Mechelany Advisors' WEEKLY MARKET REVIEW highlights the salient feature of the past week, details specific issues of the moment and reviews the Mechelany Advisors' MODEL PORTFOLIO, CHINA DEEP VALUE PORTFOLIO and the CHINA BANKS PORTFOLIO
On Friday, US equities and cryptocurrencies staged a major reversal. For the past few weeks, the mood of the market was clearly bearish and September was the first negative month in equities after 7 consecutive months of rises.
Despite Friday’s gains, the major indexes still ended with some big losses for the week. The Nasdaq had a loss of -3.2%, the S&P 500 had a loss of -2.2% and the Dow Jones ended the week with a loss of -1.4%.
However, the reversal took place on major technical support levels, from extremely oversold levels, and although it is too early to call it the final bottom before the Q4 rally that we expect, it is a sign that the tide may be turning with the Q3 corporate earning starting this week.
Both the S&P 500 and the Nasdaq rebounded on their 100 days moving averages, a level that provided support in every correction since March 2020, and ended the week above this levels.
Being deeply oversold, they are due for at least a rebound from here.
On Friday, as our targets for the down phase were reached, we closed our Short SP500 and Nasdaq in our MODEL PORTFOLIO on our target BUY Levels and took our profits on our volatility long future.
Looking at sectors, the Energy Select Sector SPDR Fund – XLE US that we own – gained 3.36%, as energy prices have been soaring globally due to several energy shortages.
Merck gained 8.37% with news of a pill that will decrease the risk of serious illness or death from Covid-19
In Cryptocurrencies, Jerome Powell confirming that there was no plan to ban crypto-currencies in the US triggered a move that was even more violent with most of the Cryptos in the universe staging a 10 % rally on the day.
There again, the two main cryptos rebounded on their moving averages, marking a higher low and delivering a BUY Signal. We were stopped out of our remaining Short Bitcoin position, reducing our strategic short position to 5 % of the portfolio.
There again it is too early to call this reversal a final bottom and the beginning of a new up-trend. For now cryptos are inscribed in significant triangles and only a break above 50’000 on Bitcoins and 4’000 on Ethers will mark the beginning of a new up-leg.
We have not changed our views that Cryptos, in their current form are ultimately doomed and that additional regulations and constraints will contain their use.
Making Cryptos legal tender in El Salvador has unleashed speculative fever with Uber drivers and restaurant waiters day-trading them, a sure sign that we are in a speculative mania, but we are disciplined investors and if the financial world has espoused the thesis that Bitcoins is the new Gold and the new hedge against inflation, then we are not going to fight it.
The current weakness in Gold in the face of rising inflation may be giving credence to that thesis, but if this is the case, then the ultimate peak in Cryptos will coincide with the ultimate peak in equities, something we expect to happen in the first quarter of 2021.
In the mean time, we will keep on trading them actively.
European Stocks are also marking a reversal, and, there again, it is too early to call it the final bottom of the current correction. European stocks, like US stocks are in the last wave 5 of their bull market and they are globally expensive.
What makes us wary of European stocks is that both the luxury sector – See LVMH Below – and the technology sector – see EURO STOXX 600 technology Index – have made major tops and are displaying ugly configurations with confirmed SELL Signals.
Conversely, the banking – Commerzbank – and energy sectors – Total Energies – are showing constructive configurations.
Selectivity is therefore warranted in Europe.
Japanese stocks were badly hit last week, with the Nikkei 225 losing 5 % on the week, its worst performance since March 2020. It is now trading on the all-important support of its moving averages and has retraced more than 60 % of its previous advance.
Fumio Kishida ís taking power on Monday as the new prime Minister with a strong team of economists at the helm, and most of the COVID-related bad news is behind us. An additional positive factor is the coming depreciation of the Japanese Yen that we expect.
We stand ready to increase our exposure to Japanese equities.
China will be closed until Oct 8th for the traditional October holiday on the occasion of its National day. This is a period where the Chinese travel back home to visit their families and offer presents. Some 127 million passenger trips are expected to be made by rail during the holiday rush that started on Sept. 28 and will last until Oct. 8, already 16million trips were done on Friday alone.
