We end Q3 this week and prepare for Q4 by looking at the current macro markets—there is a lot of reshuffling happening around energy and industrials. Countries want to control supply chain led inflation—especially China—and so we enter Q4 with a sense of anxiety around supply meeting demand.
Key takeaways
- The Fed’s November taper remains dovish—policy is accommodative but first hikes could start in 2022, stay tuned in November.
- Multi-industry stocks working in logistics and automation could be net beneficiaries of some of the current problems seen overseas.
- China’s common prosperity leads to a growth slowdown to control for inflation, and wealth inequalities—but mainly inflation and especially supply chain stress.
- Europe’s energy crisis and need for natural gas is taking a center stage position with the Qatari energy minister saying they can’t supply everyone.
- Metals sees volatility coming back as Chinese regulators lower output to control inflationary stress. In other metals, shortages and production cuts is the recurring theme.
The Fed’s mighty taper (and inflation)
Rates going up is hardly good for stocks because it usually leads to a higher discount rate which means a smaller present value. Right now, rates in the US are set at 0.00-0.25% and GDP growth YoY according to Trading Economics is greater than China’s 8% at 12% so the economy is clearly churning in the US. In Europe, same thing, and it’s picking up steam, but more on that in our next article!
The fed remains relatively dovish which means keeping rates down, and seeing more expansionary stimulation. But this could change as more hawkish whispers make their way up from the graves. That is because November has become a bit of a target month now with committee members edging towards higher rates with a first hike either expected in 2022 at the earliest or 2023. Generally, the consensus has been for 3 hikes in both 2023 and 2024, lifting the five-year interest rate to 1.75%. But this rate is still lower than the long run funds rate of 2.50%. In other words, policy is still ‘’accommodative’’ for the time being.
Inflation and supply chains
On the inflation side, higher levels of inflation is making a case for itself, but this is mainly due to greater supply side constraints, constraints that could see themselves dissipate upon supply chains resolving themselves. However, such a ‘’resolve’’ is not a guaranteed outcome, quite on the contrary. Especially considering the current levels of supply chain disruptions now estimated to last well into the next two years. We could expect a lot of improvement in multi-industrial stocks related to automation like Honeywell, Rockwell, Emerson, Ametek, Dover, Fortive or the Swiss equivalent ABB.
China and US multinationals
China’s ‘’common prosperity’’ movement could mean a reduction in US assets because China’s focus on closing their wealth gap could translate in depressed demand for high-end Western luxury brands whom we know are beloved by wealthy Chinese buyers. The pickup in China market volatility amid their crackdown has already proven to be difficult on US markets and so, ‘’common prosperity’’ could just add to the list of headwinds US multinationals face overseas.
Europe’s energy crisis
Europe has suffered some recently skyrocketing natural gas prices. Inventories at European storage facilities are at historically low levels for this time of the year. International pipeline flows have been limited which is worrying as calmer weather has reduced output from wind turbines and Europe’s nuclear plants are being phased out.
In the past year, gas prices have jumped 500% and the spike has forced some fertilizer producers in Europe to reduce output threatening to increase costs for farmers and potentially adding to global food inflation. The stage is laid out for a scramble between Europe, Asia, and other nations for shipments of LNG from exporters in Qatar and the US which say they don’t have enough to cater to their client’s increasing demand for energy.
China’s slowdown, ''common prosperity'', and credit markets
Evergrande has taken a center stage position in most news outlets, but other items remain on the list. Namely, tight credit control on property and infrastructure investments, and de-carbonization policies cutting commodity production.
There has so far been only a limited policy intervention to slowdown tight credit controls on the property sector, or lower commodity production on the back of an unusually sharp slowdown. The good news is that, and this is related to Evergrande, creditors will not be reimbursed before projects are seen all the way through (this is part of common prosperity?).
It is likely that the government will deliver some sort of easing in Q4 since further growth slowdown in coming months would confirm that August weakness was not an exception to the rule, that easing measures would be well timed now.
Such examples of ‘’easing’’ include supporting the Evergrande crisis with extra liquidity (after all, Evergrande is 2% of Chinese GDP!) and liberalizing the credit markets with things like mortgage loan relaxation and reserve requirement ratio cuts. If the government ignores this option (which it probably won’t) then there could be a spillover effect in other sectors like property and financials.
There is volatility in metals
On the metals side, China’s steel production has fallen almost 13% in August as authorities have put downward pressure on steel mills in order to reduce emissions. Some analysts even report China’s steel could see a drop in production close to 2% next year.
With steel productions cuts in China come lower iron ore prices which we have seen plummeting lately and taking with it, the Aussie dollar (though Aussie trade balances are doing well). There has also been a general slowdown in commodities demand from the auto industry linked to chip shortages which have led to falling prices of platinum metals.
Last Friday the 24th, news came out that China is planning to further consolidate its rare earth industry into just 2 large groups in the North and in the South. Remember that China accounts for roughly 60% of global rare earth supply and as such, is the global price setter.
Meanwhile, outside of China, we see aluminum smelters holding back production and on the back of an increasing demand for EV units, nickel and copper take center stage. Nickel units are being shipped from Indonesia but in volumes that are unlikely to keep the top markets out of deficit beyond 2023. Copper, on the other hand could move into surplus next year but until then the fundamental backdrop is a mixed bag because inventories are low and demand headwinds are likely in store for 2022.
Conclusion
There is a sense of anxiety around shortages, inflation and supply chains which benefits some sectors like energy, and multi-industry. Interestingly, in the last month, natural gas has been the strongest performer in the 5 top energy markets bracket when Europeans are seeing a major shortage of LNG as shown above. One man’s trash is another’s treasure…
In metals, we see that in the past month, Aluminum has been the name of the game gaining more than 10% despite only being 1% higher than its all-time low from 1743! Silver dumped 7% but all metals commodities are near their 52-week lows which is a tempting level for long-term investors.
This past month, energy has been, on aggregate, the best performing sector, up about 5%. In the Energy Equipment and Services industry, we see a lead of 9% this month despite only 40% of the sub-sector’s stocks actually seeing gains.
In all, the spotlight is on China, beyond the Evergrande crisis as they produce most of the world’s rare earth goods and are increasingly leaving their mark on other markers as discussed above.
