Daily Note – China Rising?


US: Cold weather and higher rates hit Housing Starts & China condemns US spending bill

China: GDP comes in as expected. Higher money market rates send stocks lower

Eurozone: Deutsche Bank posts Q4 loss before tax of 1.2 billion euros

Week ahead: UK & Eurozone data to the fore along with US corporate earnings

What are hedge funds’ top five currency bets for 2014?

Portfolio: Euro closes below the 100 day MA for the first time since September


Good morning.

Given our weaknesses for commemorations and the like, have you noticed the upsurge in books, documentaries, articles or radio programmes relating to the First World War these last few months? A month ago a friend bought me the book The Sleepwalkers – not Stephen King’s horror romp – but a much more horrific story about how Europe walked zombie-like into the First World War.  It is by a British academic Christopher Clark and it makes for shocking reading. Those interested might saviour the first two chapters about the nature of Serbian nationalism and how the delusions of a small set of people could drag young lads from Leitrim, Limerick and Lisburn into the killing fields of Flanders, where they were slaughtered.

One of the interesting things about the First World War is just how few clever people predicted it or understood the gravity of the situation. Financial markets were still open on July 30th 1914 even as the German army was mobilising. They closed the next day and didn’t open again for five years.

When we look at the global landscape today, the issue is not global conflict and I agree with Simon Kuper’s analysis in the FT over the weekend, contending that peace is now much more likely than war. (By the way, we don’t just believe everything that comes out of Simon’s mouth because he reviewed www.kilkenomics.com so sweetly. Honestly! See the FT’s view of Kilkenomics here.)

At the time of  the First World War, it  is interesting to see the very interconnectedness of the world back then. People talk about globalisation now as if it is new. It is not. Indeed, Chinese manufacturing is having the same effect on Western industrial production as American and Argentinian farming had on European agriculture in the golden era of globalisation from 1880 to 1914.

I believe that we should also regard the massive changes in the global economy today with the same historical perspectives, as the East rises and the West deals with its decline. It is not happening overnight, but it is happening.  This is why every data announcement from China should be seen in the same light as  an announcement from the US in the 1900s. Initially, Europeans couldn’t see the significance until the US seemed to come from nowhere to rule the roost by 1920.

Today, there is lots of talk about the evidence that the Chinese growth rate is the lowest in 14 years. This is true, but stand back and consider the great arc of history. Consider the fact that the US had many financial scares on the way to pre-eminence and understand that the Fed only exists as a result of one of those great market wobbles in 1913.

As a result, if you are a value investor, the cheapness of Chinese stocks should be something that you examine closely. We will hold your hand in that pursuit over the course of the next few months, as we too are tempted by the Middle Kingdom and the more sceptical the big banks are, the more our curiosity is aroused.

United States: Cold weather and higher rates hit Housing Starts

Table 1 Jan 20

US data released on Friday was in line with trends for early 2014. Despite a pause in housing starts due to poor weather and rising mortgage rates after the initiation of Fed tapering last month, the broader recovery remains on track.

Consumer confidence surprised on the downside, while manufacturing production was strong. A revision down to Industrial Production for November, suggests that Q4 GDP will come in at around 3%. The USD continued strengthening across the board, especially against EM currencies.

The S&P 500 fluctuated on results ranging from above-expectations numbers for Morgan Stanley to disappointing profit margins for GE. I’d prefer it to be the other way around to be honest. GE is a proper company, making proper things. Morgan Stanley is well, Morgan Stanley. A few years back, I worked for Jack Welch for a brief project and more than any other project, this gave me an insight into what it means to work hard! Have a look at the chat we had here.

This week will be another big one for US earnings. By the end of this week we should be able to get a handle  on the corporate earnings outlook.

While none of Friday’s data would give me any real long-term concerns regarding the health of the US economy, the numbers have certainly slowed. Given how the economy surprised so much to the upside late last year, I am not too worried. It’s important to see the arc, rather than the month on month moments.

The data probably needs to reaccelerate before we will get another meaningful sell off in US fixed income. We remain short the US 5 Year note (50%) and look to add to this position heading into the FOMC meeting next week.

United States: China condemns US spending bill

China’s Commerce Ministry has condemned the  $ 1.1 trillion spending bill passed by the U.S. Congress last week over clauses that limit technological purchases from China. Beijing claims that any limits clash with the principles of fair trade. An unnamed source in the ministry has been quoted as saying:

We have noted that U.S business groups have already made noises opposing the bill. The U.S. side should correct its mistaken ways and create good conditions for the healthy development of Sino-U.S. trade and business cooperation.

This source in the ministry then went on to say that the bill sent a wrong message, did not aid exchanges and co-operation in the high-tech field and would have a negative effect on Chinese companies and would harm the interests of U.S. firms.

China and the United States have clashed repeatedly over trade issues, which is hardly surprising. The Kaiser’s Germany and the British Empire clashed similarly over technological prowess in the early 1900s. This is normal when one side is on the up and the other is on the down. Indeed, China’s view of the US these days is jaundiced by its strained relations with Japan. Many of China’s top brass see Japan as an American client state in the region and argue that Abe wouldn’t be rattling sabres in the East China Sea if the Americans weren’t pulling the strings.

