Monthly Insights from Goldman Sachs
This week’s title links to the title of our October Monthly Insights, that we published yesterday, a copy of which is attached. In it, I ponder the big investment issues of our time, and question whether – at least from an investment perspective – this widespread belief about how uncertain everything supposedly is, is actually more of an emotional state about investors who crave certainty rather than anything else. Seen in the context of risk versus return, and especially the issues surrounding the equity risk premia (ERP), and with reference to long-term valuation techniques, it is not clear to me that current times are any more uncertain than they always have been. Moreover, as indicated by a high ERP and many regions of the world’s equity markets remaining so cheap compared to long-term valuations, this suggests that many are too obsessed about these supposed uncertainties. Anyhow, more of that in the attached.
It is against this background that I have thought about the latest news flow over the last week, from around the world.
IMF/World Bank Meetings.
These annual meetings took place in Tokyo this week, and for the second year running, I passed on attending. I shall be in Tokyo next month so it was not sensible for me to be there now as well. Many of the meetings relate to usual topics including the complex issue of whether the IMF will actually implement agreed changes for quotas on time, and whether they have agreed to implement a new procedure for allocating voting rights and shares by January 2013, as they are supposed to. According to some of my sources, if they continue to drag their feet, this will annoy some key Growth Market economies sufficiently. So much so, that they will simply conclude that the IMF is losing its relevance, and indeed, the idea of a BRICS Development Bank will get more ’buy-in’ from the key players. The role and decisions of China are obviously key here, as in so much else.
IMF Head, Lagarde, appears to be trying to send a different tone on fiscal policy to those tightening, especially in Europe, after evidence is growing that the so-called ’multiplier’ might be higher, i.e. tightening weakens cyclical demand more than thought before. Predictably, German policymakers are none too responsive.
One other small aspect that caught my eye, amidst all the pessimistic-styled pieces about GDP forecast downgrades, was the upgrade to the Philippines, one of our beloved N-11 countries. The FT carried an interesting piece about the country on Thursday.
China, China, China!
We await the release of Q3 China GDP figures and all the usual monthly data and we are now just over three weeks from the change in leadership. There are some mumblings this morning that the September data might be stronger than expected.
Lots of interesting things caught my eye as usual regarding China this week.
Having been off for their big holiday season, Chinese financial markets came back last week with a modest rally in equities and, interestingly, some renewed strength in the RMB, taking the US$ exchange rate to its strongest level since 1994.
Ahead of the leadership change, my mind remains highly focused on the shift from ’quantity’ to ’quality’ in China, and for what it is worth, my rumbles suggest that the incoming team will demonstrate its clear commitment to reform and accelerate some of them. One person who knows Beijing better than me, seems to think if the new top echelon has only seven people within it as opposed to nine, then that is a particular good sign.
Linking back to some of the issues I have touched on in recent weeks, I gave a talk at a well-known private school in the Midlands early last week (I know someone who teaches there), and afterwards I had a drink with some of the staff. The school has a number of students from both mainland China and Hong Kong, and to my surprise, the staff suggested that those from the mainland were generally more open and eager to mix.
Rather by coincidence, the following day I discussed China with people at two other educational establishments of a very different nature. One was for some students in a tough neighbourhood of London and the other, a top University. It is good to see more people realizing the scale of opportunity from this remarkable story.
Talking of such matters, as well as creativity and change, the Nobel Prize for Literature has gone to Mo Yan, something which appears to be being widely and wildly greeted in China.
Ahead of the data, the latest Chinese auto sales were weak, dropping by 0.3%. What is unclear is how much the disappointment was driven by the anti-Japan feelings, but the suspicion is possibly a lot, as the sales of Japanese auto-companies fell sharply. Toyota fell by 49% compared to a year ago. As I shall discuss later, is this latest unfortunate escapade something that will force the Bank of Japan to be serious about stopping deflation, or will it force them to be less independent?
The FT had a most interesting piece about the ongoing huge success of BMW in China, citing a 33.5% increase in sales year-to-date. So much so, that China is now their largest overseas market.
On the same opportunities for western firms, Anna Stupnytska pointed out to me that Karen Millen, the UK-based women’s retailer announced plans for a big China expansion, which along the lines of ’luxury-lite’ is the sort of example I would imagine will increasingly come to the fore.
Not to miss out, the FT reports today that Ken Clarke has been asked to help promote the British Health Service, the NHS, to China. See; look how useful hosting an Olympic Games can be?
I enjoyed a very interesting conversation with our own Alison Lau, who runs the asset management business of our Chinese cousin, Gao Hua. Alison had picked up on some of my recent musings about the new ’quality’ China. She felt it is a better time to select China stock pickers, or perhaps as she implied, sector pickers, instead of just passive index plays. Alison reminded me that through Gao Hua, we think about constraining for portfolio volatility via the GIVI (Global Intrinsic Value Index) methodology. She has a neat presentation which shows our preferred approach, which constrains more than the S&P GIVI index, resulting in different allocations from the norm. This sort of thing will become more and more sensible. I found myself thinking perhaps one should develop a ’five- year-plan-based benchmark’ for Chinese equity investment….