China chose to celebrate its National holidays by sending 76 fighter jest flying in Taiwan’s airspace in the past two days, raising concerns that an escalation could be at hand. However, and as we have argued many many times before, China does not need to resort to force in the China Taiwan relations. It is simply marking its message and official position that Taiwan is an intrinsinc part fo China as Hong Kong and Macau are…
The bearishness of global investors about China is at extremes. , The Western press is full of articles about the demise of or the threat that China constitutes and the dictatorial approach of XI Jing Ping to power.
In its cover story published on Oct 2, The Economist, known for being an extremely good contrarian indicator for the markets, lays the vison of China by the West :
“Xi Jing Ping is waging a campaign to purge China of capitalist excesses. China’s president sees surging debt as the poisonous fruit of financial speculation and billionaires as a mockery of Marxism. Businesses must heed state guidance. The party must permeate every area of national life. Whether Mr Xi can impose his new reality will shape China’s future, as well as the ideological battle between democracy and dictatorship.”
and worries about the impact of the intense political agenda of Xi Jing Ping over its economic growth.
It makes interesting reading but is full of subjective assessments.
Indeed, in this intense political year ahead of next years elections, China has a number of problems:
. Acute power shortages that have created household and industrial power outages in as much as 18 regions,
. 800 cases of COVID a day, a main cause of the Nanjing Port lockdown
. The Real estate crisis and Evergrande travails
. The global semiconductors shortage hampering car sales and electronic products Manufacturing.
. An ageing population and diminishing productivity
But in fact when analysing the roots of the problems, what transpires is that they are mostly due to China’s own policies and desire to contain excesses.
The power shortages are the direct result of China’s clampdown on Coal power following its desire to reduce pollution. This has led to a sharp shortage of available power and the Government has already authorised Chinese coal energy producer to exceed their quotas to provide electricity. The problem will therefore be solved relatively soon.
Data suggest that recent electricity rationing is the result of power companies being unable to keep up with the strength of demand, in the face of constrained electricity supply.
Sharp falls in output across the whole of industry have probably been avoided and things should get back toi normal in the fourth quarter.
Evergrande and the Real estate crisis are also the direct consequence of the Chinese Government policies to contain real estate speculation, over-investment and over-leverage. Now that the panic stage has passed and the damage-control of the Evergrande default implemented, the crisis will prove to be extremely positive for Chinese equities.
The Chinese are high savers, and for decades they have looked at real estate as their safety net. 80 % of the Chinese household wealth is invested in real estate, compared to 30 % in the US, and demand has gone unabated for years, leading to excesses in both leverage and supply. It is estimated that Chinese developers have plans for three times more housing units that will ever be needed when looking at the population and demographic metrics.
Ever rising prices of real estate following unstoppable demand has led to this situation and the measures imposed in 2020 to quash demand and supply led to this crisis.
But looking forward, the Evergrande saga will mark a turning point in real estate prices, developpers ambitions and the Chinese appetite for real estate. We are certainly in for a protracted period of contraction in this sector that represents globally one third of China’s economy but the silver lining is that is will re-direct Chinese savings from real estate to cheap equities. Chinese households invest only 20 % of their assets into equities, a far cry from the US, Japanese or European averages.
We have argued regularly that Hong Kong-listed Chinese equities are extremely cheap at the moment and we are getting several BUY signals in many sectors such as banks, technology, insurance and energy.
Moreover, a significant development is about to take place next week.
The Biden administration will begin unveiling its China trade policy next week following what it has called a top-to-bottom review of import tariffs and other measures imposed by the Trump administration.
As we argued many times before, Biden will change the aggressive policy pursued by his predecessor against China and the freeing of the HuaWei CFO and of two Canadians last week was the first step of that positive shift
U.S. Trade Representative Katherine Tai is scheduled to speak on the administration’s trade policy in a speech to a Washington think tank Monday morning, in a first step toward addressing a range of unresolved issues between the U.S. and China.
Business groups have been pressing the Biden administration for clarity, including whether the White House plans to start negotiations with Beijing on a follow-up to the Phase One trade deal struck in January 2020 and on whether tariffs on Chinese imports will continue.
“We need to ask ourselves, do we really want those excess tariffs in perpetuity,” said Craig Allen, president of the U.S. China Business Council, a trade group that represents American companies with large Chinese operations. Mr. Allen said he has been concerned that the Biden administration has been comfortable leaving so many tariffs in place for so long.
