The Great Unwind and the Two Most Important Prices in the World

 

“The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.” – Walden by Henry David Thoreau

  

“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” – Vladimir Lenin

 

“There are only three ways to meet the unpaid bills of a nation. The first is taxation. The second is repudiation. The third is inflation.” – Herbert Hoover

 

The Federal Reserve for the better part of a decade has been engaged in the business of supressing interest rates through the use of easy monetary policies and quantitative easing. For US bond market participants all the Fed’s policies entailing interest rate suppression meant that there was a perpetual bid for US treasury bonds and it was always at the best possible price. The Fed has recently embarked on the journey toward unwinding the suppression of interest rates through the process of quantitative tightening. QT has US bond market participants worried that there will be a perpetual offer of US treasury bonds at the worst possible price.

 

The Organisation of Petroleum Exporting Countries (OPEC) and Russia have, since late 2016, taken steps to prop up the price of oil by aggressively cutting output. With a history of mistrust amongst OPEC and non-OPEC producers and a lackadaisical approach to production discipline, oil market participants did not immediately reward oil producers with higher oil prices in the way bond market participants rewarded the Fed with immediately higher bond prices / lower yields. It took demonstrable commitment by the oil producing nations to the production quotas for oil market participants to gain the confidence to bid up oil prices. And just as confidence started to peak, Russia and Saudi Arabia signalled that they are willing to roll back the production cuts.

 

Arguably the US dollar and oil are the two most important ‘commodities’ in the world. One lubricates the global financial system and the other fuels everything else. Barring a toppling of the US dollar hegemony or a scientific breakthrough increasing the conversion efficiency of other sources of energy, the importance of these commodities is unlikely to diminish. Hence, the US (long-term) interest rates and the oil price are the two most important prices in the world. The global economy cannot enjoy a synchronised upturn in an environment of sustainably higher US interest rates and a high price of oil.

 

In the 362 months between end of May 1988 and today there have only been 81 months during which both the US 10-year treasury yield and the oil price have been above their respective 48-month moving averages – that is less than a quarter of the time. (These periods are shaded in grey in the two charts below.)

 

US 10-Year Treasury Yield10Y YieldSource: Bloomberg

West Texas Intermediate Crude (US dollars per barrel)

WTI

Source: Bloomberg

 

The longest duration the two prices have concurrently been above their respective 48-month moving averages is the 25 month period between September 2005 and October 2007. Since May 1988, the two prices have only been above their respective 48-month moving averages for 5 or more consecutive months on only four other occasions: between (1) April and October 1996; (2) January and May 1995; (3) October 1999 and August 2000; and (4) July 2013 and August 2014.

Notably, annual global GDP growth has been negative on exactly five occasions since 1988 as well: 1997, 1998, 2001, 2009, and 2015. The squeeze due to sustainably high US interest rates and oil prices on the global economy is very real.

 

Global GDP Growth Year-over-Year (Current US dollars)

global GDP

Source: Federal Reserve Bank of St. Louis

 


 

On 13 June, 2018 President Donald Trump tweeted:

 

“Oil prices are too high, OPEC is at it again. Not good!”

 

And today, nine days later, OPEC and non-OPEC nations (read: Saudi Arabia and Russia) obliged by announcing that OPEC members will raise output by at least 700,000 barrel per day, with non-OPEC nations expected to add a further 300,000 barrels per day in output.

 

Iran may accuse other oil exporting nations of being bullied by President Trump but we think it is their pragmatic acceptance that the global economy cannot withstand higher oil prices that has facilitated the deal amongst them. (Of course we do not deny that a part of the motivation behind increasing output is bound to be Saudi Arabia wanting to return the favour to Mr Trump for re-imposing sanctions on Iran.)


 

Last week the Fed raised the Fed funds target rate by 25 basis points to a range between 1.75 per cent and 2 per cent. At the same time it also increased the interest rate on excess reserves (IOER) – the interest the Fed pays on money placed by commercial banks with the central bank – by 20 basis points to 1.95 per cent. The Federal Open Market Committee (FOMC) also raised its median 2018 policy rate projection from 3 hikes to 4.

