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Sentiment has soured: How will governments and companies respond? (Part 1)

Companies are saying that the Q3 revenues will be down a bit. What’s really happening and how long will this last? Chief Economist for Avalon Advisors, Sam Rines, and a returning guest answers that with our first-time guest Marko Papic, the chief strategist for Clocktower Group.

 

In addition, both the Michigan Consumer Sentiment and the NY Manufacturing survey down as well. Watch what the experts are seeing and what they think might happen early in 2022.

 

Watch Part 2 here. 

 

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This QuickHit episode was recorded on August 19, 2021.

 

The views and opinions expressed in this Sentiment has soured: How will governments and companies respond? (Part 1) QuickHit episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

Show Notes

 

TN: So I guess we’ve started to see some negative news come in with the Michigan Consumer Sentiment with the New York Manufacturing Survey and other things. Most recently, we had some of the housing sentiment information come in. And I’ve heard companies talk about their revenues for Q3 will be down a bit. And so I wanted to talk to you guys to say, are we at a turning point? What’s really happening and how long do you expect it to last? Marko, why don’t you let us know what your observation is, kind of what you’re seeing?

 

MP: Well, I think that, you know, the bull market has been telling us that we were going to have an intra cyclical blip, hiccup, interregnum, however you want to call it since really March. And there’s, like, really three reasons for this. One, the expectations of fiscal policy peaked in March. Since then, the market has been pricing it less and less expansion of fiscal deficits. Two Chinese have been engaged in deleveraging, really, since the end of Q4 last year, and that started showing up in the data also on March, April, May.

 

And then the final issue is that the big topic right now is something we’ve been focused on for a while, too, which is this handover from goods to services, which is really problematic for the economy. We had the surge of spending on goods, and now we all expected a YOLO summer where everybody got to YOLO. It really happened.

 

I mean, it kind of did. Things were okay but, that handoff from good services was always gonna be complicated, anyways. And so I’m going to stop there because then I can tell you where I stand and going forward. But I think that’s what’s happening now and what I would be worried about. And I really want to know what Sam thinks about this is that the bull market been telling you this since March. There’s some assets that were kind of front load. The one asset that hasn’t really is S&P 500, as kind of ignored these issues.

This chart of S&P 500 Stock Market (SPX) is generated from CI Futures, an app forecasting nearly a thousand assets across currencies, commodities, market indices, and economics using artificial intelligence and machine learning technologies. Curious how it can you and your business? Book a time with our expert and get free trial.

 

TN: Right. Sam, what are you seeing and what do you think?

 

SR: Yeah, I’ll jump in on the third point that Marko made, which is that handoff from services or from goods to services. That did not go as smoothly as was planned or as thought by many. And I don’t think it’s going to get a whole lot better here. You have two things kind of smacking you in the face at the moment. That is University of Michigan Consumer Sentiment and the expectations. Neither of those came in fantastically. Today isn’t great. Tomorrow isn’t expected to be great.

 

Part of that is probably the Delta variant, depending on what part of the country you’re in, that is really beginning to become an issue. Not necessarily, I mean, it’s nowhere near as big of an issue as COVID was for death and mortality in call it 2020. But it’s a significant hit to the consumer’s mindset. Right?

 

And I think that’s the part, what really matters is how people are thinking about it. And if people are thinking about it in a fear mode, that is going to constrain their switch from goods to services and the switch from goods to services over time is necessary for the economy to begin growing again at a place that is both sustainable and is somewhat elevated. But at this point, it’s really difficult to see exactly where that catalyst is going to come come from, how it’s going to actually materialize in a way that we can get somewhat excited about and begin to actually become a driver of employment. We do need that hand off to services to drive employment numbers higher.

 

And what we really need is a combination of employment numbers going higher, GDP being sustainably elevated to get bond rates higher. So I think Marko’s point on what the treasury market is telling us should not be discounted in any way whatsoever.

