Novum Alpha - Daily Analysis 11 November 2021 (10-Minute Read)
Traders are contemplating the prospect the Federal Reserve raising rates as soon as it completes the tapering of bond purchases by the middle of next year.
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A terrific Thursday to you as markets take a turn for the worse.
In brief (TL:DR)
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In today's issue...
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Market OverviewThe argument that price pressures are temporary due to pandemic-related distortions is under pressure.
Traders are contemplating the prospect the Federal Reserve raising rates as soon as it completes the tapering of bond purchases by the middle of next year.
A more hawkish outlook is a risk for global stocks, which remain near record levels.
In Asia, markets were mixed on Thursday's morning trading session, with Tokyo's Nikkei 225 (+0.75%) up, while Hong Kong's Hang Seng (-0.25%), Sydney’s ASX 200 (-0.49%) and Seoul's Kospi Index (-0.49%) all lower on inflation concerns.
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1. China's Property Bubble Unlike Japan's
Investors struggling to understand the real estate crisis in China may look to the experience in Japan as a precedent to figure out what happens next.
To be sure, China’s real estate slowdown, its worst in years, have seen some asking whether the end of Japan’s real estate bubble in the early 1990s offers a guide.
But research from Bloomberg Economics suggests that it does not.
Japanese real estate price growth in the 1980s was far in excess of the growth of Japanese GDP, while in China, the opposite has been true over the past decade.
While Japan’s real estate prices relative to GDP more than doubled from 1980 to 1990, when prices peaked, in China, that ratio has dropped about 40% over the past decade as gains in property prices lagged the economy’s rapid expansion.
That suggests that rising demand for real estate in China has been supported by actual increases in productivity in other areas of the Chinese economy and there may be more than anecdotal evidence to support that view.
For starters, China has poured billions of dollars into electric vehicles, semiconductor manufacturing and green energy initiatives, outside of the billions of dollars spent on infrastructure.
And while the western media has enjoyed waxing lyrical about the dozens of “ghost cities” built in remote regions across China, some of those cities are actually starting to fill out, literally a case of build it, and they will come, albeit eventually.
With some 1.38 billion Chinese, improving farming techniques has seen a constant net migration into Chinese cities and with it, a demand for real estate as well as the birth of property speculation, long a pastime of the west.
According to Bloomberg Economics, another key difference between the experience of Japan and China is that while Japan was at the end of its period of catch-up growth, with per capita income levels comparable to those in the U.S., GDP per capita in China is currently less than a fifth of U.S. levels.
In other words, there’s probably a lot more room for household income growth in China to support housing demand.
And that may be why Goldman Sachs (-1.54%) is piling on distressed debt of Chinese real estate developers, even as other investors are turning sour on these securities.
China’s current economic woes, particularly in the real estate sector are of its own making.
There’s no denying that China’s property sector, which makes up some 70% of the economy and around 29% of GDP is highly levered and rife with speculation.
Rather than wait for the bubble to burst, Beijing is taking proactive steps to reign in the frenzied borrowing and building, while it’s still possible.
A controlled deflation, at least in the case of the Chinese Communist Party, may be far preferable to an uncontrolled implosion.
For China’s embattled real estate developers, the warning is clear – borrow and build according to the country’s need, and not greed.
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2. Inflation Soars in the U.S.
Equities took a beating yesterday as U.S. consumer prices soared by 6.2% in October, according to the U.S. Bureau of Labor Statistics, marking the sixth straight month that headline inflation in the world’s largest economy has been over 5%.
The Biden administration, suffering one of the lowest approval ratings in recent U.S. history has had to go on the defensive, increasing the prospects that the U.S. Federal Reserve will need to raise interest rates next year.
The 6.2% rise surprised economists, who had been predicting an increase in prices, but not at such an accelerated pace, marking the fastest annual rate of inflation in 31 years.
Primary culprits for inflation came from heightened energy prices, food, as well as used vehicles and on an annual basis, energy prices are up by about 30%.
U.S. President Joe Biden, whose approval rating has fallen to 38%, singled out rising energy costs as a primary driver of inflation, and said that it was a “top priority” to reverse the continuing trend, raising the possibility that the U.S. will start releasing some of its crude oil stockpiles.