With the Fed forging ahead with interest rate increases it may seem that it is the Fed and not OPEC that may squeeze global liquidity and cause the next financial crisis. While that may ultimately prove to be the case, the change in the policy rate projection from 3 to 4 hikes is not as significant as the headlines may suggest – the increase is due to one policymaker moving their dot from 3 or below to 4 or above. The Fed, we think, will continue the policy of gradualism championed by his predecessors Ben Bernanke and Janet Yellen. After all, Jay Powell, we suspect, oh so desires not to be caught in the crosshairs of a Trump tweet.

 

Investment Perspective

 

Given our presently bullish stance on equity markets, the following is the chart we continue to follow most closely (one can replace the Russell 1000 Index with the S&P500 or the MSCI ACWI indices should one so wish):

Russell 1000 IndexRussell 100Source: Federal Reserve Bank of St. Louis

 

If the shaded area on the far right continues to expand – i.e. the US 10-year treasury yield and oil price concurrently remain above their respective 48-month moving averages – we would begin to dial back our equity exposure and hedge any remaining equity exposure through other asset classes.

 

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. 

 

 

 

 

Charts & Markets – 21 Jun, 2018

 

Emerging Markets

The iShares Emerging Markets ETF $EEM had 3 corrections of 20% or more and another 3 corrections of between 10% and 20% from mid-2003 to late-2007, a period during which $EEM went up 400%+.

Since the 2016 low, $EEM is still to record a 20% correction. Don’t be shaken out so easily.

EEM US Equity (iShares MSCI Emer 2018-06-20 14-37-28

Nasdaq Biotechnology Index

Based on the 52-week rate of change in the index (second panel), biotech stocks during the last 18 months have been in their most benign (no pun intended) trading range over the last 10 years. A big move, either up or down, seems like its coming.

NBI Index (Nasdaq Biotechnology 2018-06-20 16-18-07

US 10-Year Treasury Yields

Yields are retreating from where they topped out during the 2013 Taper Tantrum.

USGG10YR Index (US Generic Govt 2018-06-20 14-39-24

Rogers International Commodity Agriculture Index 

Agriculture commodities are stuck in a rut.

RICIAGTR Index (Rogers Internati 2018-06-20 16-30-02

The Trillion Dollar Company

Who is going to be the first? $AAPL, AMZN or $GOOG. We think it will not be $AAPL. The momentum is surely with $AMZN.

GOOG US Equity (Alphabet Inc) UX 2018-06-21 12-41-01

Australian Banks

The price action in Australian banking stocks is terrible. Here is National Australia Bank.

NAB AU Equity (National Australi 2018-06-20 15-06-39

And here is Commonwealth Bank of Australia.

CBA AU Equity (Commonwealth Bank 2018-06-20 15-19-25

Southwest Airlines

Not feeling the $LUV.  Will it break $50? Well we have been short for some time now.

LUV US Equity (Southwest Airline 2018-06-20 17-01-26

 

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein

Charts & Markets – 11 Jun, 2018

 

Ibovespa Brasil Sao Paulo Stock Exchange Index

It has been a rough few weeks for Brazilian capital markets. In the short-term, the sell-off should be getting close to being done. We would not be surprised to see a rally soon.

IBOV Index (Ibovespa Brasil Sao 2018-06-11 10-51-06

Straits Times Index

Singapore’s equity market is attempting to break out of its 9 year trading range.
STI Index (Straits Times Index S 2018-06-11 10-38-28
Singapore Airlines

Like the broader market, Singapore Airlines has been sideways for many years and is now near the high-end of its trading range.

SIA SP Equity (Singapore Airline 2018-06-11 10-37-00

Tadawul All Share Index

Saudi Arabia’s stock market is at three-year highs with investors fully expecting MSCI to upgrade the Saudi market to emerging market status on 20 June.

SASEIDX Index (Tadawul All Share 2018-06-11 10-42-06

SABIC

The largest company in the Saudi market by market cap is making a run for 10 year highs.

SABIC AB Equity (Saudi Basic Ind 2018-06-11 10-43-14

Al Rajhi Bank

The largest bank and second largest company in the Saudi market recently recorded 10 year highs.

RJHI AB Equity (Al Rajhi Bank) U 2018-06-11 10-46-34

Uranium 

After a prolonged bear market, is uranium making an inverse head-and-shoulders bottoming pattern?

