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Market Update
August 21, 2023

Dominated By Two Sides Of The World

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Week Ending 18 August, 2023

The news was dominated by two sides of the world – upward revisions to US growth and worries over China.

US: Retail sales posted a strong +0.7% m/m to 3.2% y/y. June was revised higher to +0.3% m/m. Sales were boosted by online purchases and dining out. Consumers also splashed out hobbies, sporting goods and clothing. Building material and garden equipment rebounded +0.7% m/m while food services and drinking places shot up 1.4% m/m. Economists view dining out as a key indicator of household finances. Goldman Sachs has revised up Q3 GDP to 2.2% y/y (Q2: 2.4%) while the Atlanta Fed noted the economy is likely growing at 5.8% y/y in Q3 based on their “GDPNow” forecasting model. Two days before, they forecast 5.0%. Deutsche Bank increased its Q3 GDP forecast to 3.1% from 1.5%. There are no signs the economy is not coping with 5.25% rates. Meanwhile, every time rate-pause talk steps in, data indicates it could go the other way.

China: Bad news seems to be pouring from all sides. July property investment fell -17.8% y/y (June: -20.6%). Sales by floor area fell -23.9% y/y (June: -28.1%). More stimulus measures are expected including easing mortgage curbs, reducing down payments and mortgage rates and relaxing home buying curbs in certain areas. Nationally, property investment fell -8.5% (Jan-July) vs -7.9% (Jan-Jun). Sales decline -6.5% and -5.3% respectively. New construction starts by floor area fell -24.5% y/y while funds raised by developers fell -11.2% y/y. Given that property is some 25% to 30% of GDP, angst around the property data can be understood. Then the authorities suspended the printing of its youth jobless data arguing it needs to review the methodology deployed. The most recent NBS data showed the youth (16y to 24y group) jobless rate at 21.3%. Some 47% of graduates returned home within six months of graduation in 2022 (2018: 43%). Last, but not least, a leading Trust firm, Zhongrong International Trust Co. which had sizeable real estate exposure missed payments on many investment products from late last month. This has ignited worries over the $3tn shadow banking sector and the possibility of a string of defaults as many investors are exposed to high-yielding trust products. The reality is the impact will be confined to the better off. Is the Politburo being blasé? Yes – if you live in the West where the media likes to hype up the situation! We have had similar occurrences before – back in 2010/11 there were big, short bets being placed on property related investment. They didn’t come off. The suspension of youth unemployment data heightens fears of a coverup, and, to date, the measures announced have been targeted to specific areas and regions. All this does not add up to what “we” are conventionally used to. Could it get worse? Of course it could! However, whatever the true picture, I wouldn’t mind trading China for its much lower inflation, vast FX reserves, vastly wider toolset for controlling monetary policy and massive advances (far ahead of anyone else) in transitioning to Green energy.

Speaking of short bets, an email was circulated internally referencing Michael Burry (of “Big Short” fame) and how he has bet $1.6bn (through PUT Options, a form of insurance) on a stock market crash. This is not the first time – before this he made short bets on rising Treasury yields. This time, it is against the S&P 500 ($866mn) and NASDAQ ($739mn). Apparently, this amounts to more than 90% of his portfolio betting on a market downturn. What’s rather disingenuous about such headlines is that they don’t tell the whole story - he is also long certain stocks in specific sectors, presumably to fund his short positions in the event markets continue to rise (that’s how he settles the variation margin/P&L). If you recall, he shot to fame over his CDS bets on subprime back in 2007/8. In the film “The Big Short”, remember the scene in the film when investors were getting very angsty about losses? These losses were negative carry which was being borne by the fund. Back then, there was a proper housing bubble – fundamental research proved it. It was overlayed with toxic CDO structures (the transmission mechanism) and fraud (mis selling around mortgages). This time, there is no housing bubble. In fact, that’s been the main problem – there aren’t any significant bubbles. The US banking system saga back in March looked really shaky – but even that wasn’t a bubble, it was idiosyncratic risk focused on a specific part of the US SME banking sector. I am not saying it wasn’t significant but it lacked one, key thing: a transmission mechanism. Fast forward to today, is there a Credit bubble? Not on the immediate horizon! It would take a huge share of loans (consumer and corporate) to rollover in under twelve months to really blow the lid on the credit market and bring it crashing down thus instantly triggering CDS (Credit Default Swap) bets. Think of CDS as an insurance hedge against bonds (rather like home insurance for your house). Look at the chart below (by GS) that looks at US corporate debt maturity out to 2023. The pace of maturities picks up sharply from 2024 ($790bn) and $1tn+ in 2025. GS estimates refinancing maturing debt will boost interest expense by 2% in 2024 and 5.5% in 2025. All this assumes rates remain where they are now! It begs the question if the Fed knows all this then why keep hiking rates knowing full well most loans are fixed (household mortgages and corporates)? Because one day they will need the ammunition to bring rates down when the economy really hits hard times. That’s not happening any time soon!

So, coming back to Michael Burry, what’s his angle? We don’t know the full ins and outs of his portfolio but I strongly doubt he’s risking everything on black. A broken clock is right twice a day – eventually he will be right but whether he gets the asymmetry he is looking for (vs 2007/8) is anyone’s guess. Looking at the above maturity chart, he will have a long wait – and that’s assuming rates don’t come down in the meantime!


Source: Refinitiv Datastream/Fathom Consulting
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