It may have been that the market ran ahead of itself, and investors have been disappointed by the “reopening recovery in China.” There are a few things to note here, however. China didn’t follow the Western playbook of giving much financial support to businesses or stimulus cheques direct to consumers, or paying furloughed workers to keep businesses afloat, so after three years of lockdowns, the proverbial Mr. and Mrs. Wang are not in the best of spirits, and it will take time to get those spirits back up especially given the speed of the change from total lockdowns to zero restrictions”
And what we discussed after the NPC meeting in March on China’s continued push to reform State Owned Enterprises:
“In our view, this is not just lip service to attract back foreign investors but an understanding from the Chinese leadership that the old model of debt fuelled growth is not sustainable.
In fact, they already know this, and this is why during Covid lockdowns they didn’t follow the rest of the world’s playbook in giving mass handouts to consumers and breaks to businesses. This is a double-edged sword as it meant that their sovereign debt levels didn’t balloon like a lot of the world, especially the US, UK and the EU, but on the other hand, consumer sentiment is much more depressed in China which also makes the recovery slower than in those regions. Slower, but more sustainable in our opinion. “
What is different is that the Chinese/Hong Kong markets have now come off quite a bit, and the Government “jawboning” doesn’t seem to be working. So, when an influential China business magazine has this as their front cover and compares China to Japan where a similar dynamic played out after the Japanese property and stock market bubble played out, it may be a trial balloon to gauge the markets views for full-on stimulus. Something to keep an eye on…
The jury is still out on China’s economy. Our view continues to be that it will be a slower road than many people expect and that geopolitical headwinds mean the market will remain under pressure. But these markets, especially Hong Kong are extremely cheap with low multiples, high dividend yields and an actually improving economic environment. For anecdotal evidence of this, just visit the main shopping areas of Hong Kong, which are once again filled with mainland shoppers and which seem to be booming with the restaurants and bars full of people.
In the last few days, we have had some movement out of the Chinese authorities. They have cut deposit rates for banks (to stimulate consumption), they have cut short-term interest rates and they have leaked the following story on Bloomberg
China Weighs Broad Stimulus With Property Support, Rate Cuts
- State Council may discuss the proposal this Friday: people
- Goldman analysts expect a multi-year China property slowdown
Now, none of this has had any impact on the stock market so far although the currency has weakened a little. The Chinese consumer is actually doing okay (though maybe not as well as “expectations”) while Chinese manufacturing is weak as most of the world is in a recession. The latter is a much bigger part of the economy and so there is much handwringing over the state of the Chinese economy. Don’t get us wrong, it has plenty of problems, as do many other economies around the world, but with a closed capital account and state control over many aspects of the economy, we don’t expect the economy to implode any time soon.
Turning to the West, we have recently seen 2 central banks raise interest rates after “pausing.”
Australia paused in April but the started up again in May:
Australia central bank warns of more hikes ahead after raising rates to 11-year high
Reuters June 6th
Wrapping up its June policy meeting, the Reserve Bank of Australia (RBA) hiked the cash rate to 4.1%, saying inflation is still too high and removed a reference that stated “medium-term inflation expectations remain well anchored,” which had been in policy statements since July last year.
Canada has been on hold since January:
Aljazeera 7th June
Bank of Canada raises interest rate to highest in 22 years
The central bank had been on hold since January, but found excess demand in the economy was keeping inflation high.
The Bank of Canada on Wednesday hiked its overnight rate to a 22-year high of 4.75 percent, and markets and analysts immediately forecast yet another increase next month to ratchet down an overheating economy and stubbornly high inflation.
The central bank had been on hold since January to assess the impact of previous hikes after raising borrowing costs eight times since March 2022 to a 15-year high of 4.5 percent – the fastest tightening cycle in the bank’s history.
Australia and Canada are an important test case as both have an unusually high % of variable rate mortgages (approximately 60%). So, interest rate increases eat much more quickly into consumer’s spending and, with various reports showing housing has already fallen between 8-15% in both countries depending on the source and location, it could trigger a spending downturn as the wealth effect goes into reverse. It must be remembered that house prices soared during the easy money years, so there could be a lot further downside if rates stay elevated.
In America the situation is different as a majority of mortgages are fixed for 30 years. This explains why there have been fewer transactions in the US as people don’t want to sell and buy a new house as they cannot take their 3% mortgage with them and would instead need to pay 6-7%.
We bring this up because we are once again coming to a US Federal Reserve meeting (where the consensus is to “skip” a hike). Prior to these two central banks hiking rates, the rates market was signaling that US interest rates would be cut in the latter half of this year. That is now not the consensus.
As we have stated, we believe inflation is structural and so while we will get a cyclical reduction in inflation as the base effects of lower commodity prices come through, we are not going back to the same scenario as 2008 to 2020 with very low interest rates and quiescent CPI numbers.