UXA1 Comdty (Generic 1st 'UXA' F 2018-06-11 10-28-28

Uranium Participation Company

A pure play on uranium, is also carving out a similar pattern.

URPTF US Equity (Uranium Partici 2018-06-11 10-31-35

 

Fast Retailing Co

The largest constituent of Japan’s Nikkei 225 Index is trying to make a run for the 2015 highs.

9983 JT Equity (Fast Retailing C 2018-06-11 10-55-16

SoftBank Group

On the other hand, the second largest constituent of Japan’s Nikkei 225 Index looks in bad shape.

9984 JT Equity (SoftBank Group C 2018-06-11 10-54-59

Chipotle Mexican Grill

Is the worst over for Chipotle? It looks it wants to go higher.
CMG US Equity (Chipotle Mexican 2018-06-11 12-29-10

Starbucks

The stock has gone nowhere since mid-2015. Is the next leg lower and through the three-year trading range? We would not bet against it happening.

SBUX US Equity (Starbucks Corp) 2018-06-11 11-23-51

Darden Restaurants

A much more difficult call to make but we think this might be heading much lower eventually as well.

DRI US Equity (Darden Restaurant 2018-06-11 12-30-54

TripAdvisor

Another stock coming back from the dead. Looks like it could go much higher.
TRIP US Equity (TripAdvisor Inc) 2018-06-11 14-46-11

Mattel Inc

A little less obvious but toy maker Mattel may not be the worst contrarian long out there. 
MAT US Equity (Mattel Inc) UXA 2018-06-11 12-36-41
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. 

The Contrarian Quartet (Part II)

“You never bet on the end of the world, that only happens once, and the odds of something that happens once in an eternity are pretty long.” – Art Cashin

“A thing long expected takes the form of the unexpected when at last it comes.” – Mark Twain

This week’s piece is a follow up to last week’s Contrarian Quartet (Part I). We outline the remaining two out of the four opportunities where we find the risk-to-return profile in being contrarian is far more attractive than in following the herd.

Rather fortuitously we decided to delay writing about Italy, the first of the two opportunities we discuss below, to this week as the deterioration in sentiment towards the sustainability of the European Union has accelerated.

Italy

“In investing, what is comfortable is rarely profitable.” – Robert Arnott, chairman and chief executive officer of Research Affiliates

As recently as three weeks ago, investors were disregarding the risks of political turmoil in Italy and lifting the Italian stock market higher. From the start of the year to market close on 7 May, 2018, the FTSE MIB Index generated a total return of 12.2 per cent in US dollar terms versus a measly return of 41 basis points for the MSCI All Cap World Index. Starting 8 May Italian outperformance started to unwind and the year-to-date return for the market, based on live prices as at the time of writing, is now negative. As the cliché goes, stocks take an escalator up and an elevator down.

FTSE MIB IndexFTSE MIB.pngSource: Bloomberg

Investors were first spooked by the two leading populist parties in Italy – the Five Star Movement and the League – moving to form a coalition to run the country. And then by President Sergio Mattarella’s decision to block the formation of a eurosceptic government and selecting Carlo Cottarelli, an International Monetary Fund alumnus, as prime minister-designate, to try to form a new government.

The selection of Mr Cottarelli, who has consistently defended Italy’s membership in the euro and became known as “Mr Scissors” for making cuts to public spending in Italy during Enrico Letta’s brief period as prime minister, has antagonised the populist coalition.  The populists see the selection as a deliberate attempt by President Mattarella to undermine the Italian people’s will as expressed by them in the recent election. Moreover, choosing Mr Cottarelli flies in the face of the coalition’s desire to put eurosceptics in key cabinet positions – as they tried to do by choosing Paolo Savona, the 81-year-old Eurosceptic economist, as their economy minister.

Given the antagonist nature of the President’s selection, Mr Cottarelli is highly unlikely to win a vote of confidence in parliament. Italy, in all likelihood, will have to hold a new set of elections in the autumn. And the next election has inextricably become about Italy’s membership in the euro. The worry is that the populists will use the bitterness from President Mattarella’s actions to rally their voters and emerge even stronger after the new elections.

