2021 has already had a few of these moments so tossing in an earthquake would seem to make sense.
The good news is that there was very little damage so we can tuck that one away to experience.
In bigger news, after 57 years, Melbourne has won a AFL premiership. To give this some context, when they last won a premiership (1964), the Vietnam war was in its early stages (1955 – 1975), JFK had just been assassinated (Nov 22, 1963), Martin Luther King Jr had just won the Nobel peace prize and Sir Robert Menzies was the Prime Minister of Australia (Prime Minster 1949 – 1966, although he was also the Prime Minister from 1939 to 1941). The Americans were also yet to land on the Moon!
In fifty-seven years time they may well be talking about the Covid-19 pandemic as ancient history and Hannah, our diehard Demon’s supporter, could be celebrating their next win though she would be 79?
But on to investments and the truth is there is a lot going on and the endless dialogue about Covid-19 is drowning out information that may have much bigger impacts both domestically and internationally.
China, China, China!
China has been our largest trading partner for the last two decades after replacing Japan who was our biggest partner into the 90’s.
Due to ‘philosophical differences’ (little things like the origins of Covid19 and human rights violations and abuses) China decided to flex some trade muscle in regards to our trade relationship. Australia is not that special! The UK, Canada, Japan, US and EU have all been having their own issues.
Trade issues aside, we shouldn’t ignore that Xi Jinping is dragging China well and truly back down the totalitarian track. This is under the guise of common prosperity Time: Common Prosperity for China
Those of you watching current market volatility are seeing the impacts of this.
- Investors in the Chinese market are very concerned about the ‘redistributing’ of wealth and abandoning shares that are being targeted by the Chinese Communist Party (CCP). These include e-commerce companies, Real estate developers (most obvious with Evergrande, China’s largest property developer), private tuition companies (big business in China) and the gaming sector. Up to $1 trillion (US) wiped off valuations since February.
- The CCP may also be bringing in property, inheritance and capital gains taxes to reduce the accumulation of wealth in the uber rich – some of this may also be about reducing influence.
- The CCP has been reigning in dissenters like Jack Ma, CEO of the e-commerce giant Alibaba. Jack criticised the CCP and he, his company and the ANT IPO have suffered for it.
- Media and movie stars are being ‘cancelled.’
- China has banned the lucrative tutoring sector. This has an impact for Australia in regards to international students but will be much more concerning for the Chinese community that values education and spends generously in this sector. China Crack down on Tutoring
It is important to remember that China has only been controlled by a communist regime since 1949, which is a very small part of its rich history.
- Membership of the communist party sits around the 90-95 million of the country’s 1.45Bill citizens – around 6%.
- The rise of Mae Zedong was brutal but was also against a back drop of an already flawed structure. A very précised read can be found in this link China before and after the communist revolution
- Debatably the communist party retains power if its citizens believe they will continue to have a better life under the regime. Yes they control the media and the party leadership dictates to the National People’s congress but like all governments, they need to keep their citizens happy or eventually they lose them.
I only provide the above because it is important to understand what is happening with our biggest trading partner and the lens through which they view the world.
Evergrande. ABC: China Property Bust Evergrande
The failure of Evergrande leaves the CCP in a quandary. Arguably they don’t want to be seen to be supporting a highly leveraged property developer and one could argue, they probably don’t really care about the bond holders who have provided that leverage. Evergrande has up to $400 billion in liabilities, which includes loans from Chinese Banks and onshore and offshore bonds.
The quandary is;
- They are big employer (they employ over 123,000 people)
- They have a huge amount of construction going on. A large part of that construction is the Chinese consumer building houses/apartments.
- The article in the link above talks to 1.4 million uncompleted apartments that have been bought off the plan.
- While there may be some contagion impacts around the world, the contagion in China is already much bigger with share prices of other property companies plummeting.
This is not a good look for the country that wants to be the world’s largest economic power and it is hurting the consumer.
