David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Hot Spots

    Thanks to a subscriber for this report from KKR which may be of interest. Here is a section:

    What to do with China: Stay the course, but get more local. There are many reasons to worry about deploying capital in China these days. Geopolitical noise is high, with the recent intentional China currency weakening, the U.S. selling military equipment to Taiwan and Hong Kong poised to celebrate China National Day on October 1, 2019, more bumps in the road likely lie ahead. Moreover, the economy is now also clearly feeling the adverse impact of a decade-long debt stimulus program, and we believe that disinflationary forces are likely to keep a lid on pricing power. Finally, the ability to realize capital gains is becoming tougher as pulling capital out of China is now more difficult and/or seeking liquidity through the U.S. IPO market is likely to become more constrained.

    However, China remains a core market where investors need to be active locally for several reasons. For starters, the shift we are seeing in technology – and the delivery of goods and services related to technology – is unlike anything else we see in any other market in the world. As such, we all need to learn more about and invest meaningfully behind these changes. In addition, given the rise of the Chinese millennial, we think that there is considerable money to be made as these 330 million individuals come of age.

    Investors also need to work harder to better understand the rules of engagement to ensure that they are backing initiatives that do not conflict with the government’s agenda. Doing so will create significant opportunity because China still needs an increase in GDP-per capita to meet its stated 2020 goal of doubling total GDP since 2010. In our opinion, healthcare, food safety, travel, leisure, and wellness are all areas of significant investment potential, as they represent areas where the government wants and needs private sector support to continue to improve the quality of life for its population of approximately 1.4 billion.

    Finally, given the uncertainty, we think that the opportunity to buy complexity at a discount is significant. Beyond just acquiring positions through the public markets (which is becoming a more relevant opportunity set for PE firms), our conversations in Beijing with senior executives lead us to believe that there is a forthcoming wave of deconglomeratization in China that could soon rival what we are seeing in Japan these days. Simply stated, multinationals are increasingly of the mindset that doing business in China as a foreigner is getting tougher, not easier. If we are even partially right, this opportunity could be quite meaningful to KKR’s Private Equity, Real Estate, Credit, and Infrastructure franchises over the next five to seven years, we believe.

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    German Profit Warnings Signal Trade Woes May Trigger Recession

    This article by Jan-Patrick Barnert for Bloomberg may be of interest to subscribers. Here is a section:

    Industrial companies have fared worst during the second-quarter earnings season. Expectations for German businesses were comparatively low, but even so, only 41% of them managed to beat sales estimates. The ratio is well above 50% in France, Italy and Spain.

    The consequences are starting to be felt. Unemployment rose by a total of 62,000 in the three months through July and demand for new workers continued to soften. That’s bad news for a country hoping to make up dwindling exports with consumption and investment. Domestic demand still supported the economy in the second quarter but that might change once uncertain prospects prompt companies and households to rein in spending.

    Economists at Deutsche Bank AG and ABN Amro Group NV see Germany’s economy contracting again in the third quarter, pushing the nation in recession -- it’s first in six and a half years. Many more analysts say the risk of such a scenario has increased significantly after Wednesday’s report.

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    Corbyn's Plan to Stop a No-Deal Brexit Is Dead

    This article by Therese Raphael for Bloomberg may be of interest to subscribers. Here is a section:

    That puts paid to the idea of a national unity government for now, unless Corbyn were to back down and accept another figure in charge (pigs will fly first). The various other blocking options, detailed in a column earlier this week, offer little confidence to those wanting to stop no deal either. Probably the best chance, short of a change of government, is for the opposition to force through legislation that requires an extension of the deadline. House of Commons Speaker John Bercow would be instrumental in this and he seems to be bullish.

    “I will fight with every breath in my body to stop that happening. We cannot have a situation in which parliament is shut down. We are a democratic society and parliament will be heard,” he told an Edinburgh festival audience this week.

    Binary choices in politics are like truth serum. Theresa May offered her deal or said the country would head toward a no-deal exit. Lawmakers refused her deal. Offered the prospect of Johnson’s no-deal exit or Jeremy Corbyn in Downing Street, they again took a pass at the alternative. Perhaps they still believe a no-deal Brexit can be averted through other means, or else they are willing to accept it and go to an election laying the blame elsewhere (the government, parliament, the EU). Either way, it’s not very reassuring.

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    Macro Outlook: Will the Fed's Pivot Save the Day? Guggenheim Partners

    Thanks to a subscriber for this report by Brian Smedley for Guggenheim may be of interest to subscribers. Here is a section:

    The U.S. economy is slowing as headwinds mount and tailwinds fade

    The labor market is tight but is beginning to lose momentum, a clear late-cycle signal

    Our research continues to point to a recession beginning in H1 2020

    The next recession could be prolonged due to limited policy space at home and overseas

    A looming recession means reducing risk, upgrading credit quality and extending duration

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    U.S. Delays 10% China Tariffs on Some Holiday-Shopping Favorites

    This article by Jenny Leonard and Shawn Donnan for Bloomberg may be of interest to subscribers. Here is a section:

    While some tariffs will take effect on Sept. 1 as planned, “certain products are being removed from the tariff list based on health, safety, national security and other factors,” the USTR also said.

    About $250 billion of Chinese goods have already been hit by 25% duties.

    Chinese Vice Premier Liu He talked with USTR Robert Lighthizer and Treasury Secretary Steven Mnuchin by phone on Tuesday, according to a statement posted on the Ministry of Commerce website. Another conference call is planned again in two weeks.

    The tariff announcement came shortly after Trump insisted again that his levies were not causing higher prices for American consumers and that China was bearing the cost of them. Economists and businesses have disputed that last point.

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    Email of the day on the ramifications of negative yields

    See yield chart middle page 1.  How low (negative) can govt credit yields (-1%) go till the financial system freezes over?  Serious Q……………this negative yield stuff wasn’t taught in Economics 101.

    There must be an absolute level of negative rates that destroys money velocity (V) as it means no one puts money in the bank anymore and lending gets restricted.  At -10% I wouldn’t lend to UBS.  What happens at say -5%?  Assuming a real rate of 3%, bank lending -after a margin of say 2%- would essentially be FREE (0%).  But what does that do to banking system integrity (banks make money but less of it as their margins collapse; their deposit base shrinks as they struggle to increase/ attract deposits………….not only do depositors go on strike but existing depos are decreased annually by negative yields!)….and what about regulatory oversight?….would CBs and regulators afraid of imprudent lending caused by needy borrowers at 0% step in to restrict the very process that they are trying to encourage via making money so cheap?  i.e. will they try to stop “BAD” lending.  How will they judge/enforce?

    And where does inflation fit into this calculus?...without any inflation the interest rate structure/ yield curve that might restore banking margins is hard to normalize/ become positive again.

    Or should governments everywhere borrow vast sums at negative rates for 50 years to finance a massive infrastructure spend (highways, 5G, clean energy, railways etc.) i.e. “GOOD” lending?  Wouldn’t this raise rates and restore normality?  Then what debt / GDP levels are prudent (see Italy)?  I recall Argentina’s 100-year bond issue in 2017 at 7.9%, 3x over-subscribed by famished yield scavengers.

    Investment implications

    • Negative bond yields unattractive versus investment in high quality equities paying well covered dividends, though it is certainly not a good world for poor quality companies who don’t
    • How is any of this bad for gold, whose carry cost is collapsing?


    Just sharing some thoughts, largely written out of confusion

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