Covering our shorts, Going Long China, Japan, India and Chinese Tech.
The sharp correction we anticipated in the past few weeks ( see our post A sharp global correction may be imminent published on Sep 28th ) took place this week, surprising the majority of investors by its violence.
Global equity markets tumbled 5 to 6 % on average as US bond yields rose to level not seen since 2014.
Two major changes are taking place in investors’ psychology :
1 . Investors are finally realizing that inflation is back and is here to stay
Since 2014, we have been advocating that inflation would return structurally in the world economies after 34 years of disinflation and 10 years of deflation scare following the 2008 financial crisis.
10 years of extra-ordinary monetary stimulus and abnormally low short and long term interest rates engineered by the three main Central banks of the world succeeded in kick-starting the economies again and growth is back strongly in the USA, but also in Europe and in Japan despite their structural imbalances.
By the same token, inflation took time to re-appear, but record low unemployment in the US, Japan and Germany is finally yielding higher labor costs and the 2016 OPEC agreement to cut oil production triggered a trebling of Oil prices from their 2016 US $25 low to the US$ 75 level reached in the past few weeks.
Donald Trump’s Tax cuts at the beginning of 2018 amounted to a shot-in-the-arm in the already booming economy he inherited from his predecessor and boosted US economic growth to above 4 % in the second and third quarter of the year as well as corporate earnings that grew at 20 % plus for most of the year thanks to the one-off effect of the tax cuts.
Moreover, the ill-conceived and ill-timed Trade Wars launched by Donald Trump will first and foremost increase price pressure in the USA rather than really impacting the Chinese economy, at least in the short term, adding to inflationary pressures.
Extremely ample liquidity and record-high interest rates boosted asset prices almost everywhere giving us the Longest US US equity bull market in history but also the most expensive one by many measures of valuation.
The need to normalize monetary policies has become evident and we claimed many times in the last year that the FED was still very much behind the curve and had no choice but to accelerate the pace of rate increases, something that is taking place now – It has raised rates 8 times since the process began – and to start unwinding the massive stock of debt it had accumulated on its balance sheet since 2008.
Jerome Powell is clear, and despite what Donald Trump may say about him, he is going to do his job and continue raising rates until inflation comes under control.
Higher interest rates are bad for stocks, especially when these are at stratospheric valuations, and investors have finally taken notice.
In its latest data release of today, German inflation rose to 2.3 % in September, the highest level since 2014 and way above the ECB target of 2 %.
2. Technology Stocks have ended their bull market
The entire 2009-2018 bull market was powered by the Technology and Social Media giants – most commonly called the FAANG – and brought two of them to reach the amazing valuation of US$ 1 Trillion in the summer of 2018.
US$ 1 trillion is the annual GDP of an economy like Indonesia with its 260 million people and 23 times the GDP of a country like Lebanon.
US$ 1 trillion is also 5 % of the entire US GDP.
These milestones usually take time to digest and we have been warning for months now that the leadership of the technology sector was coming to and end and should now be traded on the short side as valuations were unsustainable. ( see our posts THE END OF TECH posted on March 26th 2018 and SHORTING APPLE INC posted on April 19th 2018 )
As always, the leaders of any stock market rally are the best performers and become, over time, the stocks where everyone wants to be investing creating an extremely dangerous situation of highly concentrated participation in these few stocks.
Last week’s rout is global stocks was scary and very few markets were spared, but technology was affected much more than any other sector as the leading companies got hammered by individual investors rushing to cash-in on long term capital gains.
The MSCI World Equity Index shows how European and Emerging Markets got killed and the technical picture there is looking truly ugly.
However, we do not see last week’s correction as anything more than a global and healthy correction for now, and in fact it has provided the opportunity to build positions in markets and sectors that have been brought to extremely attractive levels of under-valuation.
We do not see the rout developing into a market crash of a lasting bear market for now because the fall in bonds that we had predicted has now probably run its course, because increases in inflation will remain subdued, because oil prices are rolling over and finally because US corporate earnings for the third quarter, which are starting to be reported this coming Friday will still be North of 20 % year-on-year.
WE SEE THIS CORRECTION AS AN OPPORTUNITY TO GO LONG IN ANTICIPATION OF THE LAST BULL PHASE OF THE ENTIRE BULL MARKET.
A PHASE THAT WILL TAKE US INTO Q1 2019 AND WILL END WHEN US CORPORATE EARNINGS WILL STRAT DECREASING UNDER THE WEIGHT OF HIGHER LABOR COSTS, HIGHER INTEREST RATES AND THE DISAPPEARANCE OF THE ONE OFF EFFECTS OF THE 2018 TAX CUTS.
WE ALSO ALSO EXPECT THE REPUBLICAN PARY TO TAKE A BEATING IN THE NOV. 8 MID-TERM ELECTIONS ( See our post DONALD TRUMP’S POLITICAL SUICIDE dated Sep 10th 2018 ) AS THE SILENT MAJORITY WHO DID NOT VOTE IN THE PAST PRESIDENTIAL ELECTIONS MOBILIZES ITSELF TO WEAKEN DONALD TRUMP.
As our readers know, we had been anticipating the correction and protected our Model Portfolio through short positions on the main indexes, and through our structural shorts in many Technology stocks.
In the past week, – one day too early – we took our profits on our US index short positions and we started re-investing in Europe and China.
Yesterday we added India, Chinese Technology stocks and Japan.
We also started building significant positions in the beaten-down Chinese technological Giant such as ALI BABA, BAIDU, JD.COM. C-CTRIP and WEIBO.
The Chinese equity markets have been hammered down by US hedge funds selling short massively as the general view in the US is that China is doomed to fail and that US sanctions will take the economy down.
But unfortunately, China’s economy is robust and the US sanctions are doing very little to tame the pace of Chinese exports.
Exports from China rose 14.5% yoy to USD 226.6 billion in September, after a 9.8% rise in July, beating consensus of 8.9%. It was the fastest growth in outbound shipments since February, due to strengthening global demand and despite intense trade tensions with the US.
Moreover, and contrary to the USA where interest rates are going up, China is easing monetary policy and has plenty of ammunition to support growth through massive investments in infra-structure.
Finally, after the 2018 correction where Chinese indexes have lost 40 % of their value since the beginning of the year with individual investors and institutional investors are under-invested and hedge funds are massively shorts, whereas in the US which has risen 8 % since the beginning of the year and where investors. are massively long, a significant supply-demand mean reversion is likely to take place very soon.
The Chart below shows that the SHANGHAI COMPOSITE INDEX trades at exactly the same level it was at 10 Years ago, despite China’s economy having grow at an average of 8 % per annum over the period, and that in the mean time the US SP 500 rose by 400 %, despite the US economy growing at an average of less than 2 % over the same period.
In other words, we expect a MAJOR MEAN REVERSION PHENOMENON to take place in the coming two months and the trigger may well be a significant defeat of the Republican s in the November 8th Mid-term elections.
Technology: SHORT USA – LONG CHINA
US technology leaders are overextended, over bought and over valued.
Their Chinese equivalent are oversold, Under-owned and Cheap