 

The treasury market is telling us we’re not exactly going to a 4% growth rate with elevated inflation.

 

United States GDP Annual Growth Rate
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TN: Right.

 

SR: It’s telling us we’re going to something between Japan and Germany at this point.

 

TN: Yeah. That’s what I’m a bit worried about. And with the consumer sentiment especially, I’m a bit worried about sticky sentiment where we have this Delta variant or other expectations, and they remain on the downside, even if there are good things happening.

 

Do you guys share those worries, or do you think maybe the Michigan survey was a blip?

 

SR: Oh, I’ll just jump in for 1 minute. I don’t think it was a blip at all. I think what people should be very concerned about at this point is what the next reading is. That reading did not include the collapse of Afghanistan. It did not include any sort of significant geopolitical risk that is going to be significant for a number of Americans.

 

Again, it’s kind of like Covid. It might not affect the economy much. It’s going to affect the psyche of America significantly as we move forward. And if consumer sentiment were to pick up in the face of what we’ve seen over the last few days, I would be pretty shocked.

 

TN: It would be remarkable. Marko, what do you think about that?

 

MP: So I’m going to take the other side of this because I have a bet on with Sam, and the bet is, by the end of the year, I’m betting the 10-year is going to be closer to 2%. He’s betting it’s going to be closer to 1%. So he’s been winning for a long time, but we settled the bet January 1, 2022.

CBOT 10-year US Treasury Note
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Here’s why I think I would take the other side of a lot of the things, like when we think about where we’re headed. So first, I think there’s three things I’m looking at. There’s really four things. But the fourth is the Fed. And I’m going to like Sam talk about that because he knows a lot more than I do. The first three things I’m looking at is, as I said, there are reasons that the bond market has rallied. And I think a lot of these reasons were baked in the cake for the past six months, or at least since March.

 

The first and foremost is China. And China is no longer deleveraged. The July 30th Politburo meeting clearly had a policy shift, but I would argue that that been the case since April 30. They’ve been telling us they are going to step off the break. And, quite frankly, I don’t need them to search infrastructure spending a lot. I don’t need them to do a lot of LGFB. I just need them to stop the leverage. And so they’re doing that.

 

And the reason they’re doing that is fundamentally the same reason they crack down on tech. And it has to do with the fact that Xi Jinping has to win an election next year. Yeah. And an election. It’s not a clear cut deal. He’s going to extend his term for another five years. CCP, The Chinese Communist Party is a multi sort of variant entity, and he has to sell his peers in the communist party that the economy is going to be stable.

 

And so we expect there to be a significant policy shift in China. So one of the sort of bond bullish economic bearish variables is shifting. The second is fiscal policy. Remember I mentioned that in March, investors basically started, like the expectations of further deficit increases, basically whittle down. This was also expected.

 

The summer period was also going to be one during which the negotiations over the next fiscal package were going to get very difficult. I would use the analog of 2017. Throughout the summer of 2017, everybody lost faith in tax cuts by the Trump administration. And that’s because fundamentally, investors are very poor at forecasting fiscal policy. And I think it has to do with the fact that we’re overly focused on monetary policy. We’re very comfortable with the way that monetary policy uses forward guidance.

 

I mean, think about it. Central bankers bend over backwards to tell us what you’re going to do in 2023. Fiscal policy is a product of game theory, its product of backstabbing, its product of using the media to increase the cost of collaboration, of cooperation. And so I think that by the end of the year, we will get more physical spending. I think the net deficit contribution will be about $2 trillion, the net contribution to deficit, which is on the high end. If you look at Wall Street, most people think 500 billion to a trillion, I would take double of that.

 

And then the final issue is the Delta. Delta is going to be like any other wave that we’ve had is going to dissipate in a couple of weeks. And also on top of that, the data is very, very robust. If you’re vaccinated, you’re good. Now, I agree with everything Sam has said. Delta has been relevant. It has, you know, made it difficult to transition from goods to services, but it will dissipate. Vaccines work. People with just behavior. So.

