☀️☕️ “Uninvestable” China?

📊 Also: Meta mega up; US labour red hot; CSI 5-yr low vs Nifty all-time high; Paytm limit down… again; US Offices, Banks and a Tail Risk 🎓 IN- DE- DISIN-flation

📈 Market Roundup [05-Feb-24]

US large-cap S&P 500 closed 1.07% UP ▲

Tech-heavy Nasdaq Composite closed 1.74% UP ▲

Pan European STOXX Europe 600 closed 0.01% UP ▲

HK/China's Hang Seng Index closed 0.21% DOWN 🔻

Japan's broad TOPIX closed 0.22% UP ▲

📝 Focus

  • “Uninvestable” China?

📊 In the Markets

  • Meta mega up; US labour red hot; CSI 5-yr low vs Nifty all-time high; Paytm limit down… again;

  • US Offices, Banks and a Tail Risk

📖 MoneyFitt Explains

  • 🎓 IN- DE- DISIN-flation

💸 Personal Finance Corner

📝 Focus

“Uninvestable” China?

China's CSI300 Index plunged 6.3% last month, hitting five-year lows amid economic challenges like a damaging nationwide property slump (not just Evergrande!), weak consumption and dangerously deflationary🎓 pressures. Concerns are mounting over China's future growth, with the IMF warning of a potential slowdown to 3.4% by 2028, citing a range of challenges, including a rapidly ageing population, higher unemployment, and the property crisis. (MFM: Deflation Nation, Deflating China, Old before Rich.)

Following Premier Li Qiang’s market-dampening appearance in Davos, in which he showed bravado at delivering strong 2023 economic growth of 5.2% with limited stimulus (i.e. no bazooka), words and deeds from Beijing have stepped up, though confidence remains low. A 2 trillion yuan ($280 billion) stimulus package for state-owned enterprises to buy onshore shares with offshore money and a 1 trillion yuan boost to bank lending through a cut in RRR (MFM: Bazooka(ish), BazookaRRR) plus some short-selling restrictions and property loosening was followed last week with talk of "more forceful and effective measures to stabilise the market and boost confidence" after a cabinet meeting chaired by Premier Li. 

Also last week: Over 40% of foreign investors at a bank conference in HK still view China as "uninvestable," according to the FT, citing the well-trodden concerns above along with strained diplomatic relations with both current and potential US administrations. Despite low valuations, foreign interest remains scarce, joining hordes of frustrated local investors already crushed by real estate. This obviously contrasts sharply with past perceptions of China as a high-growth market and an inexhaustible source of cheap manufacturing with the promise of booming middle-class consumers.

The Hang Seng China Enterprises Index (of “H-Shares”) has dived 70% since its 2007 peak. A year ago it was already down 60% and has since dropped another 30%. (Maths.) - Image credit: Wonder Woman (2017) / Warner Bros. via Tenor

..... ▷ But this notion is extremely crowded and potentially priced in if one takes a long-term view. Global fund managers' pessimism or even capitulation regarding China's economic and stock market prospects can be seen in Bank of America’s monthly Global Fund Manager survey, which showed that in November and December, a majority of Asia-focused managers were already underweight Chinese shares. 

That bearishness increased in the January survey (taken 5-11 Jan.) even while pointing to crowded trades, such as overweight US big tech and underweight China, as a top concern.

..... ▷ So, taking the other side of the trade, a contrarian investor could possibly look at

  • The long-term growth potential of the world's second-largest economy, with a vast domestic market and still young population;

  • The low correlation of Chinese equities with other major markets, offering portfolio diversification benefits and potentially mitigating global economic downturns;

  • The Chinese government’s active support of key industries, attempting Darwinian global competitiveness behind protectionist walls (viz shipbuilding and steel, EVs and semiconductors); 

  • And compared to developed markets, many Chinese companies in comparable sectors trade at much lower  (some may say undervalued) valuations;

  • China’s still huge weighting* in emerging market indexes, accounting, as of 31st Dec-23, for 24% of the MSCI Emerging Markets Index, though down from its peak weight in 2020 of 40%.

..... ▷ Unfortunately, contrarian sentiments would have served investors poorly as recently as a year ago, when “uninvestable” calls in 2022 were turned on their heads by the abrupt ending of China’s zero Covid policy setting the stage for a massive “pent-up demand”-led recovery in 2023. Which we’re still waiting for. 

