- US FOMC
- Aus inflation
China’s recent government interventions have provoked some dramatic stock reactions.
For those that haven’t followed along closely, we’ve seen a raft of new regulations across anti-trust (Tencent, “abuse of market power”) data security (DiDi, a ride-hailing app, with the app removed just moments after the US IPO) and worker protections (Meituan, online delivery services) aimed at improving minimum wage and working conditions.
Most recently, an edict banning for profit education/tutoring services has sent shares into a spin.
In perhaps an odd twist for a fund manager, we don’t view all of these moves as necessarily bad. Whole books have been written on the tales of worker woes for those on the Amazon factory floor, or those working as “contractors” to companies like Uber and Lyft.
But, that said, there are investment implications. We’ve been underweight the emerging markets for a variety of reasons, a trade that has worked very well this past year.
A) China is a disproportionately large weight within the Emerging market indices. A bet on the index is a bet on China, India and Korea, rather than a larger more heterogenous group. B) we are bearish on China, viewing the multi-decade debt binge in both household and corporate credit as dangerous to financial stability C) COVID related challenges for the healthcare systems across the region, and the low penetration of vaccines, D) that the EM sectoral allocation to technology stocks is quite large, an exposure that we already get in our developed equity markets, and a sector that we are concerned about given valuation grounds.
We can now add E) geopolitical risk, but, that risk was always there, it is perhaps just a bit more visible now. As such the headline cheap P/E ratios of the EM region are interesting, but insufficient, from a DAA perspective.
Heading into the FOMC meeting, we expect a fairly benign update, with the Fed likely to make “soothing noises” to market concerns regarding the set up for an eventual taper and exit of QE.
We expect acknowledgment of strong data, but given the present COVID resurgence, to press the point more firmly at the next meeting. And that data is strong. Below is durable goods orders.
The Fed will be very aware that there remains at least a trillion dollars of pent up household savings associated with fiscal support packages that will be unleashed into the market over the coming months. Below is retail sales.
And last but not least, inflation, which, whilst we agree with camp transitory, will still remain high enough over the remainder of the year to trouble Fed members.
We continue to think Fed hawkishness remains a very underrated market risk. For the past year every “risk on” trade has been commodities and bank centric, and every “risk off” trade has been healthcare and tech centric. However the higher real rate story will hit commodities and secular growth stocks, like healthcare and tech, where valuation multiples are often 40-50x, and given some early signs of a buyer’s strike in US housing markets on affordability grounds, the prospect of higher mortgage rates, from current rock-bottom rates, will likely only serve to accelerate the decline in mortgage debt demand.
Our investment style is Quality Growth at a Reasonable Price (QGARP), and we’ve gone to great lengths to hunker down in good Quality stocks with good growth prospects, but at valuation multiples that imply a materially lower duration (sensitivity) to interest rate risk.
Our CPI print was something of a non event for macro markets. The headline number was high, but base effects are well noted, and the trimmed mean remains <2%.
There’s no implication for tightening, on these numbers, and in any case, given lockdowns, not implication for tightening, inflation or no inflation.
Yet the dollar fell, and bond yields & risky assets (equity market) were both lower, which is consistent with market disappointment, and in this case associated with a tightening of policy in the sense that the natural rate of interest has likely moved lower. You can see the announcement affect on the dollar, below (which is annoyingly stuck at US time, rather than the Australian time of 11.30am AEST).
And on the 10 year yield.
In our view, whilst it was a defensive kind of day for local markets, it was much more likely governed by offshore markets, than in response to tea-leaf reading of the RBA’s reaction function on the basis of today’s print.
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