 

TN: Let me go back to the first thing you mentioned, Marko, is you mentioned China will have a new policy environment. What does that look like to you?

 

MP: There’s going to be more monetary policy support, for sure. So they’ve already, the PBOC has basically already told us they’re going to do an interest rate cut and another RRR cut by the end of the year. Also, they are going to make it easier for infrastructure spending to happen. Only about 20-30% of all bonds, local government bonds have been issued relative to where we should be in the year. I don’t think we’re going to get to 100%. But they could very well double what they issued thus far in eight months over the next four months.

 

So does this mean that you should necessarily be like long copper? No, I don’t think so. They’re not going to stimulate like crazy. The analogy I’m using is that the Chinese policy makers have been pressing on a break, really, since the recovery of Covid in second half of 2020. They’ve been pressing on the breaks for a number of reasons, political, leverage reasons, blah, blah, blah. They’re not going to ease off of that break. That’s an important condition for global economy to stabilize.

 

Thus far, China has actually been a head wind to global growth. They’ve been benefiting from exports, you know, because we’ve been basically buying too many goods. They know the handoff from goods to services is going to happen. Goods consumption is going to go down. That’s going to hurt their exports. On top of that, they have this political catalyst where Xi Jinping wants to ease into next year with economy stable.

 

Plus, they’ve just cracked down on their tech sector. They’re doing regulatory policy. They have problems in the infrastructure and real estate sectors. And so we expect that they will stimulate the economy. Think about it that way. Much more actively than they have thus far.

 

TN: Great. Okay. That’s good news. It’s very good news. Sam?

 

SR: Yeah. So the only push back that I would give to Marko and it’s not really pushback, given his assessment, because I agree with 99% of what he’s saying. But the one place that I think is being overlooked is, one thing is the fiscal policy with 2 trillion is great, but that’s probably spread over five to ten years, and therefore it’s cool. But it’s not that big of a deal when it comes to the treasury market or to the economic growth rate on a one-year basis. It’s not going to move the needle as much as the middle of COVID.

 

TN: Let me ask. Sorry to interrupt you. But when you say that’s going to take five to ten years, when we think about things like the PPP program isn’t even fully utilized. A lot of this fiscal that’s been approved over the last year isn’t fully utilized. So when these things pass and you say it’s going to take five to ten years, there’s the sentiment of the bill passing. But then there’s the reality of the spend. Right. And so you just take a random infrastructure multiplier of 1.6 and apply it.

 

There’s an expectation that that three and a half trillion or whatever number happens, two trillion, whatever will materialize in the next year. But it’s not. It’s a partial of it over the next, say, at least half a decade. Is that fair to say?

 

SR: Correct? Yeah. Which is great. It’s better than nothing in terms of a catalyst to the economy. The key for me is it’s not being borrowed all at once. It’s not being spent all at once. Right.

 

If it was a $2 trillion infrastructure package to be spent in 2022, I would lose my bet to Marko in a heartbeat. It would be a huge lose for me, and I would just pay up. But I would caution to a certain degree, it’s $200 billion a year isn’t that big of a deal to the US economy, right. That’s a very de minimis. Sounds like a big number, but it’s rather de minimis to the overall scale of what the US economy is.

 

And you incorporate that on top of a Federal Reserve that’s likely to begin pulling back, or at least intimate heavily that they’re going to begin pulling back incremental stimulus or incremental stimulus by the end of 2021 and 2022. And all of a sudden you have a pretty hawkish kind of outlook for the US economy as we enter that 2022 phase. And it’s difficult for me, at least, to see the longer term, short term rates, I think, could move higher, particularly that call it one to three year frame. But the ten to 30-year frame, for me is very difficult to see those rates moving higher. With that type of hawkish policy in coming to fruition, it’s kind of a push and pull to me. So I’m not obviously, I don’t disagree with the view that China is going to stimulate and begin to actually accelerate growth there. I just don’t know how much that’s actually going to push back on America and begin to push rates higher here.