A year ago, right about now, China’s CSI 300 was already down 30% from its all-time high almost exactly a year earlier, and since then, it’s collapsed a further 23%. The HK-listed China Enterprises index this time last year was down 14% on the year-ago, even after a 55% rally from October 2022 through, and has since fallen 29%.)

As economist (and superb investor) John Maynard Keynes said in the 1930s: “Markets can stay irrational longer than you can stay solvent.”- Image credit: Public Domain via Wikimedia

*Fund Manager Geek Corner

Many mutual fund mandates limit “tracking error” while also demanding alpha. Those can be internally inconsistent requirements for beleaguered fund managers (already busy fending off ETFs) because limiting tracking error essentially means closely following the benchmark while generating alpha requires outperforming the benchmark. 

First, definitions:

1.) “Tracking Error” is the divergence between the price behaviour of a position or a portfolio and the price behaviour of a benchmark index. A lower tracking error indicates that the fund's returns closely follow its benchmark. (This is the goal for index funds or any fund that aims to replicate the performance of a specific benchmark.)

2.) “Alpha”, on the other hand, represents an asset manager’s performance in guiding a fund into yielding returns relative to the benchmark index. A positive alpha indicates that the fund has outperformed its benchmark. This is typically the goal of actively managed funds and their raison d’être (or, at least, their excuse for charging enormous fees and incurring massive costs.)

A fund that strictly limits tracking error will have less freedom to take positions that deviate from the benchmark, potentially limiting its ability to generate alpha. Officially or unofficially, there were many such managers back in the day, known as “closet index funds” while comfortably collecting active mutual fund fees.

On the other hand, a fund that seeks to maximise alpha may need to take positions that significantly deviate from the benchmark, leading to a higher tracking error and potential for large underperformance (as seen in the vast majority of mutual fund managers underperforming their benchmarks and competing passive funds over almost any period.)

🇸🇬 Singapore: Let’s Get MoneyFitt!

📊 In the Markets

US stocks surged to a record high on Friday, buoyed by strong earnings and supported, a bit surprisingly, by a stronger-than-expected January employment report, even as hopes for near-term rate cuts by the Federal Reserve diminished.

Meta Platforms and Amazon.com reported solid quarterly results after the close on Thursday, driving the S&P 500 and Nasdaq over 1% higher. 

Two years ago, Facebook owner Meta crashed on an earnings miss, producing the single biggest market value destruction in stock market history. Last Friday, Meta rose 20% to close at an all-time high of $474.99 per share, adding $197 billion to its market capitalisation, the biggest market value addition in a single session, eclipsing the $190 billion gains Apple and Amazon made in 2022.

Also on Friday: CEO Mark Zuckerberg’s net worth increased by more than $28bn to $170bn (putting him at #4 after Musk, Bezos and Arnault.)

Mark Zuckerberg in 2005. Nineteen years later, worth $170bn (via Bloomberg)- Image credit: Elaine Chan by CC 2.5

The US labour market remains red hot, adding 353,000 jobs in January, almost double the 180,000 experts were expecting in an LSEG survey. And the report revised the December figure from 216,000 up to 333,000 (so you can’t blame highly paid experts for again being a million miles off — this time.) 

Along with unexpected wage growth acceleration (annual 4.5%), Treasury yields jumped, and futures markets cut back the implied bets that the Fed would cut interest rates not just in March but also from a near certainty by the May meeting.

Europe erased its gains on the US Labor Department’s January jobs report, closing flat having earlier rallied by more than 0.7%.

Türkiye’s central bank governor, Hafize Gaye Erkan, resigned last week after a series of allegations by former and current central bank employees accusing her of unethical conduct and an apparent smear campaign against her. President Recep Tayyip Erdogan appointed her deputy governor (ex-NY Fed, Ivy League PhD, econs professor) as the new governor, signalling that Finance Minister Mehmet Simsek and Gaye Erkan’s high-interest rate policies (a pivot from Erdogan’s) will continue.

South Korea’s Kospi led gains in Asia-Pacific markets following Wall Street's rebound with a 2.9% rally on Friday to log a weekly gain of 5.5%. 

Going the other direction, Hong Kong’s Hang Seng index fell 0.24%, while the mainland CSI 300 tumbled 1.18% to its lowest since January 2019 and followed six consecutive monthly drops. 

Even as India’s Nifty 50 hit an all-time high for the fifth time this year, driven by heavyweight Reliance Industries and IT stocks, digital wallet provider Paytm's shares plummeted 20% for a second straight day, reaching a 13-month low. Starting Monday, India's stock exchanges have cut the stock’s daily share trading limits to 10% from 20%.

