Give last week back to the Indians
As Paulie Walnuts from the Sopranos would have said, “You can give last week back to the Indians”, even though it is when volatility spikes that investment opportunities start to arise. In this spirit, and to take us away from ISIS, Ebola, Ukraine and whatever other horsemen of the apocalypse the media will focus on next, we thought we would review the more important macro-trend confirmations provided by the markets recently.
1) There is no ‘peak’ anything: what we have seen is a fairly normal, if super-charged, commodity cycle. An investment drought in new production capacity over 20 years from 1982 to 2002, combined with a surge in demand from 2002, led to a supply shortfall in almost every commodity there is. The resulting jump in prices between 2003 and 2008 triggered a boom in capital spending in the sector, and a significant increase in supply. Now, we have entered the long phase in which prices gradually grind down towards the marginal cost of production of the cheaper producers. In this sense, commodities are almost the polar opposite of equities: they take the elevator up, and the stairs down again.
2) Euroland are sliding towards a deflationary bust: with the two most important prices in an economy (interest rates and exchange rates) fixed, it is no surprise that the other two main variables (asset prices and employment) must adjust to the world’s accelerating Schumpeterian forces. Any investor benchmarked against the MSCI World, EAFE, or even Europe, is better off underweight euroland equities, unless (like Japanese stocks in the 1990s and 2000s) they become either a) ridiculously cheap, or b) an obvious policy catalyst is unleashed.
3) China is doing what it has always done: deal with a slowdown in its structural growth rate by embracing further deregulation. After Deng Xiaoping deregulated China’s labour markets in the early 1980s and corporate structures in the early 1990s, after Zhu Rongji deregulated real estate and reformed state enterprises in the late 1990s, and after Hu Jintao and Wen Jiabao deregulated commodity markets a decade ago, Xi Jinping is confronting the final frontier: the deregulation of capital. To a large extent, this is happening through Hong Kong in the form of renminbi internationalisation, the creation of the dim sum bond market and the Shanghai-HK Stock Connect programme. This may help to explain why the Chinese government feels the need to ensure that Hong Kong’s chief executive will always be Beijing-friendly, a need which has led to the current street protests.
4) Japan is doing what it has always done: embracing mercantilism. What else does one call a policy that on one hand constrains domestic consumption with higher sales taxes, and on the other tries to boost exports via currency devaluation? Sure, one could call it ‘Abenomics’, but ‘mercantilism’ does just as well. And though further sales tax increases may now be on hold (see Shinzo Abe’s comments over the weekend), it is a safe bet that Tokyo remains set on devaluing the yen further, until Japan moves back into a trade surplus. After all, the last thing the Japanese want is to become increasingly dependent on foreigners for debt financing (especially if-God forbid-those foreigners are likely to be Chinese). And if one doesn’t want to become dependent on foreigners, one cannot afford to run a trade deficit.