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Geopolitical-risk

Equity outlook Restrictive policy and geopolitical risks raise the odds of a global recession What a difference a year makes. 2022 saw the ‘reopening’ of markets from the COVID pandemic evolve into a ‘recession’. Margaret Thatcher put it succinctly on 27 February 1981 – “The lesson is clear. Inflation devalues us all.” Monetary policy has been on the most pronounced tightening campaign in decades as inflation progressed from being transitory to potentially permanent due to the energy crisis. Politics is driving economics, not the other way around In the pre-war global economy, globalisation was an important source of low inflation. A large amount of global savings had nowhere to be deployed, rendering interest rates lower on a global basis. However, post-war, global defence spending has risen to a level not seen in decades as national security consumes government’s agendas. There will be vast opportunity costs involved, tied to the increase in world military spending. We expect the rate of globalisation to take a back seat, as Europe would never want to be as dependent on Russian energy as it is today. In a similar vein, the US does not want to fall privy to the same mistake Europe made and will aim to strengthen ties with Taiwan in order to ensure the smooth flow of chips. National security is inflationary We are in the midst of a war in Europe, owing to the brutal battle being waged by Russia in Ukraine. While the war is centred in Ukraine, the reality is we are all paying the price of this war by allowing it to continue. There is another war brewing in the background that we must not fail to ignore. The United States’ deepening ties with Taiwan is aggravating China. The Taiwan issue remains sticky. Taiwan’s role in the world economy largely existed below the radar, until it came to prominence as the semiconductor supply chain was impacted by disruptions to Taiwanese chip manufacturing. Companies in Taiwan were responsible for more than 60 percent of revenue generated by the world’s semiconductor contract manufacturers in 20201. Tensions between Taiwan and China could have a big impact on global semiconductor supply chains. The United States’ dependence on Taiwanese chip firms heightens its motivation to defend Taiwan from a Chinese attack. The desire for control of technologies, commodities, and straits is paving the way for economic wars ahead. China needs to get its house in order The economic headwinds that China faces are multifaceted. Unfortunately, policy easing from China in H1 2022 has been insufficient to arrest the extent of the slowdown. Of late, China’s State Council stepped up its economic stimulus further by announcing a 19-point stimulus package worth $146 billion (under 1% of GDP) to boost economic growth2. The property markets continue to deteriorate. The problem stems from a lack of financing among many developers that is needed for construction of their residential projects. All of this came about from the central government’s decision in 2020 to introduce the ‘three red lines’ policy to rein in excessive borrowing in the real estate sector. Vulnerable property developers are struggling to secure capital to sustain their businesses. Alongside, demand for housing has deteriorated due to intermittent COVID lockdowns, weakening economy, and doubts over developers’ ability to deliver completed housing units. However, the weakness in China’s economy extends beyond the property sector with rising unemployment and energy shortages. Chinese earnings growth since Q3 2019 has lagged the rest of the world. China has also suffered significant capital outflows, owing to its adherence to COVID-zero. This has set back its rebalancing towards a consumption-driven economy, rendering China to remain more addicted to export-led growth. However, export demand has begun to weaken as the rest of the world slows. US is in the early innings of a recession The US economy appears a safe haven amidst the ongoing energy crisis as it is less exposed to the vagaries of Russian oil supply. It also recovered faster from the pandemic compared to the rest of the world. The labour market remains strong as jobs continue to be added, wages accelerate, consumption has continued to grow (albeit more slowly), and unemployment remains at a five-decade low. Despite the recent upswing in GDP growth, caused by noise in the foreign trade numbers and technicalities in inventory data, the big picture of a slowing economy in the face of aggressive monetary tightening remains intact. There are mounting signs of slowing too, especially in the housing sector owing to the rapid rise in mortgage rates. Earnings in 2022 have reflected the challenging environment being faced by US corporates with earnings growth for companies grinding down to 3.17%3.The more value-oriented sectors such as energy, industrials, and materials continue to outperform. Looking ahead, earnings revision breadth for the S&P 500 Index are in deeply negative territory suggesting downside is coming from an earnings growth standpoint. Core inflationary pressures remain concerning, especially housing rents and medical inflation – components that are typically much stickier compared to goods and transport inflation. The stickier high services inflation reflects strong labour market dynamics as services are labour intensive and housed domestically. The Federal Reserve (Fed) appears unwilling to declare victory in its war against inflation. As we look ahead, it’s clear that the Fed’s role in quelling inflation without tipping the economy into recession will take centre stage. Harsh winter ahead for Europe Europe is heading for a recession in response to a strong external shock. Gas flows from Russia to Europe have declined substantially to 10% of their levels in 2021, causing gas prices to spike. The Russian war in Ukraine is showing no signs of abating, with Russia deciding on a partial mobilisation after a rather successful Ukrainian counter-offensive. These higher energy prices are squeezing