Biden is also lobbying Congress to pass his US$1.75 trillion spending bill, which he claims will “ease inflationary pressures” even as some Republicans baulk at the fiscal injection adding to already rising prices.
Expectations that the Fed will bring forward its rate hike schedule are increasing, as evidenced by short-dated U.S. treasury yields, the most sensitive to changes in monetary policy, surged following the consumer price report.
With headline inflation now well past 5% for the past six months and forecast inflation for the year at 4.6%, the Fed will have a harder job convincing the economy that price pressures are transient.
Against this backdrop, a surge in factory gate prices in China, to their highest levels in over 26 years, is threatening to spillover inflationary pressures to the global economy.
Soaring prices of everything from raw materials, labor and shipping costs is exporting inflation to all corners of the globe, with some central banks already raising rates in response.
Whether or not the Fed will remain steadfast in its view of “transitory” inflation remains to be seen, with senior officials including Jerome Powell and Richard Clarida, the chairman and vice chairman of the Fed respectively, contending that current imbalances will eventually recede as global supply chains and labor markets adjust.
There is some reason to buy into the Fed’s narrative.
Although prices are spiking right now, it’s also important to put those into context.
For decades, central banks globally have had to contend with inflation that was muted and well below the 2% target.
With the unprecedented infusion of liquidity into the global financial system in the wake of the pandemic, prices were bound to go up at some point and pent-up demand with the lifting of many Covid-19 restrictions is exacerbating the problem.
The inflation data itself is also somewhat misleading because compared to last year, this pent-up pandemic demand will skew prices and create the impression that inflationary pressures are runaway.
And a few months do not a millennium make.
So while prices may be rising relative to where they were a year ago, they may just be making up for lost time – what matters more is that wages rise ahead of prices, to ensure that the economy continues to consume and keep chugging along.
Nonetheless, with Powell’s confirmation for another term as chairman of the Fed still hanging in the balance, there will be pressure from the Biden administration for him to do something and if he’s perceived as turning a deaf ear to inflation, may see a more hawkish Fed chairman ushered in.
If so, investors need to brace themselves for sharper rate increases and the prospect that higher borrowing costs will impact already frothy asset prices.
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3. Bitcoin Flirts with US$69,000 Before Pulling Back
Alas, the course of true all-time-highs never did run smooth.
Like the peaks and valleys of the pyrenes, the road to crypto riches is paved in volatility.
With Chinese factory gate prices rocking a 26-year record and U.S. Consumer Price Index data shooting past 6.2% last month, its fastest pace since 1990, investors momentarily lifted bitcoin to a fresh all-time-high, talking up its inflation-hedging chops.
Flirting with US$69,000 before profit taking has since seen the benchmark cryptocurrency trade lower, the narrative that bitcoin can act as an inflation hedge has gained traction in recent months.
According to bitcoin maximalists, unlike dollars or other fiat currencies which are designed to lost their face value with time, bitcoin is algorithmically limited to a finite supply and so isn’t susceptible to debasement by a central bank or government.
With prices on everything from food to fuel advancing faster and proving to be more persistent than any economists could have predicted, some are suggesting that high inflation could be a hallmark and not a coincidence of the pandemic recovery, eroding spending power even as wages rise.
More major Wall Street players are revealing that they’ve bought into bitcoin, or at least become interested in it, based in large part on the inflationary hedge thesis.
Bolstering bitcoin’s inflation-hedging chops has been the fact that gold has languished during a period when it ought to have shined – flows have moved out of gold and into bitcoin.
But others argue that bitcoin simply doesn’t have a long enough history to determine if it can in fact be valued as a hedge against inflation.
To be fair, the relatively short history of bitcoin specifically and cryptocurrencies in general means that both views could technically be correct, just not at the same time.
There’s no denying that gold has languished while bitcoin has risen, but neither may be a proper hedge against inflation, without the benefit of hindsight.
At the very least, the rate of return for bitcoin more than exceeds current levels of inflation, so bitcoin does satisfy that criteria at this very moment, longer term however is harder to say.
The pullback in bitcoin today, to around US$64,500 at time of writing indicates that there is still a significant pool of investors who liken bitcoin to any other risk asset and the drop in the cryptocurrency correlated relatively tightly with equities and other more speculative assets.
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Nov 11, 2021