US Continuing To Creep Better?
There were no big data releases in the US last week, with most of the attention on the drama surrounding the opinion polls and the sudden possibility that Romney might emerge. Weekly job claims showed another big drop, but there is a hint that it is an odd seasonal figure. If this is not reversed next week it will be most interesting, especially after that impressive drop in unemployment to 7.8% last month. The latest US trade figures came in with a deficit around $44 billion, a bit higher than expected. But trawling through some of the detail, I was struck by the fact that the level of US exports is now around 80% of the level of imports, which for someone who has been around for the decades that I have, that is quite an ongoing change. Moreover, for the year-to-date deficit through August (the US is so slow to report its trade data), the nominal deficit is $374.4 billion, just $5 billion higher than a year ago despite the economic rebound. This suggests the US is making progress on reducing its external imbalance as a share of GDP. This adds to the positive picture shown by the Q2 BOP current account improvement.
We had a very interesting discussion about the recent election debate and the polls, and some of our macro team are quite confident that if Romney now goes on to win, it would have big consequences for markets. This is not least because they believe the forward-money market curve would take out some of its confidence about how long the Fed will stay so generous, as well as a possible reduction in the ERP. I found myself wondering whether indirectly – due to the forward rate differentials – this could be rather bullish for $/Yen (but I find that idea frequently too easy to consider J). Anyhow, there are no two-ways about it, the swing in the polls means we will all be on tenterhooks for the next Presidential debate, and the big day itself.
Noise, but No Real News in Europe.
Not much real news this week, but plenty of noise as usual. Spanish downgrades received all the attention one might expect, but interestingly little market reaction. As I mentioned, there appears to be a bit of a spat between the IMF and Germany on the appropriate degree of near-term fiscal tightening in the Euro area. According to the FT, Merkel is suggesting that the government is exploring the idea of tax cuts, not least as it would help boost imports from the rest of the Euro area through higher German consumption. In addition, Italy positively surprised with a bounce in industrial production, although to my eyes, given the jump in their September PMI, it shouldn’t be a surprise.
Perhaps the most interesting Euro-area-related news was the collapse in the EADS merger talks. According to the media, the talks failed because Germany couldn’t get what it wanted. Let’s hope this isn’t a sign of broader things going forward on EMU matters. Meanwhile the uncomfortable standoff between the Spanish, German authorities and the ECB continues, leaving the European bond markets a bit suspended.
UK Exporting Its Future.
Here in the UK, the autumn political party conference season came to an end with the Conservatives hosting their conference. The Prime Minister, Cameron, gave a rousing speech in which some of his words had a familiar ring to it. He was talking about the growing importance of the likes of China, Brazil, Indonesia, and the following little nugget popped up: “China creates the equivalent of another Greece every 3 months”. When I was told about this, it was rather convenient as it allowed me, a few minutes later, to mention it at a couple of speeches I was making that day. One interesting person remarked to me that I should have told him, given the weakness of Greece, it is now every 11 and ½ weeks. Most amusingly, he also asked “do you think he might be saying in a few years that China might be creating another UK every three months?”
I spent quite a lot of time talking to various UK audiences this week, and it feels to me as though business and thinkers are really starting to understand the huge opportunity for our exports to step-jump in the future; the NHS idea I mentioned earlier is a perfect example.
Japan. Time for Change?
Following some events and a one-on-one meeting, a couple of investors picked up on our CAPE valuations (they can be seen in the attachment) and asked why I was only highlighting the cheapness of the Euro area and the Growth Markets, and not Japan? This was a very good point indeed, as Japan is looking very cheap by its own past standards. Of course, just as with the other cheap markets, the ‘cheapness’ can sometimes be because there are things going on that people don’t like. In Japan’s case, where does one start? Poor demographics, weak service-sector productivity, declining international edge for its past cutting-edge companies, cultural isolation, disputes with China, huge challenges on energy requirements, declining savings, deteriorating balance of payments, a debt outlook that makes Greece’s seem respectable, and a central bank that has an inflation target it doesn’t seem to really treat seriously. No doubt there is more…
But they do have Kagawa, and he is proving to be quite a catch for Manchester United so far. Not that this alone is sufficient for the Japanese equity market to turn. But there are two interesting issues. One, is there anything else that could possibly go wrong that hasn’t in Japan? Two, there appears to be more and more pressure building in the background for the Bank of Japan to shift its fundamental approach to its monetary policy. And even the IMF is now saying that the Yen is overvalued. Are we finally close?