The Trump administration imposed tariffs on nearly $370 billion in imports from China beginning in 2018. The Biden administration has yet to touch those tariffs, although the levies no longer have the impact they once did.
Importers have shifted to goods from China that weren’t hit by tariffs, and as of earlier this year the tariffs only covered about $250 billion in trade.
Many U.S. importers — who pay the tariffs — have been angered because they haven’t been able to apply for relief from the duties. The Trump administration had created a process by which U.S. importers could apply for exclusions.
The Biden administration allowed this process to expire, however, saying that it must conduct its review. That left many companies in a situation where they were forced to pay tariffs but their Chinese competitors weren’t.
Another issue to be resolved is the extension of China’s commitment to purchase U.S. goods. A centerpiece of the Phase One trade deal was Beijing’s promise to boost its purchases of soybeans, corn, meat, energy products and manufactured goods.
The pact called for China to increase purchases of goods and services by an extra $200 billion over the course of 2020 and 2021. China missed the goal for goods purchases by nearly 40% in 2020, according to calculations from Chad Bown, a senior fellow at the Peterson Institute for International Economics who has been tracking the effort. With four months to go in 2021, China is on pace to be 30% short of its goal.
The economic disruption caused by the coronavirus pandemic made the goals far more difficult to reach than anticipated. Thus far, there has been no consequence for China for missing the targets by such a wide margin.
The Phase One deal contained specific goals for 2020 and 2021, meaning that aspect of the deal effectively expires at the end of this year.
“I’m not convinced that the purchase-commitment approach had much influence on China,” said Mr. Bown. “After nearly two years, it looks like China bought what it needed — a lot of farm products and semiconductors — but it didn’t buy a lot of airplanes or cars that the Trump administration wanted it to.”
Economist highlight the fact that far from having reduced the trade surplus between China and the US, tariffs and sanctions have had no impact and the Chinese trad surplus is higher than where it was before the tariffs and sanctions.
Another area where changes can be expected is the lifting of sanctions or de-listing of Chinese companies. Xi Jing Ping was extremely clear on the subject stating that there will be no improvement in the relationship as long as Chinese companies are targeted unilaterally by the USA on unfounded National Security reasons.
Finally, the entire period of US aggressiveness against China since February 2018 has only led to one lasting consequence :
A re-birth of the Chinese Nationalistic sentiment and a considerable drop in the appetite of Chinese consumers for American brands and products. Economic history will look at this period of the American Trade history as one of the most damaging and less productive ever.
As foreign investors are now largely out of Chinese stocks and sentiment is at extremes of pessimism, the stage has been set for a sharp rally in Chinese equities in the fourth quarter of 2021.
Last but not least, using Peter Lynch’s Price to Earnings Growth valuation yardstick, the HSCEI index is sending a strong buy signal.
The Index is trading at 7 x earnings, the lowest of all equity markets, while EBITDA per share – last line of the table below – is expected to grow respectively by 13, 10 and 17 % in the next three years
Investing in technology
Although we expect a last rally to unfold in global equities in the coming months, we expect the US Tech mega caps to underperform and would be extremely surprised if they were to make new highs.
US technology mega caps are PRICED FOR MORE THAN PERFECTION and their business models are starting to be constrained by both competition – legal actions – and the regulators.
Investors enthusiasm is fading, sentiment is getting far more cautious and everybody will be watching their results for the third quarter now that new privacy rules have been put in place.
The following chart of Apple shows both a sell signal and a very worrying loss of momentum in the moving averages. The rate of progression is slowing and the next two charts show that WE HAVE PROBABLY SEEN THE PEAK in US technology stocks.
We will continue to remain strategically short the US mega tech while trading them actively.
Conversely, it is extremely interesting to take a look at the Chinese technology sector.
We truly feel sorry for US momentum investors like Cathy Wood or Bill Hwang who lost their shirts in the past 6 months to their own excesses. They are now out of the Chinese technology sector at a time where global investors should probably pile into them
A recent study by the excellent Jason Goepfert of Sentiment Trader show that pessimism is at an extreme.
“Few markets have suffered more of a barrage of uncertainty and negativity this summer than Chinese stocks. Technology-related issues have been hit particularly hard from all sides. Based on the last 15 years of history, they’ve reached a point of maximum pessimism.