Investors have been selling-off all things Italy in apprehension. Most drastically, the yield spreads between Italian and German government debt has blown out.

Italian vs. German 10 Year Government Bond Yield SpreadYield SpreadSource: Bloomberg

This is not the reaction President Mattarella was expecting, we suspect.

While we acknowledge that political risk in Europe is back in vogue, we consider the probability of an Italian exit to be low and with the caveat that Señor Draghi keeps the monetary spigots up and running we see even less risk of financial contagion spreading through Europe.

Consider the state of Italian sovereign debt today versus that at the height of the Euro Crisis. Foreign-ownership of Italian sovereign debt is down from 41 per cent in 2010 to 32 per cent today, with non-European investors holding a paltry 5 per cent. At the same time, Italy’s debt servicing costs as a percentage of GDP are at their lowest level since the euro was instituted – this of course is largely down to the ECB’s benevolence.

The Italian economy has been humming along quite nicely with first quarter GDP year-over-year growth of 1.4 per cent. Italy is also running a primary fiscal surplus and the fiscal deficit for 2017 was just 2.3 per cent of GDP and is likely to fall below 2.0 per cent in 2018.

The possibility of a fiscal blow-out due to extortionate spending by the populist coalition, if it is elected in the next elections, is also highly improbable. Since 2012, the Italian constitution mandates the balanced budget law and the president has the power to veto any decision that is not in adherence with this law. We are almost certain that a Europhile like President Mattarella will not hesitate in exercising the veto should the need arise.

Lastly, there are clear ideological differences between the two coalition parties and it is likely that such differences will be severely tested in the run up to the elections and, if they are elected, by the highly bureaucratic legislative system in Italy.  We suspect that the differing ideologies will impair the populist coalition’s ability to implement policies, which in turn will severely test its survival.

For these reasons we consider the drastic widening of the yield spread in Italian debt relative to German debt to be somewhat unwarranted. Despite this and given where absolute yields are in Europe, we do not think investors should have any sovereign or corporate bond exposure in Europe.

We also think it might still be a bit early to add broad based exposure to Italian stocks. Although selectively we are starting to see opportunities in high quality Italian companies, which we will be monitoring closely for potential entry points.

Where we see the greatest opportunity is to go long the euro relative to the US dollar. We think the current sell-off in the euro is sowing the seeds for the next down leg in the US dollar. The political uncertainty has facilitated the unwinding of bullish euro and bearish US dollar positioning. We suspect positioning will quickly become, if it has not already, very bearish in the euro and bullish in the US dollar. Overly bearish positioning is in our minds a necessary condition for the euro to re-assert its bullish trend.


US Long Dated Treasuries

GS US Financial Conditions Index versus US 30 Year Treasury YieldsGS US FCI vs 30YSource: Bloomberg

In The Convergence of US and Chinese Bond Markets we wrote:

“The shifting secular trend does not, however, warrant shorting US treasuries. The last secular US bond bear market lasted thirty-five years and can be sub-divided into thirteen parts: seven major price declines and six bear market rallies. Moreover, even though short-term interest rates bottomed around 1941, long-term bond yields continued to decline till 1946. We would not be overly surprised if a similar dynamic played out once again, with short-term rates bottoming in 2015 and long-term bond yields bottoming several years after.”

While we remain secular bears on US government bonds, we think long dated US treasuries currently offer a tactical opportunity on the long-side. US financial conditions have started to tighten after the easing induced by the enactment of the Trump tax plan – for instance US companies pre-funded their pension schemes to benefit from the higher tax rate in 2017 and contributed to the easing in financial conditions – is beginning to wear off and the reality of higher rates and higher oil prices squeezes system-wide liquidity. As demonstrated in the above chart, as financial conditions tighten, long-term bond yields tend to decline shortly after. Add to this the near record levels of short positioning in long-dated treasuries by non-commercials and you have a recipe for sharp rally in long-dated US treasuries.

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This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein   

The Contrarian Quartet (Part I)

“If all the economists were laid end to end, they’d never reach a conclusion.” – George Bernard Shaw

“Twenty years from now you will be more disappointed by the things that you didn’t do than by the ones you did do.” – Mark Twain

 “Studies have shown that most rational people, including people that fit that profile, that their decision making breaks down in an environment of negative reinforcement. The ultimate example of which would be interrogation, where your ability to withhold information is broken down by various physical or mental techniques.” – Jim Chanos

 

  

Is there any population cohort exposed to a more rigid daily routine than school going children and teenagers?