China: GDP comes in as expected but higher money market rates send stocks lower

Table 2 Jan 20

The China GDP data came in marginally better than expected. It never ceases to amaze me how the China data is always so close to “forecast”. Given its size and complexity and (relatively) few economists, you would think there would be some volatility around such a number.(Maybe the fewer economists the more accurate the overall forecasts!)

A slowdown is hardly surprising when you have had on-going monetary tightening from the Bank of China.

The market digested the numbers and then gave way to its usual fears about the short-term money market rates. The seven-day repo spiked again this morning to 7.5% (from 5.17% on Friday). This sent stocks down . Again, tax payments and the approaching New Year holiday are cited as reasons for the tightness of liquidity, but we continue to believe (see Friday’s note for more) that the quality of banking assets is the major driver.

As we saw in 2008 in Europe, the US  and in Ireland in particular, without clarity on what “assets” the banks actually have on their balance sheets, no functioning interbank market can operate because the banks don’t trust each other.

The Shanghai Composite slumped 0.7 percent to 1,991.25 at the close, sliding below 2,000 for the first time since July 31st 2013.

Despite the worries, I believe there will come a time soon, when the long-term story in China is a must buy. This is particularly the case because its huge current account surplus means the market shouldn’t be too worried about the “taper” in the US.

Eurozone: Deutsche Bank posts Q4 loss before tax of 1.2 billion euros

The German giant posts a surprise pre-tax loss of 1.153 billion euros for the fourth quarter of 2013, reflecting:

  • A €623 million charge for adjustments in credit, debt and funding valuations. (This is the on-going legacy of bad investments in the boom.)
  • €509 million in new costs for its overhaul program
  • €528 million euros for litigation (The lawyers always win!)

Revenue fell by 16% to €6.580 billion. This was due in part to weakness in its corporate banking and securities division. The bank was originally scheduled to report its results on January 29th  which certainly explains the weakness in the Dax on Friday as rumours swirled around that Deutsche was about to announce something nasty.

Indeed a puff piece on the front of Saturday’s FT  about Deutsche not working the interns to the bone should have warned the cynic that all wasn’t kosher in Frankfurt.

Week ahead: UK & Euro zone data to the fore along with US corporate earnings

Table 3 Jan 20

With the US closed today and not much economic data out over there, our main focus this week will be on US corporate earnings along with numbers of France & Germany. Employment data in the UK is also out on Wednesday and a weak number may finally give us the opportunity to get long GBP.

What are hedge funds’ top five currency bets for 2014?

From Reuters over the weekend, we got a guide to the top 5 currency bets this coming year. Nothing of much surprise in the list though I was pleasantly surprised not to see our ‘short Euro long USD’ call on the list!

It is important when considering an investment to be aware of what everyone else is doing. It is not always right to go against the crowd but a compelling investment thesis combined with poor positioning of the rest, tends to lead to the best investment returns. The Yen and GBP are two ideas we do like but just not at these levels. Indeed as someone who  married into the Ulster tribe, I tend to get my best tips on the strength or weakness of sterling from family members in Belfast whose eye for a bargain in the Free State is unaffected by politics, flags or the shambles at Stormont.

So here are the Reuters top 5.

1. Long USD/JPY

“The whole driver (this year) is going to be yen. If you’re only a USD guy and you’re … only in euro/dollar, you’re going to get a whole lot of nothing,” said Aaron Smith, managing director at currency hedge fund firm Pecora Capital, who said the yen was his heaviest weighted currency pair.

2. Short AUD/NZD or AUD/USD

Short the Aussie in the belief it will suffer as China’s demand for commodities cools. One star manager to benefit is CQS founder Michael Hintze, who has cited the “very, very clear” wish of central bank governor Glenn Stevens for the Aussie to weaken.

3. Long GBP/EUR

The UK is nevertheless seen on the tightening path, in contrast to the euro zone, where disinflation remains a concern. According to the Newedge Trend Indicator – a model portfolio that replicates the trades that computer-driven trend-following funds might make – these funds have been long the pound for 158 days.

4. Long USD/CAD

5. Long Mexican peso vs. emerging market currencies

“The Mexico peso is (our) favourite overall because of the ongoing reform process, especially on energy, and the implications this has for stronger foreign direct investment and other inflows into Mexico, as well as the impact on potential growth,” said Ian Gunner, manager at Altana Hard Currency Fund.

Portfolio: Euro closes below the 100 day MA for the first time since September

The euro broke the 100-day moving average for the first time since mid-November. It closed below the mark for the first time since September. Bank of America advised selling EUR/USD on a break of $1.3550 and plenty of traders did just that. Rumours of a German sovereign downgrade (unsubstantiated) and profit warning at Deutsche Bank helped. EUR/USD selling began the moment US traders arrived, knocking the pair through $1.3580 and from there, it was a series of cascading stops that continued after Europe went home for the weekend. It hit a low of $1.3517. Nothing moves in a straight line so we expect some consolidation from here.

Table 4 Jan 20

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