The most popular domestic fund for trading Chinese internet stocks is KWEB, based on the CSI Overseas China Internet Index. The index has just over 50 member stocks, and it’s hard to find an uptrend among them.
During mid-August, precisely 0% of these stocks were trading above their 50-day moving averages. That spiked to around 40% during a relief bounce and has since slid back under 10% as recently as last week. It’s an even uglier picture when looking at the percentage of these stocks in long-term uptrends. In recent days, only 4% of them have closed above their 200-day moving averages, ranking among the very worst readings in available history.
The plunge in late July caused more than 50% of Chinese ‘net stocks to fall to a 52-week low, only the third time in 15 years that so many have done so at the same time. Many are gyrating around those low prices, and on any given day, between 10% – 25% of stocks have been setting fresh 52-week lows.
The other two times when more than 50% of them fell to a new low, the China Internet Index rebounded quickly, then fell back in the months ahead to test the low during a bottoming process. That’s very similar to what it’s been doing in recent weeks. If it continues to follow that pattern, then it should bottom within the next 20-40 sessions without undercutting its August low by much.
Not only have these tech stocks been falling to new lows, but they’ve also suffered huge drawdowns.
Across the 53 companies in the index, the average stock is down nearly 60% from its 52-week high. The only period that exceeded this washout was the puke phase of the global financial crisis in 2008. During other waves of panic since then, the average drawdown stopped at about 45%.
We have clearly reached a stage of panic in Chinese technology stocks and these phases have always been followed by strong rallies.
Finally, as US and global investors have been selling, Chinese corporations are buying their own shares .
Tencent Holdings, which has an excellent track record at buying its own shares, has authorised and executed stock buybacks almost every day since August 19. While it’s not a significant percentage of its outstanding shares, it’s still the largest in nearly a decade and ranks 4th since 2004. They’re on pace to exceed their buyback binges from 2011 and 2013.
Using this as a signal, the following table shows the performance of Tencent shares 6 months and one year after the company bought its own shares in the past.
As we have highlighted many times since August most of the Chinese technology giants such as Ali Baba and Tencent are trading at hefty discounts from their fair value based on discounted cash flow ,models.
Here is the chart of the Golden dragon Index
The case for being Short US technology mega caps and long Chinese tech stocks is compelling.
Weekly Market Review
SHORTING NATURAL GAS
The energy crisis is all ove the financial narrative and it si mainly due to short term technical bottlenecks following the mismatch of supply and demand after COVID.
But it will ne temporary and OPEC is already increasing Oil supply while China is increasing coal supply.
The most interesting part is that Natural gas prices have shot up to an equivalent of USD 190 if its was expressed in Oil barrel prices.
Time has come to Short Natural Gas.
European inflation at a thirteen year high
Preliminary data showed the Eurozone consumer price inflation soared to a 13-year high of 3.4% in September, after ECB President Lagarde said earlier in the week that there are no signs that recent price increases are becoming broad-based across the economy. Meanwhile, retail sales in Germany rose less than expected in August and manufacturing PMI data was little changed from earlier estimates for both the Euro Area and Germany.
US Inflation still High
For August, US personal income increased 0.2% and personal spending increased 0.8%.
But, the PCE Price Index showed a monthly increase of 0.4%. Year over year, the PCE Price Index is up 4.3%, a bit higher than the previous month’s reading of 4.2% and the Core PCE Price Index increased 0.3% on a monthly basis and 3.6% year over year.
Meanwhile, inflation expectations for the year ahead were unchanged at 4.6%, below a preliminary of 4.7% while the 5-year outlook rose to 3% from 2.9% in the prior month.
US Consumer Sentiment Revised Higher
The University of Michigan’s consumer sentiment for the US was revised higher to 72.8 in September of 2021 from a preliminary of 71 and above August’s 70.3. The current conditions gauge climbed to 80.1, above a preliminary of 77.1 and up from 78.5 last month. Expectations were revised higher to 68.1 from 67.1 and compared to August’s 65.1.