The Reserve Bank of India (RBI) found that Paytm (which allows users to make digital mobile transactions and access loans, listed as One 97 Communications and a former portfolio holding of Berkshire Hathaway) violated its licensing guidelines by offering core banking services such as accounts and wallets without proper authorisation (with thousands of accounts created without proper identification, according to Reuters.) The action on Paytm Payments Bank ordering it to halt new deposits from March is an enforcement rather than a change or new policy.

The clue is in the name: Paytm Payments Bank is not a fully licensed bank in India but a “payments bank”, which has several limitations compared to traditional full-service banks. While not a licence cancellation, the RBI's move severely restricts Paytm's operations since Paytm Payments Bank is a crucial component of the suite of payment services for consumers and merchants in its two-sided ecosystem.

Indian market circuit breakers - a mini-explainer

The Securities and Exchanges Board of India (SEBI) has a three-stage circuit breaker for individual stocks and the overall market, using the earlier of either the BSE Sensex or NIFTY 50 index.

When the index or any individual stock crosses a certain price range within which it is allowed to move, a circuit breaker is triggered with a coordinated trading halt in all equity and equity derivative markets nationwide. 

There are three stages, 10%, 15% and 20%, each with different periods of trading halt and reopening, depending on the time of day they are triggered (details), with the maximum 20% move triggering a halt for the remainder of the day.

Note that India’s circuit breakers are sequential. In other words, the market cannot directly jump from the 10% trigger to the 20% trigger without first going through the 15% level. Each level acts as a safety buffer to prevent abrupt crashes or surges.

(US markets also have a three-stage circuit breaker, but at 7%, 13% and 20%. Circuit breakers for individual securities are triggered whether prices move up or down, but at the market level, using the S&P 500 Index, they are only triggered on the downside.)

US Offices, Banks and a Tail Risk

Regional bank shares stabilised after New York Community Bancorp rebounded 5.0%, helping to lift the KBW Regional Banking index up 0.2%. We noted last Friday that clouds are gathering with weakness in the US commercial property market as banks in the US, Asia, and Europe reveal mounting losses there. 

NYCB, which took a bunch of Signature Bank (remember them?) assets and liabilities from the Federal Deposit Insurance Corporation (FDIC) after it failed. NYCB crashed earlier in the week after reporting some huge property loan losses. Still low occupancy rates and still high interest rates are fuelling worries that we will see widespread defaults among US commercial property owners. The value of office buildings has plummeted amid the shift to remote work, while historically elevated interest rates can make highly levered real estate developers struggle to repay their loans. 

In 2023, a record $541 billion in debt tied to commercial real estate matured, with an estimated $2.2 trillion more due by 2028, according to the WSJ. And Bloomberg News notes that banks are facing roughly $560 billion in commercial real estate maturities by the end of 2025, quoting an investor who says that "the link between commercial property and regional banks is a tail risk for 2024."

So the longer interest rates stay high to squish out the last remnants of inflation above 2.000%, the shakier the mid-sized regional banks might look.

AND… In Japan, Aozora Bank sank 34% in two days last week after it reported that bad loans in US offices are (partly) the reason for a projected annual loss of $190 million last year. And in Europe, though making up only 1.5% of its loan book, Deutsche Bank quadrupled provisions for losses in the value of the US commercial real estate portfolio that it actually owns.

📖 MoneyFitt Explains

🎓 IN- DE- DISIN-flation

Inflation is basically a general increase in prices in an economy over a period of time. 

When this happens, the value, or purchasing power, of money goes down. Inflation is usually caused by too much demand for something relative to how much is available or by the cost of producing (or importing) something going up. Both can lead to a vicious cycle of rising prices, usually when higher prices become expected and built into wage demands.

The Consumer Price Index is a way of measuring inflation in an economy based on the increase in the overall price of a "basket" of items that an average individual would spend on. (There are many measures, but the "CPI" is the most commonly used.)

Deflation is the opposite: A decrease in the general price level of goods and services. This sounds good, but can be as damaging in a different way, as buyers may sit on the sidelines and wait for lower prices, thereby sending economic activity through the floor, while their real (inflation adjusted) debt burden actually goes up.

Disinflation, on the other hand, is a decrease in the rate of inflation, meaning that prices are still going up, but not as quickly as before on either a month-on-month basis or year over year. This is generally seen as a good thing, especially if inflation is above the target rate.

💸 Personal Finance Corner

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