I am doing a spot on CNBC Squawk Box tomorrow morning to talk about what’s going on in China and its connection, if any, to the big Friday sell-off of global stock markets. As you will see below in the talking points I sent the producers to brief the anchors, a pretty small event in China–a modest drop in their manufacturing purchasing manager’s index–is triggering a very big reaction from investors. I have no idea how to forecast this sort of thing but I am pretty sure of a few things: 1) the developed countries are starting to grow again, 2) rising US interest rates this year are forcing investors to sell tons of emerging market assets they spike their yields while rates were zero here, 3) there is still almost $3 trillion in excess bank reserves in place that are finding their way into rising business loans and asset prices. As long as these conditions remain I want to be fully invested in US assets. My favorite stock and biggest position for some time has been Blackstone (BX). They hugely benefit from increased bank lending. The talking points are below FYI:
-Investors seem to have their finger on the trigger, with small bits of news leading to big price changes.
-One of those small bits of news was the weak china growth news that triggered a big Friday sell-off.
-HSBC “flash” China manufacturing PMI January report 49.6 (50.5 December).
Translation: China manufacturing is likely to fall a little in coming months.
most components down (orders, jobs, backlogs, prices, delivery times, inventories)
but Jan OUTPUT index actually increased to 51.3 (51.4 in December)
-Couple things to remember.
This is a “flash” (preliminary) report–final report 1/30.
HSBC report has more small companies than next week’s (2/1) official report.
-Manufacturing will continue to be weak relative to services as govt tries to rebalance from too much infrastructure spending and manufacturing to more service sector jobs. Low growth in US/EU/Japan also a factor. Some migration out of Japan to cheaper sites (Vietnam).
-The small company story is important. Central bank has been trying to “rein in” the shadow banking sector (black market in loans) since last summer when interest rates spiked. This is where China’s small, fast-growing companies get their working capital. There is a structural problem in China. Big banks only lend to big companies; there is no formal lending channel for small, private companies. Most of China’s growth, and most of capital spending, comes from these small, private companies. China needs a way to provide steady working capital for these companies, which is why growing more small private banks was in the reforms announced last month.
-There is no banking crisis in China although there are some bad loan issues with China’s non-bank lenders (trust companies), especially their loans to local governments to finance infrastructure projects in recent years.
-Property prices are rising again but no bubble there to pop because there little debt financing and no securitized mortgages.
-Chinese government is concerned with stability, but more worried about creating enough jobs, containing pollution and corruption, and providing enough affordable housing to avoid political ‘unrest’ than debt or banking issues.
-Bottom line: China will continue to grow but at at gradually declining rates for a long time. Investors will be spooked every time there is a new number.
-In addition to the specific China story, there is a much bigger global story in play. The death of the carry trade.
-world is growing a little faster this year but it is the developing countries (US, EU, Japan) that are improving. They don’t buy commodities, they buy iPhones and copy paper.
-The emerging market carry trade is unwinding. In recent years weak growth in developing countries has kept interest rates at zero (QE) so investors borrowed in dollars to buy emerging market assets at higher yields. This made hot money problems in emerging markets. Stronger growth and rising rates now in the US are forcing investors to sell their emerging market assets, which means soft growth, weak stock markets, soft commodity prices there.
-Biggest upside opportunity 1) US asset prices driven by $3 trillion in excess bank reserves left behind after QE. (leveraged finance (e.g., BX), real estate best way to capture it and my 2 biggest positions today.
-Biggest risk 1) US long-term interest rates are going much higher. 2) Assets that depend on low US rates for support are going to get killed, including interest sensitive stocks and emerging market stocks and currencies. There are 40 reasons why I never encourage investors to invest directly in Chinese stocks, but to do so through ‘surrogates’ (BHP, RIO, FCX)in safer places (Australia, Korea, US,…) but this is not a time to buy them either because growth in China is not high enough to support rising commodity prices today.
So I am fully invested in US stocks but am staying away from bonds and emerging market assets for now.