The constant ringing of bells, schedule of classes, lunchtime, homework, each a daily fixture throughout the academic year. It is no wonder then that most people tend to be conformists – the rigidness of school stamps out individualism in favour of conformity.

The irony of it all is that we celebrate the individuals who have managed to resist the rigidness and maintain their non-conformist streaks. Our heroes are Steve Jobs not Jeffrey Immelt, Muhammad Ali not Floyd Mayweather, The Beatles not Coldplay.

Capital markets too have on occasion handsomely rewarded the contrarians, like Dr Michael Bury during the Global Financial Crisis, Paul Tudor Jones in 1987, and Jesse Livermore in 1929. Markets do not, however, look kindly upon the reflexive contrarian – the investor that cannot help but go against the trend. Markets can be conformists for extended periods of time and hence why momentum following strategies can be so rewarding.

We like to consider ourselves independent investors – investors that scour the market for signals that may provide us with opportunities to generate outsized returns. Our aim is neither to be contrarian nor momentum driven. Today, however, we see four areas of the market where the risk-to-return profile in being contrarian is far more attractive than in following the herd. We outline two out of the four areas of opportunity below and will outline the remaining contrarian opportunities in a follow-up next week.

Turkey

“Bull markets are born on pessimism, grow on scepticism, mature on optimism and die of euphoria.” – Sir John Templeton

  

In Turkey today we see many reminisces of what occurred in Brazil in 2015, with the caveat that with Turkey embroiled in a geopolitical storm as compared to the internal political strife in Brazil in 2015 makes Turkey potentially far more volatile.

Consider Brazil at the height of its crisis in 2015:

  • The premium on Brazil’s three-year credit default swaps surged by 189 per cent over a period of four and half months
  • The Brazilian real declined by 43 per cent versus the US dollar in a period of four and half months
  • Using the twenty-five year average, Brazil’s real effective exchange rate was one standard deviation below its average

Brazil Real Effective Exchange Rate (25 Years)Brazil REER 25Y

Source: Bank for International Settlements

  • Using the five year average, Brazil’s real effective exchange rate was two standard deviations below its average. As the political turmoil subsided and the real effective exchange rate reverted towards the mean, the Brazilian equity market rallied and foreign investors enjoyed the leveraged effect of a rising equity market coupled with the strengthening real

Brazil Real Effective Exchange Rate (5 Years) vs. MSCI Brazil IndexBrazil REER 5YSources: Bank for International Settlements, Bloomberg

  • Brazil’s rating was downgraded from Baa2 to Baa3 by Moody’s and from BBB-minus to BB-plus by Standard & Poor’s

Now consider Turkey in 2018:

  • The premium on Turkey’s three-year credit default swaps has increased by 152 per cent in less than three months
  • The Turkish Lira has declined by 26 per cent versus the US dollar in a period of less than three months
  • Using the twenty-five year average, Turkey’s real effective exchange rate is almost one standard deviation below its average

Turkey Real Effective Exchange Rate (25 Years)Turkey REER 25Y

Source: Bank for International Settlements

  • Using the five year average, Turkey’s real effective exchange rate is two standard deviations below its average

 

Brazil Real Effective Exchange Rate (5 Years) Turkey REER 5Y Sources: Bank for International Settlements, Bloomberg

 

  • Turkey’s rating has been downgraded from Ba1 to Ba2 by Moody’s and from BB to BB-minus by Standard & Poor’s

The bad news is that Turkey runs a current account deficit of around US dollar 40 billion a year and has external debt stock of approximately US dollar 450 billion. The net amount of outstanding external debt is around US dollars 290 billion, representing 34 per cent of its GDP.

The good news is that the vast majority of Turkey’s foreign currency denominated debt is held by local banks. We do not expect Turkey to default on the debt it owes to foreign investors. This view is founded on the assumption that while President Recep Tayyip Erdoğan can afford to antagonise the US and Europe on the political front given Turkey’s geopolitical significance, he cannot afford to antagonise foreign investors as Turkey relies on international capital markets to fund its economy.