This means rates will stay “higher for longer.” Now it should be noted that when rates stay high there is still an ongoing tightening of monetary policy as existing debt comes due to be refinanced, or a new loan will need to be taken out at a higher rate.
Turning to Commodities, there are signs of economic weakness in many places and manufacturing globally is in a recession as evidenced by PPIs and certain commodity markets including industrial metals, oil and gas etc. (part of this is also due to the increased cost of financing holding, storing, and investing in commodities).
Oil has continued to be weak even as we had another announcement of a cut in production by OPEC+. This was done unilaterally by Saudi Arabia after the meeting which means most other participants of the cartel didn’t want to do this. Now we can only speculate as to the reasons why. Are they again seeing signs of economic weakness? Are the other countries short of cash and want to continue to pump? Does Saudi Arabia want to continue to put pressure on shale producers? Do the Saudi fields need maintenance?
The end result was that this action had an even shorter positive impact on the oil price than the last cut in April.
Saudi pledges big oil cuts in July as OPEC+ extends deal into 2024
VIENNA, June 4 (Reuters) – Saudi Arabia will make a deep cut to its output in July on top of a broader OPEC+ deal to limit supply into 2024 as the group seeks to boost flagging oil prices.
Saudi’s energy ministry said the country’s output would drop to 9 million barrels per day (bpd) in July from around 10 million bpd in May, the biggest reduction in years.
To add fuel to the fire, on the 12th of June, Jeff Currie, an influential analyst and the head of commodities research at Goldman Sachs lowered his forecasts for oil.
Rigzone.com
Goldman Sachs Group Inc., one of the most bullish banks on the outlook for oil, has once again lowered its price forecasts amid increasing global supplies and waning demand.
The bank has dropped its Brent forecast for December to $86 a barrel, down from its previous estimate of $95 a barrel, according to a note to clients on Sunday. This is Goldman’s third downward revision in the last six months after having previously stood by its bullish $100-a-barrel prediction. Brent’s August contract settled at $74.79 a barrel on Friday.
“We have never been this wrong for this long without seeing evidence to change our views,” Jeff Currie, Goldman’s head of commodities research, said in a Bloomberg Television interview last week.
This is effectively, the price target following the price (down or up) as often happens on Wall Street, as he is admitting that actually his view hasn’t changed or at least he sees no evidence that his view has changed. Now we have been waiting for a signal that it is time to buy more energy and we may well be getting closer. When a renowned and famous analyst changes their bullish view AFTER the price has already dropped more than 50%, it is usually a signal that the towel has been thrown in which marks a bottom. Oil is now trading where it was just prior to Covid hitting the world, dropping from $130 to $67.
We are getting closer, but we are not there just yet. For reasons on why were positive on oil please see Commentary # 4. Recession worries as well as Russia pumping as much as it can to fund its war machine are still headwinds but as we have discussed, there is limited supply, no investment and growing demand which is a set up for much higher prices in the future.
The below chart is courtesy of Goehring and Rozencwajg (a commodity focused research and fund management house).
It dispels quite neatly the idea that commodities will go down in a recession. Summarising their report, they found that a portfolio of commodity stocks bought at the market peak in 1929 more than doubled by 1938 while the overall market was still 50% lower. In the 1970’s a similar portfolio advanced by 500% versus 170% for the S&P 500. During the dot-com boom, the S&P 500 was flat between 1999 and 2010 while a resource portfolio rose 300%. You can see where we are now on the chart and what this likely means for the future path of investing in the right commodity stocks….
Before we go, we will just share some news from the crypto world. On June 5th and 6th the Securities and Exchange Commission filed suit against Binance and Coinbase. These are two of the biggest crypto exchanges remaining after FTX was uncovered as a fraud earlier this year. Now without going into the details of the charges (which relate to the claim that crypto is a security and hence should be subject to sercurities regulation), this is another salvo at the industry. As we said when we discussed the bank closures/bankruptcies with Silvergate and Signature Bank (in commentary #9):
“We believe the message is loud and clear and would not be surprised to see more regulation or even legislation banning crypto. This view may be incomprehensible for many crypto enthusiasts (and I am no expert), but if the Fed doesn’t allow the on and off ramps – ie people using the banking system to get fiat currency in and out of crypto then it makes crypto much less useful. We all know central banks are experimenting with digital currencies of their own and so from their perspective, it makes sense to only have their own so they can track exactly where all the money goes.”
The attack continues (and really, this is like slamming the stable door after the horse has bolted), but politically now that people have lost a bunch of money in crypto it is easier to do. The agency would have been a lot less popular trying to do something like this during the boom years up to 2021.
Until next time,