real disposable income out of consumers and raising costs higher for corporates, causing further curtailment of output. The energy driven surge in headline inflation to 10.7% year on year4 has sent consumer confidence to a record low, leaving Europe in a bind. Fiscal policy in focus The European Union (EU) aims to define the direction and speed of Europe’s energy policy restructuring through REPowerEU strategy. However, crucial energy policy decisions have been taken by EU countries at national level. In an effort to shield European consumers from rising energy costs, EU governments have ear marked €573 billion, of which €264 billion has been set aside by Germany alone. In most European countries, both energy regulation and levies are set at the national level. The chart below illustrates the funding allocated by selected EU countries to shield households and firms from rising energy prices and their consequences on the cost of living. No pivot yet from the ECB We experienced a decade of almost no inflation and quantitative easing in Europe. We have now entered a phase in which the European Central Bank (ECB) has gone ahead with its third major policy rate5 increase in a row this year, thereby making substantial progress in withdrawing monetary policy accommodation. The ECB remains eager to have policy choices dominated by risks, rather than the base case, owing to which more rate hikes are coming. If Eurozone inflation continues surprising to the upside, the ECB will have to continue raising rates and determine when to activate the Transmission Protection Instrument (TPI) to support the periphery. We expect the ECB to take the deposit rate to 2.5% by March, as it continues to see risks to inflation tilted to the upside both in the short and long term. A tightening cycle into a slower-growth macro landscape has never been helpful for equities. European equities are faced with an extremely challenging backdrop ranging from high energy prices, growing cost pressures, negative earnings revisions estimates, and cooling growth. Amid the sell-off in equity markets in the first half of this year, European equities currently trade at a price-to-earnings ratio of 14.3x, marking the steepest discount versus its long-term average of 21x compared to other major markets. The risk of a recession to a certain degree is being priced into European equity markets. Conclusion In our view, the global economy is projected to avoid a full-blown downturn; however, we expect to see a series of individual country recessions take shape at different points in time. Evident from recent data, the downturn in the US is expected in the second half of 2023 whilst the Eurozone and United Kingdom will enter a recession by Q4 this year. Contrary to the rest of the world’s key central banks, China and Japan are expected to keep monetary policy accommodative which should help buffer some of the slowdown. Given the highly uncertain environment, investors may look to consider US and Chinese equities, whilst potentially reducing weighting towards European equities. Across factors, we continue to tilt to the value, dividend, and quality factors given the expectations for weak economic growth, higher rates, and elevated inflation.
ICEUS:MWL1!
by aneekaguptaWTE
China's Economy Crisis: What You Need To Know‍China is the world’s second-largest economy. If that doesn’t impress you, consider this: It has grown from a ragtag collection of state-owned firms to the world’s second-largest economy in just 35 years. China is now the world’s largest producer of goods, from smartphones to steel, autos to aircraft carriers. In 2017 alone, China produced almost as much output as the U.S., Japan, Germany, France and Britain combined. However, there are signs that China is heading for a recession. The country’s stock market has crashed twice (in July 2015 and again in January 2016), and Chinese investors have lost a lot of money as a result. There are many reasons that explain why an impending economic crash in China is imminent... China Has a Debt Problem China’s debt-to-GDP ratio (Private Sector) is now over 250%, which is extremely alarming. China’s debt problem is a ticking time bomb that could go off at any moment. As interest rates rise in the U.S., the cost of servicing the debt will become more expensive for Chinese issuers. If China continues to grow its debt at its current pace, it could easily become the next Greece or Argentina, where economic collapse is imminent. The Chinese government has tried to curb the rise in debt by tightening its domestic monetary policy. That caused the country’s stock market to plummet and its currency to depreciate. China’s aggressive money-printing has helped to fuel an emerging debt crisis that could trigger a global economic slowdown. In fact, the Bank for International Settlements (BIS) says that China’s debt-to-GDP ratio has jumped from 150% in 2008 to more than 250% today. The Chinese Yuan Is Dropping Like a Rock China’s controlled currency is starting to depreciate. And that usually occurs before an economic crash. The Chinese yuan (also known as the renminbi) has fallen more than 7.7% against the U.S. dollar since March 2022. The yuan’s decline is partly due to the trade war with the U.S. China’s central bank has been intervening in the markets to prevent the yuan from declining too quickly. That’s caused the dollar to rise against other currencies. It’s also helped to fuel a rise in Treasury yields. A strong U.S. dollar is bad for American exports. But it’s also bad for China, since a strong dollar makes it more difficult for Chinese companies to compete abroad. China’s controlled currency is starting to depreciate. And that usually occurs before an economic crash. CNH1! Manufacturing Is Slowing Down China’s manufacturing PMI has been falling for months. In July 2018, it was 48.3, which is below the 50 mark that separates growth from contraction. A number below 50 is also considered to be “bad”, while a number above 50 is “good”. The PMI reading for July 2019 was 49.7. This may sound like good news