The other elephant in the room is of course the origins of Covid19. This has been very damaging to China’s public standing and you can imagine Xi Jinping takes any criticism personally as it happened on his watch. While the You Tube link here is very entertaining, this is not something the CCP would appreciate – definitely worth a watch though. Jon Stewart on the late show
A last point on China. Since the GFC, China had seen a surge in Government debt as it provided massive domestic stimulus packages. Chinese government debt is now at 230% of their annual Gross Domestic Product (GDP).
To put this into comparison, Australia Government Debt is 28.6% of GDP, thanks to a much better result than expected in the 20-21 Financial Year.
This reduces China’s ability to spend huge amounts on a military build-up and also helps explain why China’s largest companies are making very large ‘voluntary’ contributions to the ‘Common Prosperity’ ideology.
Politics 101 is, when you are in trouble, distract the masses, so some would argue the friction we are seeing with trading partners and neighbours is to divert attention from domestic issues.
Australia has felt the brunt of this but there is also sabre rattling in the South China Sea, political influence thought the Chinese belt and road initiative, cybersecurity issues, the annexation of Hong Kong and the aggressive dialogue about Taiwan.
With Covid news dominating the front page, this sort of information is generating very little commentary.
Really there is a lot of good news for Australia at the moment
A vastly improved deficit outlook, very low levels of unemployment, the vaccine roll out is accelerating and we can see international travel reopening in the not too distant future. NSW has led the way in management of the opening and other states can look at the impacts both there and in the UK and US and follow the same trajectory without some of the now established concerns.
The property market is booming and retail shopping is still doing very well.
Internationally, the US, UK and Europe are all coming out of the forced Covid recession and productivity and growth is improving rapidly.
So why are markets nervous?
As we know markets generally react to forecast returns and the very impressive last 15 months of returns were predicated on a V shaped recovery. We were coming off a low so returns looked very good for the one year, a bit more modest over three years.
We are now seeing the headwinds that will come from a slowing Chinese Economy. Our Iron Ore exports are likely to drop as building slows in China and export demand for Chinese goods has also taken a hit.
In the US, corporate earnings growth has been high but valuations on the underlying equities, especially in the top 5-6 stocks, are pretty ridiculous.
- Tesla has a Price to Earnings (P/E) ratio of 225 – as at 30 Sep 2021 (Average PEs used to be 16-20).
- The US is dealing with the ‘Biden’ agenda and he has been far more active than the analysts expected and that isn’t a good thing for company profits.
- Corporate taxes have been lifted from 21% to 25% and might go up to 26.5%.
- The Federal Government has started to taper its bond purchases which is allowing interest rates to edge up and of course,
- We are starting to see inflation, some from supply chain disruption, but also from wage growth, energy cost increases and medical costs which is less transitory.
Europe has had similar concerns both about the US tapering its bond purchases and the domestic governments reducing their Covid relief packages.
- We have also seen the German elections which leaves a lot of confusion and
- Generally a drop in global commodity prices. This has impacted steel, oil, copper, aluminium and Zinc.
So where are we sitting…
We were probably more concerned about markets prior to this recent softening. Yes share markets have dropped but our active managers have performed quite well and most of the news I have shared above was something our analysts have provided over the last two months.
Portfolios had already been repositioning and we took profits through the reweights on the 30th of June and 30th of September (last night) – this is for clients within our model portfolios.
In the last month we have seen our portfolio managers taking profits, as some stocks have become very expensive and there has been better value in other market sectors. The Iron Ore trade is a good example where there have been warning signs for some time and some consumables are looking more attractive again.
In volatile markets, good active managers can add substantial value and this is being demonstrated by managers like Franklin Templeton, Hyperion and Bennelong.
We are not particularly bullish but also not seeing events like Evergrande causing serious structural market change.
As per our usual updates, most of this information is already built into our portfolios and positions that need to be changed have already been adjusted.
This does not mean we won’t see capital volatility but our portfolio managers will generally have a smaller drawdown than the market and historically have recovered more quickly.
As always, if you have any concerns, please do not hesitate to contact us.
One month closer to ‘post pandemic’