 

I think we’ve had max dovishness. And strictly Max dovishness is when you see max rates and when you begin to have incremental hawkishness on the monetary policy side and fiscal side. And 2 trillion would be slightly hawkish versus 2020 and early 2021. When you begin to have that pivot, that it’s hard for me to see longer term interest rates moving materially higher for longer than call it a month or two.

 

TN: Okay, so a couple of things that you said, it sounds like both you agree that China is going to do more stimulus. I think they’re late. I think they should have started five or six months ago, but better now than never. Right. So it sounds to me like you believe that there will be the beginning of a taper, maybe a small beginning of a taper late this year. Is that fair to say.

Categories
QuickHit

QuickHit: Can Western companies solve the China dilemma?

This week’s QuickHit, we have Isaac Stone Fish of Strategy Risks to talk about how western companies and other companies around the world should deal with China and compromises that you need to do for that. He also shares the status of Hong Kong as a gateway to China. How about the environmental and human rights violations of China and how the US companies can make sure they are running an ethical business? And what is the status of non-profit organizations in China, especially those that are environment and human rights focuses?

 

Strategy Risks quantifies corporate exposure to Beijing. This was started because Isaac got frustrated at the way that ESG environmental, social and corporate governance providers were ranking Chinese companies and US companies that had exposures to China. Isaac thought it would be fun and interesting and hopefully very useful to have a different way of measuring and quantifying this exposure.

 

Isaac grew up in Syracuse, a nice little place but basically about as far away from the center of anything as possible. He started going to China when he was 16 for something different. He started in Western China and ended up living in Beijing for about six years. He also worked in journalism mostly, it was the Asia foreign policy. Spent a few years doing a mix of public affairs, commentating, bloviating, writing, and then started Strategy Risks roughly six months ago.

 

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📺 Subscribe to our Youtube Channel.

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📈 Check out the CI Futures platform to forecast currencies, commodities, and equity indices

 

This QuickHit episode was recorded on February 3, 2021.

 

The views and opinions expressed in this Normalization of China QuickHit episode are those of the guests and do not necessarily reflect the official policy or position of Complete Intelligence. Any content provided by our guests are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.

 

Show Notes

 

TN: It’s really interesting looking at ESG and public markets and I think we’ve seen over the past few years a lot of tensions between China and the U.S. They’ve been there for 10 years but they really took shape over the last few years. If you’re a publicly traded company today in the U.S. or traded on a U.S. exchange, what are the things that you need to really think about with regard to China? What are the biggest risks and biggest considerations that you’re talking to your clients about?

 

ISF: One thing that people overlook is the risks of their China strategy. Not in China itself but globally and especially in the United States. The rules for engagement in China are so different for these corporations in China than they are in the United States. And the U.S. is drawing some pretty thick regulatory lines especially around Xinjiang, the region of northwest China where there are roughly a million Muslims in concentration camps. That a lot of times, these major corporations, their China offices will ignore or overlook or not put nearly enough attention on.

 

The messages that we’re communicating and the things that luckily are starting to bubble up into these board rooms is the understanding that to have a China strategy, you need to have a global strategy that is very aware both of what Beijing wants but also what the Biden administration and many American people want.

 

TN: For the last 15, 20 years it almost seems like companies have had a global strategy and then they’ve had this China strategy off to the side because it was such a big market, growing so fast. It seems to me like you’re talking almost about the normalization of China in terms of performance expectations, social expectations, those sorts of things. Is that right? Is that kind of what you’re implying?

 

ISF: One of the smartest ways of the Chinese communist party, which has ruled China since 1949, were the smartest things they have done is made it seem like their country was a normal country. And there’s nothing aberrant about China or the Chinese people. But there’s something quite apparent about the Chinese Communist Party.

