Market Outlook by Lee Robinson - June 2015
China Syndrome
More and more clients are asking us our currency views especially with the large moves in major currencies over the last 12 months. We have always maintained that when interest rates are controlled by central banks volatility leaks out via the currencies.
One noticeable exception is of course the Chinese Renminbi [CNY] which is pegged to the US dollar with a slight accretion. Hence it has been the best performing currency of the last one and two years with significant gains against competitors such as Europe, India and Russia. Is this going to continue? We believe this policy of strong CNY is here to stay even in the face of several commentators believing there is a strong need to devalue.
First of all, stepping back, the Chinese economy has certainly grown, from 0.6 trillion dollars twenty years ago to 7 trillion dollars today. In that time the US GDP has gone from 7.7 to 16.7 trillion dollars. The Chinese currency is the second largest trading currency in the world.
Shouldn’t the US be looking over its’ shoulder?
Yes, Despite the fact that the USA seen off all challengers to the crown of #1 trading currency over the last 100 years, ranging from the UK to Germany to Russia to Japan – China is different.
Just over 125 years ago Great Britain believed it had the most innovative thinkers, access to capital and land [via the empire] in the world. However, they had only beaten off competitors with smaller or similar populations not larger ones. Russia, Germany and the USA were in ascendancy. With a greater population there are more innovative superstars, cheaper labour and large domestic markets to build upon and create global franchises. One of the reasons why American firms do better overseas than foreign firms entering the US market is that spending a small percentage of a larger domestic sales revenue on building out a foreign franchise in a smaller target market is lower risk and less draining than say a French firm that would require a much larger spend to capture scale in a 300 million person market utilising profits from a 65 million person domestic market. China’s vastly larger domestic market is a threat not yet encountered by the USA. History says that if I have 4 times more manpower than you then you have to be 4 times better per person. With access to information creating a level playing field, plus the first waves of highly trained Chinese professionals and entrepreneurs entering the workforce and outpacing the USA, day by day the US will see its’ competitive advantage diminish. As an aside the extremely low scores achieved in numeracy and literacy by US schools is troubling. Ranking at or near the bottom in G20 is just not good enough for the largest most powerful nation globally.
If we believe China wants to be number one in economic terms, then it needs to attract capital both longer term and short term, particularly as the economy is clearly slowing down. We believe the decision to open the capital gateway between China and Hong Kong was a great idea. As we have said previously, we believe that there is a flight of capital to the $ and $ linked assets. This trend is more important than yield differentials or short term trading flows. China wants this capital inside its borders. Additionally a lot of US dollars fleeing Switzerland and Russian sanctions ended up in the US dollar pegged Hong Kong dollar. Add in the pending IMF 5 year review of whether the CNY should be part of the special drawing rights and we can see that China will not devalue by choice.
Do we believe China has not noticed that those countries that maintained a strong currency as they built their international companies and economies such as Germany, Japan and Switzerland have vastly outperformed those that took the easy option to devalue rather than adapt and be more competitive such as UK and Italy? No nation has ever devalued itself to prosperity. China doesn’t want the weaker companies to thrive, doesn’t want a zombie corporate system as seen in Japan and now in the rest of the West. Remember China has long term plans, they may or may not succeed but they are unlikely to take short term fixes without serious thought.
China requires commodity imports such as oil and food. A strong and low volatility currency helps offset volatile commodity prices which is especially important when you have 1.3 billion people to consider who may revolt if they are starving. Do we really believe Russia agreed long term contracts for oil in CNY without adjustments for CNY weakness?
Just this quarter we have seen Chinese companies buy icons such as Pirelli, shortlisted for Portugal’s Novo Banco and seen the USA’s staunchest ally, Great Britain, amongst others sign up for the new Chinese development bank.
Finally, the CNY was valued at 4:1 in 1990 when the economy was barely functioning and debt in the USA was much lower. Why can’t it go back there? After all the Deutschmark strengthened five fold over 50 years of rebuilding.
China is here to stay but will it be number one economically? Maybe not but a strong number two certainly seems a reasonable assessment. That means Renminbi denominated assets will become the 2nd largest holding in a global benchmark portfolio. Even if you are not sure the cost of a one year 5% out of the money option protection is just 0.5%.
What is your Renminbi asset weighting?denominated assets will become the 2nd largest holding in a global benchmark portfolio. Even if you are not sure the cost of a one year 5% out of the money option protection is just 0.5%.
What is your Renminbi asset weighting?
Video
We believe the future of the web/mobile will be video. With faster download speeds this is becoming the norm. We expect 95% of all websites including financial ones will have videos embedded on their sites within the next 3 to 5 years. We are certainly moving that way with our revamped website. Our friends over at Real Vision TV, www.realvisiontv.com , have started a video channel focusing on superior and intelligent financial interviews. This is not the usual mundane, scripted and controlled comment which we see on the satellite networks but the best channel for high quality interviews with thought and money making ideas. I was asked in late April to give an interview on a breadth of topics. The link to the video is http://teaser.realvisiontv.com/130484872. (Please click on the “>” sign in between the large numbers in the centre of the page). If you like what Real Vision has to offer then Real Vision are also offering Altana clients a discount of $100 off the $400 annual fee. Use the code ALTANA on the link asking you to join.
Market Volatility
As some of you know, my first job involved trading the Nikkei in 1991 which had daily moves up and down at the time that would seem frightening today. I traded interest rates in the boom of ‘93 and bust of ‘94, credit in many crises including Asia ‘97, LTCM ‘98 and ‘02-‘04 and the big one in ‘07-‘09. Using options and CDS some of these movements have been even larger relative to risk capital. I have seen many exciting moves in my trading career and as a keen reader of market history, I have read about many others. An oil price move of 50% in six months is big but not a stand out move. But I would point out the following as memorable: -The US stock market had six Hindenburg Omens in 6 of 8 trading days in December and between early December and January over 40% of trading days exhibited Hindenburg Omens. To my knowledge neither has happened before. A simple way to think about Hindenburg Omens is basically when over 2.2% of all stocks are making new highs and new lows on the same day which implies the underlying market is pulling in separate directions. Remember that almost all stock market crashes have been preceded by confirmed Hindenburg Omens, although they can occur without a crash subsequently happening. They are rare events normally.
Silver moved from $16.5 to $14.5 back to $16.5 in one trading session in December. That is a 25% round trip in a commodity which has been priced for thousands of years and should not therefore be behaving in such a volatile fashion ordinarily. The Ruble was even more volatile. One year ago it was at 32 to 1 $ yet in one day it moved from 58 to 80 back to 68 – a round trip of 32. Russia is a G8 nation with 140m people. Now of course we have the Swiss bank move and competitive devaluations in Turkey, Belarus and Kazakhstan. We expect the other former communist states to shortly follow leading to further euro weakness. Finally, the Baltic Dry is an index that is hard to manipulate, despite money printing it heads towards new lows and companies such as UPS complain about poor thanksgiving and Xmas sales despite a strong $ and low oil price 2015 is going to be a volatile year. Again we implore clients to think carefully about their currency and counterparty exposures.
Altana News
We are pleased to announce that since the last quarterly outlook which we sent, the strong performance in 2015 of our Corporate Bond UCITS Fund, managed by Stevan Bajic, has been recognised by Barclayhedge. The fund was ranked #1 for April in their list of 66 Fixed Income long/short funds which are greater than $10mn in AUM.