for those employed in the U.S. However, it’s not. A slowdown in the manufacturing sector usually leads to a fall in consumer spending and a slowdown in the economy. That’s because reduced consumer spending leads to fewer sales and an excess of inventory or unsold goods. That often leads to a drop in GDP. China is Producing a Lot of Empty Buildings As an economic crash approaches, developers start to build a lot of empty buildings. That’s because people start to slow down their spending and are not prepared to make the necessary financial commitments. China’s ghost cities are the canary in the coal mine. These are cities where 90% of the buildings are either vacant or incomplete. Now, it’s interesting to note that China’s ghost cities were entirely vacant as recently as 2010. At that time, few people would have predicted that China would build an entire city and have no one living in it. China's shadow banking problem is a major concern for the Chinese economy. Shadow banking refers to financial services provided outside of the traditional banking sector. These include weaker institutions such as peer-to-peer lending, pawnshops and informal lending networks. Shadow banking is often used to circumvent government restrictions on the traditional banking system, which can make it harder for the government to monitor and control the overall economy. Shadow banks are also more likely to lend to high-risk borrowers, fueling asset bubbles and economic instability. As a result, shadow banking has become increasingly important in China as the country's economic growth has slowed. Despite its importance, understanding shadow banking in China is difficult due to its complexity and lack of transparency. It is best to keep an eye on developments in this area as they could have a significant impact on the Chinese economy in coming years. China Consumer Confidence Index China Unemployment Rate Conclusion In the final analysis, there are many signs that indicate that a looming economic crash in China is imminent. Indeed, analysts expect that the country could be poised for a major economic slowdown in the near future. If this happens, it will have a negative impact on global economic growth. Investors should be careful about which companies they invest in and may want to avoid companies that are heavily reliant on the Chinese economy.
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NASDAQ:MCHI
by EQTSHARES
102
What Will A Geopolitical Compromise Means For Markets?Henry Clay was a US Senator from Kentucky, the Speaker of the House of Representatives, the US Secretary of State, and a Presidential candidate in the 1800s. His legacy and nickname were “The Great Compromiser” for his involvement with the Missouri Compromise, the Compromise Tariff of 1833, and the Compromise of 1850. As Henry Clay understood, any great compromise means that both sides at the negotiating table must come to an agreement that makes them uncomfortable or incomplete. The price of an asset is always the correct price A messy geopolitical landscape Option one- A Great Compromise- High Odds Option two- A prolonged conflict Option three- The unthinkable In 2022, the geopolitical temperature has risen to the highest level since WW II. On February 4, Chinese President Xi and Russian President Putin met at the opening ceremony of the Beijing Winter Olympics. The leaders signed a $117 billion trade agreement, but the watershed event was the “no-limits” cooperation understanding. Twenty days later, after the end of the Olympics, Russia invaded Ukraine, launching the first major war on European soil in over three-quarters of a century. Many analysts believe the Russian invasion sets the stage for Chinese reunification with Taiwan. Markets reflect the economic and geopolitical landscapes. Volatility in markets across all asset classes has increased, and uncertainty is the market’s worst enemy. The war, sanctions, retaliation, and a Chinese-Russian alliance threatens the status quo over the previous decades. The price of an asset is always the correct price As we learned in early 2020 in nearly all asset classes, bear markets can take prices to levels that defy logic and rational and logical analysis. The same holds on the upside as price spikes can reach unthinkable heights. The moves to the upside or downside compel many market participants to sell what they believe are tops or buy when they think the market cannot go any lower. Picking tops or bottoms is more about ego than making money, as the effort contradicts to prevailing trends. Picking a top or a bottom is a statement that the current price is too high or too low, which is always a mistake. Market participants can be wrong, but markets are never wrong. The price of any asset is always the right price because it is the level where buyers and sellers agree on a value in a transparent marketplace. Declaring a market top or bottom is a contrarian statement as it goes against the prevailing trend. A messy geopolitical landscape Two years ago, the world faced a common enemy as COVID-19 ignored borders, race, religion, political ideology, and all of the other factors that separate countries and people. In February and March 2022, the world faces new and daunting challenges: The Chinese and Russian leaders shook hands on a “no-limits” alliance. Russia invaded Ukraine, starting the first major war in Europe since World War II. Ukraine continues to put up fierce resistance. The US, NATO allies in Europe and allies worldwide slapped sanctions on Russia. Russia retaliated with export bans and other measures. North Korea test-fired ICBM missiles. Iran fired missiles near the US embassy in Iraq. Russian missiles came within miles of the Polish border. An attack on Poland triggers article five of NATO’s charter- An attack on one member is an attack on all. China and Russia stand on opposite sides of the conflict from the US and Europe. China plans to reunify with Taiwan against their will. On the US domestic scene, the US remains divided along political lines with mid-term elections in November. The central