Daily Note – The great game



Ukraine: A pawn in someone else’s chess game

United States: Economic growth expectations pick up

China: Property stocks hit as house price appreciation slows

The UK: Rain stops play

Eurozone: CPI key release for this week



Good morning.

Many years back I worked briefly in Kiev and in 1998 I  wrote what was probably  one of the first comprehensive reports on the Ukraine economy for BNP.  The Hrvynia was under pressure then, as too were its Eurobonds; all collapsed following the Russian default in August 1998.

During my time there, I was struck by the extent to which Ukraine was not regarded by the big powers as an economy/country in its own right. Rather it was a chess piece in a great game between the EU and the USA on one side and Russia on the other. Unfortunately, it seems to be the same situation today.

Ukraine appears more like a Balkan country of the early part of the 20th century, constantly being moved this way and that by the vagaries of the big powers as they jostle for geo-political supremacy.

For now the EU/US side has won, but it remains to be seen if the West can bribe the Ukrainians with short-term loans as opposed to the Russians who have more fundamental interests in the economy and the Ukrainian military industrial complex.

Expect a large currency devaluation and a partial default on the foreign debts following the elections in three months’ time and not before them. A EU/IMF/USA bailout loan will be offered to bridge financing gaps for the short-term. If there is a rally, I’d consider it the final chance to sell.

The conclusion of this part of the Ukrainian story will be a positive for other emerging markets.

United States: Economic growth expectations are picking up

Meanwhile across the pond, following the minutes of the FOMC meeting and some further comments from FOMC board members on the outlook for the US economy, US bond yields have moved off their recent low levels.

Few people feel that the weather effect will have a material negative effect on the economy. One of the consequences is that US growth expectations have begun to pick up as measured by the US yield curve (see below).

Figure 1: Economic growth expectations United States vs Germany

Chart 1 24 feb

I remain positive on the US economy. What was more interesting, was the turn down in the slope of the German yield curve reflecting both some weaker December 2013 data and the concerns around the low level of inflation.

It’s hard to understand the recent rally in the Euro (2%) given such interest rates divergence between the US and Germany. Inflation data at the end of the week is a key focus; it may give the ECB room to move in early March.

United States: Existing Home Sales weaker than expected

Table 1 24 feb

Existing home sales posted a  larger-than-expected 5.1% decline in January (vs. consensus -4.1%). The level of existing home sales stood at 4.62million (vs. consensus 4.67 million). The single-family category (-5.8%) accounted for the entire January decline, while condo and co-op sales were flat.

All four regions of the US declined, including the West which has experienced less adverse weather. Sales fell in the Northeast (-3.1%), Midwest (-7.1%), South (-3.5%), and West (-7.3%). As a fairly lagging indicator of home sales activity, the January existing home sales report may not yet reflect the full extent of weather-induced weakness.

United States: US companies ramp up capex as confidence grows

One of the core pillars of our positive outlook on the US economy is a pickup in spending by large cap US corporates. According to a Thomson Reuters analysis, 70% of the 227 S&P companies that have announced 2014 spending plans, have exceeded Wall Street’s expectations. This represents the highest level of cap-ex spending  in at least five years.

Capital expenditure for the year is set to be about $1.71 billion according to the Thomson Reuters data. That is up only 2% from last year’s $1.68 billion, however, analysts on average had been predicting spending to fall nearly 4 percent from 2013.

The primary drivers of this pickup seem to be companies wanting to make sure their production capacity keeps up with rising demand because they are currently using roughly 78.5% of their production capacity. That’s up substantially from June 2009′s record low of under 70 percent.

“We’re approaching 80 percent (on capacity utilization) and that’s usually the mark where they’re starting to feel some pressures to add a little bit more capacity into the equation,” said Russell Price, senior economist at Ameriprise Financial Services in Troy, Michigan.

China: Property stocks hit as house price appreciation slows

The Shanghai Composite was down -1.9% o/n. The property sector was the main driver: -5.2% on average after a couple of negative headlines over the weekend. These involved the Industrial Bank suspending loans to some Chinese property developers and tightened lending to real estate-related industries including steel and cement. Meanwhile, a developer in Hangzhou cut sales price of units by about 19%. Another in Changzhou reduced property sales price by about 40%.

The markets calmed somewhat in late trading after comforting comments from People’s Bank of China Governor Zhou Xiaochuan. He told the G-20 that the Chinese government will push ahead with economic reform. He also played down the risks associated with “shadow banking”. Zhou said the deceleration of the Chinese manufacturing sector may have some impact on the world economy but it will be limited.

Economic growth of 7% to 8% suits China and helps support global growth and stability

He noted the services sector is accounting for an increasing share of domestic economic activity, while the manufacturing share is shrinking. China’s rising debt-to-GDP ratio has already caught the government’s attention:

“The Chinese government attaches great importance to economic risk and learning from international practice, paying particular attention to shadow banking supervision

The scale of China’s ‘shadow banking’ isn’t large but has been growing relatively quickly (and) we will carefully handle it.”

I remain long China (50% allocation), although as I’ve said, this position is not without risks. The FXI ETF  invested in is the Top 25 China stocks which should insulate me against the worst of the property-related speculation unwind.

United Kingdom: Rain stops play

Table 2 24 feb

Retail sales volumes (exc. auto fuel) fell by 1.5% m/m in January. This was a slightly larger fall than was expected by consensus (Cons: -1.2%mom) – but in fairness who goes shopping in a monsoon?

I am becoming somewhat more cautious on the UK economy and am looking at an investment this week that would aim to take advantage of this divergence.

Week Ahead: EZ flash CPI key release for the week

Table 3 24 feb

This is a key week for the ECB as Draghi waits for the CPI data on Friday to see if he has scope to ease further. As you can see from the chart below, EZ core inflation has been trending lower with some prospect that we get a weaker than expected number on Friday.

Figure 2: Eurozone Core CPI

Chart 2 24 feb

Elsewhere,  consumer confidence in the US will be closely watched to see if there is any hint of a lasting effect from the recent poor performance.

Portfolio: Pickup in US growth expectations help our 5 Year investment

Table 4 24 feb

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