 

And the rules for playing in China are quite different than they are in basically everywhere else. What we’re starting to see is the realization that companies need to do something to limit the influence of Beijing on their corporate headquarters, on their products and on their decision making.

 

TN: But can you do that actually? Because if you’re saying an automotive company and most of your revenues come from China, and the Chinese government says something, it seems really hard. And companies have been awkward about doing that for the past say 10, 15 years. Really changing how you help companies treat them like any other country? I think what you raised about what the CCP has done since 1949 is amazing. It’s great perspective. But can the CCP understand that they’re being normalized as well?

 

ISF: The CCP are doing this as an active strategy in as much as such a complex institution has a single strategy. They’re certainly trying to make people think that they are normal in our sort of western liberalism definition of that. Most of the companies that we talk about in this space, the U.S. is a far more important market for them than China. NBA is a great example.

 

China is its growth market. The USA is its most important market and what companies are starting to realize is that what happens to them in China and what touches China doesn’t just touch on their business in China but affects their business in the United States as well.

 

What we do at Strategy Risks is less working with the companies like the NBA that are having these problems, but work with other people in the financial chains, institutional investors, pension funds, endowments and explain to them the different risks and exposures that they’ll have with the companies in their portfolio and some of the problems they might have with being overweight in certain companies about Chinese or American that are complicit in Chinese human rights abuses.

 

TN: From a portfolio investor’a perspective, until very recently, you could park a whole lot of money in Hong Kong and then dip into China as needed. But it seems that that’s becoming less of an easy strategy since the crackdown in Hong Kong last year. Is that the case or is Hong Kong still in a pretty good place to take advantage of mainland stuff?

 

ISF: From a pure markets perspective, Hong Kong is still an excellent place for that. What’s really changed is the safety and the rule of law and the feeling of security for people doing deals in Hong Kong. Hong Kong is still an excellent window into China and we’re seeing Shenzhen and Shanghai supplanting a lot of what Hong Kong is doing in Seoul to agree. But the issue with Hong Kong is much more for the people there as opposed to the people who are using it as a conduit.

 

TN: That’s really interesting what you say about Shenzhen, Shanghai, and Seoul because I’ve been seeing that take shape over the last five or six years and it’s interesting that it’s getting a lot of traction.

 

With Xinjiang and with other things happening socially in China, what about things like non-profits? Issues that they have to raise in China? How can you operate a non-profit in China and stay true to your mission if it’s kind of awkward with Beijing or with the CCP, which are one and the same?

 

ISF: Most times, you can’t. What’s been happening is that a huge amount of western nonprofits have, sometimes it’s this evangelical view and sometimes it’s just well this is a very important country filled with a lot of lovely people and we want to come here and do good. But they find that knowingly or unknowingly, their message and their mission gets corrupted because they need to work with their government partners. And sometimes, their mission is totally at odds with the mission of the party. And so, they have to make sacrifices that I would say perverts what they’re doing.

 

We see this perhaps most intently in both the very human rights focused nonprofits and in the environmental focused non-profits. A lot of whom have found themselves being very praiseworthy of what Beijing is doing even though China’s far and away the worst polluter and the worst carbon emitter. They take signs coming from top leaders that Beijing is committed to making these changes even though the changes often don’t get made. But they are finding themselves in a position where in order to be there, they have to sacrifice some of their credibility. A very heartening sign I’m seeing is people saying, maybe I don’t actually need to be in China in order to do something that’s positive for the world.

 

TN: Do you see a path to China having that type of environment in 5, 10, 20 years time? Or do you think we’re kind of on this this really is it slower than that?

 

ISF: It’s such an important question and I wish I had some good way to answer it. In China, as Chinese officials love to say, has 5,000 years of history. The Communist Party has been in power for what, one and a half percent of that time. At some point, in the near future, the party will no longer rule China. Will that be next year? Will that be 30 years? Will that be 200 years? It’s so hard to say, but it’s certainly not inevitable.