We think the time is coming to scale into Turkish assets. The sequence of scaling in being the Turkish lira first, foreign currency bonds second, local currency bonds next and the equity market last.


Swiss Franc

“You can’t do the same things others do and expect to outperform.” – The Most Important Thing by Howard Marks

Hedge funds and speculators are holding the biggest net short Swiss franc position in more than ten years at a time when the Swiss franc is close to being undervalued relative to the US dollar – a first since the start of the new millennium.

CFTC CME Swiss Franc Net Non-Commercial PositionCHF CFTC

Source: Bloomberg

Over the last decade, Switzerland has run an average current account surplus of 9.3 per cent of GDP. The Swiss franc should not be undervalued. If anything, given that Switzerland has consistently run current account surpluses and enjoys the so called global safe haven status, the Swiss franc should be overvalued.  We all know the reason why the currency is not overvalued: the non-stop printing and selling of its currency by the Swiss National Bank.

At the end of last year, the State Secretariat for Economic Affairs revised its economic growth forecasts for Switzerland upwards, forecasting GDP to grow by 2.3 per cent in 2018 after growth of 1 per cent in 2017. The revision was driven by industrial orders rising by a fifth in the fourth quarter last year and a booming tourism industry that is benefiting from the artificial suppression of the Swiss franc.

In the face of such strong economic growth we doubt that the Swiss National Bank can sustain the suppression of its currency. We suspect the Swiss National Bank, not for the first time, is going to cause a lot of pain to those unwisely betting against its currency.

We will gradually look to get long the Swiss franc once we see the broader short interest against the US dollar unwinding – we expect such an opportunity to be presented imminently.

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein  

AIG, Robert E. Lighthizer, Made in China 2025, and the Semiconductors Bull Market

“The icon of modern conservatism, Ronald Reagan, imposed quotas on imported steel, protected Harley-Davidson from Japanese competition, restrained import of semiconductors and automobiles, and took myriad similar steps to keep American industry strong. How does allowing China to constantly rig trade in its favour advance the core conservative goal of making markets more efficient? Markets do not run better when manufacturing shifts to China largely because of the actions of its government.” – Robert E. Lighthizer

“Patience is essential. We should step back, take a deep breath and examine carefully the ties that bind us together.” Maurice “Hank” Greenberg, former CEO of American International Group, at the congressional hearing on US-China economic ties in May 1996

American International Group (AIG), the once venerable multinational insurance group, was founded in 1919 in Shanghai, where it prospered until the communists forced it to leave in 1950. AIG had to wait over four decades to re-enter the Chinese market. In 1992, AIG became the first foreign insurance company licensed to operate in China and established its first office on the Mainland in Shanghai.

We doubt it was sentiment that led China to grant AIG the license. After all, there is little room for sentiment in the high-stakes game of global trade.

In 1990, Maurice “Hank” Greenberg, then chief executive of AIG, had been appointed as the first chairman of the International Business Leaders’ Advisory Council for the Mayor of Shanghai. In 1994, Mr Greenberg was appointed as senior economic advisor to the Beijing Municipal Government. In 1996, at the time when China’s status as Most Favoured Nation (MFN)[1] was under threat due to a resolution put forth to the House of Representatives in the US, he was appointed as the Chairman of the US-China Business Council.

While all of above mentioned appointments may have raised an eyebrow or two, they do not amount to much in and of themselves. When we throw in the fact that Mr Greenberg had been part of the President’s Advisory Committee for Trade Policy and Negotiations since the 1970s – the official private-sector advisory committee to the Office of the US Trade Representative – we begin to realise the possible reason why the Chinese leadership took a liking to Mr Greenberg and afforded his company the luxury of becoming the first foreign insurer to operate in China.

In May 1996, Mr Greenberg, during a key congressional hearing on US-Sino economic ties, testified in favour of not only renewing China’s MFN status but also making it permanent.

There we have it: quid pro quo.

In June 1996, the House of Representatives endorsed China’s MFN status by a vote of 286 to 141. At the time of vote AIG had eleven lobbyists representing its interests in Washington. One of those lobbyists was Skadden, Arps, Slate, Meagher & Flom, where AIG’s affairs were handled by one Robert E. Lighthizer – the current United States Trade Representative.