bank liquidity and government stimulus that stabilized the economy during the pandemic ignited an inflationary fuse before the geopolitical landscape deteriorated. The war in Ukraine only exacerbates price increases as Russia is a leading world producer of raw materials. Europe’s breadbasket in Ukraine and Russia is now a mine and battlefield at the start of the 2022 crop year. Russia and Ukraine typically supply one-third of the world’s wheat and other crops. They are also leading fertilizer exporters, causing problems in other worldwide growing regions. In 2022, the war will lead to rising prices, falling supplies, and the potential for famine and civil uprisings. Historically, food shortages have caused many revolutions. The 2010 Arab Spring that began as food riots in Tunisia and Egypt caused the sweeping political change in North Africa and the Middle East. Meanwhile, the Biden administration pledged to address climate change by supporting alternative and renewable fuels and inhibiting the production and consumption of fossil fuels. US production declined in 2021. After decades of working to achieve energy independence from the Middle East, US policy handed the pricing power to the international oil cartel. Since 2016, Russia has had an increasing role in OPEC’s production policy. In 2022, the cartel does not move unless Moscow agrees to cooperate. Oil prices were already rising when Russia invaded Ukraine, and they moved over $100 per barrel after the attack. Meanwhile, other fossil fuels have moved higher. Coal traded to a new all-time peak. US natural gas rose to a multi-year high, and European and Asia gas prices rose to record levels. Rising energy prices fueled inflation, and the war has poured fuel on an already burning inflationary fire. The war in Ukraine is less than one month old, and the human toll is rising. Tensions are at the highest level in decades. Markets are nervous, and the developments on the geopolitical over the coming days and weeks will dictate the direction of markets across all asset classes. I see three potential outcomes. Option one- A Great Compromise- High Odds In the current standoff, neither side wants to give an inch. The Russian leader faces disgrace or worse if he loses to an inferior military but impassioned Ukrainian population, many of who would choose death over capitulation. The US and Europe do not want to appease Russia like the UK’s Nevil Chamberlain appeased Hitler in the 1930s. China may support Russia, but the world’s second-leading economy has close economic ties with the US and Europe. A Henry Clay-inspired great compromiser could emerge and come up with a solution where Russia, China, the US, Europe, and the rest of the world walk away from the negotiating table unhappy but with a workable solution. I believe, and it is more than a bit of wishful thinking, that this is the high odds result of the current geopolitical mess, and the result will go down in history as the great compromise of 2022. A great compromise would likely lead to a significant stock market rally and a commodity correction. Option two- A prolonged conflict A prolonged conflict where Russians fight a long and bloody war against Ukrainian forces will devastate the world economy and peace. Russia may capture territory, but it is clear President Putin will never capture the souls of the Ukrainian masses. The Russian brutality over the past weeks will never be forgotten. President Putin did not count on the passionate resistance Russian troops encountered across Ukraine. The longer the battle and the more brutal the weapons, the greater the price for Russians controlling the territory over the coming years. Millions of refugees have left the country, but that leaves over 40 million Ukrainians; most now consider Russians their mortal enemy. A long battle will weaken the Russian military and the Russian leader abroad. A prolonged conflict will cause sanctions to collapse Russia’s economy, causing domestic problems for President Putin and his government. Moreover, skirmishes are likely to break out worldwide. In the early days of the war in Ukraine, North Korea and Iran flexed their military muscles. With Europe and the US focused on Ukraine, China could use the opportunity to seize Taiwan. A prolonged conflict would weigh on US stocks and likely lift commodity prices to higher highs. Option three- The unthinkable The final option is the nuclear one, which is low odds, but a highly frightening scenario. If Russian aggression spreads across the Ukraine border into Poland or any NATO member country, it will trigger Article five that states an attack on one is an attack on all. The US and Russia have the most nuclear weapons, which increases the potential of MAD or mutually assured destruction. In this scenario, it does not matter how markets react as the world would face a disastrous situation. I believe that a great compromise is on the horizon, which would cause markets to stabilize. However, the extent of the compromise is critical as it must address the current situation in Ukraine and Taiwan and threats from North Korea and Iran. Anything short of a comprehensive understanding between the world’s powers will cause years of rising tension and threats to the nearly eight billion people that inhabit our planet. Where is Henry Clay when the world needs him? Expect the volatility in markets to continue. -- Trading advice given in this communication, if any, is based on information taken from trades and statistical services and other sources that we believe are reliable. The author does not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects the author’s good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice the author provides will result in profitable trades. There is risk of loss in all futures and options trading. Any investment involves substantial risks, including, but not limited to, pricing volatility , inadequate liquidity, and the potential complete loss of principal. This article does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.
SP:SPX
by Andy_Hecht
2