US ISM Manufacturing PMI Beats Forecasts
The ISM Manufacturing PMI in the United States increased to 61.1 in September 2021, up for a second straight month and above market expectations of 59.6. The latest reading signaled one of the strongest rates of expansion since 1983, boosted by solid increases in production (59.4 vs 60.0 in August) and new orders (66.7, the same as in August), as well as a slight rebound in employment levels (50.2 vs 49.0). At the same time, factories experienced longer delays getting raw materials delivered and paid higher prices for inputs.
Canada GDP Contracts Slighlty in July
Canada’s economy shrank 0.1 percent over a month in July of 2021 following a 0.6 percent growth in June. The biggest decreases were reported for agriculture (-5.5 percent), utilities (-3.6 percent), manufacturing (-1.1 percent), and wholesale trade (-1.9 percent), while growth was seen in the accommodation and food services sector (8.1 percent), and transportation (1.1 percent). Looking forward, preliminary information indicates real GDP grew approximately 0.7 percent on a monthly basis in August.
Russia GDP Growth Slows in August
Russia’s gross domestic product rose 3.7 percent year-on-year in August of 2021, following an upwardly revised 4.9 percent rise in the previous month. It was the sixth consecutive month of economic expansion. Output eased for construction (6.2 percent vs 9.3 percent) and industrial production (4.7 percent vs 7.2 percent) but rose faster for retail sales (5.3 percent vs 5.1 percent).
Brent Crude Approaches $79 ahead of OPEC Meeting
Brent crude futures rose toward $79 a barrel on Friday, getting closer to a three-year high of $80.75 hit earlier in the week and after posting a 9.5% jump in September. Investors’ focus shifted to an OPEC+ meeting on Monday, where producers will discuss whether to increase production in November and December to ease supply concerns.
Uranium Retreats from Multi-Year Highs
Uranium futures traded below $44 a pound, having touched an over 9-year high above $50 on September 17th as enthusiasm over buying frenzy by Sprott Physical Uranium Trust eased after Morgan Stanley warned that supply-demand fundamentals did not change over the last months to warrant the price surge. On top of that, Canadian-focused ASX-listed exploration company 92 Energy announced the discovery of a new zone of uranium mineralization on its 100% owned Gemini Project in the Athabasca Basin, Saskatchewan. Meanwhile, the International Atomic Energy Agency has revised up its projections of the potential growth of nuclear power capacity for electricity generation during the coming decades, as the world aims to move away from fossil fuels to fight climate change. IAEA expects world nuclear-generating capacity to double to 792 gigawatts (net electrical) by 2050 from 393 GW(e) last year and compared with the previous year’s high case projection of 715 GW(e) by 2050.
Baltic Exchange Dry Index at 13-Year High
The Baltic Exchange Dry Index rose 0.7% to 5,202 on Friday, its highest level since September of 2008. The capesize index, which tracks iron ore and coal cargos of 150,000-tonnes, went up 1.4% to 9,066, also scaling a 13-year peak; while the panamax index which tracks cargoes of about 60,000 to 70,000 tonnes of coal and grains, dropped 0.5% to 3,992. Among smaller vessels, the supramax index edged up 1 point to 3,383. The Baltic Dry Index gained 12% on the week and about 53% in the third quarter of 2021, largely driven by high iron ore exports and abundant coal imports along with shipping constraints, in particular congestion in China.
THE WEEK AHEAD
All eyes turn to the US employment report next week, which will probably show job growth accelerated in September, as well as worldwide services PMI surveys and an OPEC+ meeting that is expected to offer guidance into the coalition’s production plans.
Elsewhere, key data to watch for include US foreign trade balance and factory orders; Eurozone retail trade; UK house prices; Australia business morale; and Japan household spending and current account. Central banks in Australia, New Zealand and India will be deciding on monetary policy.
Mechelany Advisors MODEL PORTFOLIO
As there are not much variation form our 30 th September report, we will only add here our transaction lits for the week and our asset allocation on Friday.
Transaction List October 1st 2021
CHINA DEEP VALUE PORTFOLIO
Mechelany Advisors’ CHINA DEEP VALUE PORTFOLIO was up +0.66 % on the week ending the first 9 months of the year up +18.76 %.
As we expect significant changes in the US policy towards China, our deep value could be favourably impacted in the coming months by the lifting of sanctions on construction and telecommunication companies. We are also on the verge of a significant move in banks.
It is not too late to invest in the EXANE leveraged index certificate replicating our portfolio.
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