Senior American and Chinese officials concluded two days of negotiations on trade and technology related grievances the Trump Administration has with China. As many may have suspected, the talks appear to have achieved little despite the US sending a team comprised of top-level officials including Treasury Secretary Steven Mnuchin, Trade Representative Robert Lighthizer, White House trade advisor Peter Navarro, Secretary of Commerce Wilbur Ross, and National Economic Advisor Larry Kudlow.

As part of the talks the US representatives have submitted an extensive list of trade and technology related demands. In our opinion, the demands represent a hodgepodge of objectives as opposed to one or two key strategic objectives the Trump Administration may have – symptomatic of the differing views held by the various members of the US team. We expect US Trade Representative Robert E. Lighthizer to slowly take control of proceedings and to set the agenda for US-China trade relations – after all he is the only senior member of the team with meaningful experience in negotiating bilateral international agreements.

Mr Lighthizer’s primary objectives with respect to US-Sino trade relations are (1) for China to open up its economy – by removing tariffs and ownership limits – for the benefit of Corporate America and (2) to put an end to Chinese practices that erode the competitive advantages enjoyed by US corporations – practices such as forcing technology transfer as a condition for market access.

Mr Lighthizer’s goals are ambitious. They will require time and patience from everyone – including President Trump, Chinese officials, US allies, and investors. For that, he will need to focus Mr Trump’s attention on China. He will not want the President continuing his thus far ad hoc approach to US trade policy. If NAFTA and other trade deals under negotiations with allies such as South Korea are dealt with swiftly, we would take that as a clear signal that Mr Lighthizer is in control of driving US trade policy.


Unveiled in 2015, “Made in China 2025” is China’s broad-based industrial strategy for it to become a leader in the field of advanced manufacturing. The strategy calls for directed government subsidies, heavy investments in research and innovation, and targets for local manufacturing content.

To date, China’s industrial base is dominated by manufacturing of basic consumer products such as clothing, shoes and consumer electronics. The overwhelming majority of technologically advanced exports out of China have been made by multinational companies. The Made in China 2025 strategy identifies ten key areas – such as robotics, electric and fuel-cell vehicles, aerospace, semiconductors, agricultural machinery and biomedicine – where China aims to become a global leader. And it is these very industries that Mr Lighthizer aims to attack for the benefit of Corporate America.

One area where China is clearly at the cutting edge of global research is artificial intelligence. According to research published by the University of Toronto, 23 per cent of the authors of papers presented at the 2017 Advancement of Artificial Intelligence Conference were Chinese, compared to just 10 per cent in 2012. And we suspect, especially given the Chinese leadership’s dystopian leanings, China is going to be unwilling to relent on its progress in artificial intelligence regardless of the amount of pressure the Trump Administration applies.

Artificial intelligence requires immense amounts of computing power. Computers are powered by semiconductors. China cannot risk its AI ambitions by being hostage to semiconductor companies that fall under the US sphere of influence. China, we believe, will pull out all the stops over the next decade to develop its local semiconductor industry manufacturing capabilities with an aim to end its reliance on US-based manufacturers by 2030.

Investment Perspective

Investors often talk about the one dominant factor that drives a stock. While we consider capital markets to be more nuanced than that, if semiconductor stocks have a dominant factor it surely has to be supply – it certainly is not trailing price-to-earnings multiples as semiconductor stocks, such as Micron, have been known to crash when trading at very low trailing multiples. Chinese supply in semiconductors is coming.

While we expect the bull market in tech stocks to re-establish itself sometime this year, if there was one area we would avoid it would be semiconductors.

[1] From Wikipedia: MFN is a status or level of treatment accorded by one state to another in international trade. The term means the country which is the recipient of this treatment must nominally receive equal trade advantages as the “most favoured nation” by the country granting such treatment. (Trade advantages include low tariffs or high import quotas.) In effect, a country that has been accorded MFN status may not be treated less advantageously than any other country with MFN status by the promising country. There is a debate in legal circles whether MFN clauses in bilateral investment treaties include only substantive rules or also procedural protections.

This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein