China is launching a major offensive for headlines with the EU. Wen’s comments over the weekend were his strongest and most pointed yet as he warned of the possibility for “huge downward pressure” on the economy. At the same time, inflation was reported at a very modest 2.2% leaving open the possibility of additional near term stimulus. Additionally, Wen, in separate comments, remained resolute in keeping property prices under control. As much credit as is inexplicably given to China by way too many strategists for ultimately being able to manage their downturn and draw a line in the sand at nothing less than 7.5 – 8% GDP growth, Wen does not seem as sanguine. Whether China ultimately experiences a hard landing remains an unimportant conclusion at this point as that is the direction they are moving toward. The bursting of their property bubble will be much more damaging to their economic future than was to the US when ours fizzled given that so many important Chinese cities have relied upon land sales and borrowing for their out-sized infrastructure spending. It’s one thing for an individual to be upside down on their mortgage, but quite another for a large portion of a country to be in that position particularly when so much of the world’s economic growth has been dependent on China’s previous voracious appetite for commodities, machinery, etc.
But wait – there’s those trillions in reserves that China is going to shower on the economy much like an NFL defensive back at a “gentleman’s” lounge. My view is that China, continuing to think long term, would rather see asset values to decline meaningfully so that they can swoop in and acquire them. It’s not only asset prices that soften, but also political resistance in the targeted countries as the fate of elected leaders is tied to declining personal fortunes of their constituents.
Steel stock rally? Done before it started. Angang Steel said it will report a loss of 1.98 billion yuan for the first six months compared to a profit of 220 million yuan last year. Angang is China’s largest HK traded producer of steel. Despite this, China keeps adding to its steel capacity and keeps running its plants at capacity, more concerned with employment levels than price realization. It’s expensive to shut down capacity in steel and it remains the industry with the highest costs of exit. Sector will bounce around but direction is lower. Take a lesson from coal (PCX bankruptcy filing) and stay away.
And within the backdrop of all this, those optimistic about the market say all the bad news is fully discounted. After all, once it’s in print, see yesterday’s WSJ’s article on the earnings season – it is immediately old news. That’s an interesting thought considering that the S&P is up mid-single digits this year while expectations on global growth have been ratcheted much lower. Seems like a disconnect to me. I’m not looking for a major sell-off but a slow ebbing of the averages.
Meanwhile, back in Brussels, the framework announced out of the latest – that is the 19th, EU meeting to solve their financial crisis, has hit a predictable speed bump as Hollande offered that a more unified political and banking system will not happen as quickly as thought while Germany remains resolute in requiring government to be the ultimate guarantor for the debts of troubled banks. Seems that the Europeans don’t yet realize that substance is actually longer lasting than headlines. Not sure the markets realize this either.
So here we go again. Rather than focusing on current fundamentals, the markets pin their hopes on major fiscal policy moves by China, the US and, of course, the EU – hoping coordinated easing becomes reality, stimulating spending, credit and investment. Could be but I still don’t see an immediate, significant QE3. But there is good news: the EU has set the bar very low.
There is value to be found. I still believe the Euro is overvalued relative to the USD; that higher yielding equities with good fundamentals will continue to offer a good total return (mortgage reits, telco); and certain areas of energy remain attractive longer term such as natural gas and special situations. TOT has a monstrous yield and HK, a build it and sell it story run by someone who has built it and sold it multiple times before (Petrohawk being the latest), is in a great spot, being able to acquire assets cheaply with financing both available and inexpensive. I mentioned on CNBC on Thursday that I was starting to rebuild a position in WLP. This group is also inexpensive, but I would wait for a pullback after yesterday’s action. Sentiment has been horrendous and MLR’s are likely going higher this quarter, but in an industry with changing fundamentals, the smart players find opportunity.