“The good times of today, are the sad thoughts of tomorrow.” — Bob Marley
Chinese Economic Data
The Chinese economy grew at 6.4 per cent year-over-year during the first quarter of 2019, matching the economy’s growth during the fourth quarter of last year but below the 6.6 per cent growth achieved for the full year during 2018. Growth came in slightly higher than consensus expectations and appears to have been buoyed by strong credit growth — system-wide financing was up 10.7 per cent year-over during March, led by an acceleration in lending by Chinese financial institutions. Total loans extended by financial institutions increased by 13.7 per cent year-over-year in March to reach its highest rate since June 2016.
There was a sharp recovery in the Chinese industrial sector during March, industrial value added surged to 8.5 per cent year-over-year, up from 5.7 per cent in February. Part of this growth can probably be attributed to the Chinese New Year falling in early February this year versus being in late February last year — factories are likely to have only reached stable production into March in 2018. We will look to April data upon its release for further clarity.
Despite the above caveat, some of the notable metrics on the industrial side include:
- Steel, glass and cement production were up 10, 8 and 22 per cent year-over-year in March, respectively. The strong growth in production figures of construction materials reconciles with the 12 and 18 per cent year-over-year increases in property investment and construction starts, respectively. The growth in construction starts was matched by the 18 per cent year-over-year growth in mortgage lending.
- Smartphone, automotive and semiconductor production dropped by 7, 3 and 2 per cent, respectively.
The bad news for semiconductors was not limited to production. Chinese imports of diodes and semiconductors during March declined by 11.8 and 12.7 percent year-over-year in value and volume terms, respectively. For the first quarter imports are down 9.6 and 14.7 per cent year-over-year in value and volume terms, respectively.
The decline in semiconductors may prove to be a red herring. It is altogether possible that Chinese authorities are eager to limit semiconductor imports up until a trade deal has been struck with the United States. Unleashing a flurry of semiconductors orders from to help close the bilateral trade deficit, upon signing of a trade pact. If this indeed is the case, it would go someway towards explaining the discrepancy between the strength in China’s Purchasing Manager’s Index and the weakness in Korean and Taiwanese exports to China.
Given the softness in Chinese semiconductor imports, our conviction in our earlier call of shorting Taiwanese semiconductor companies as a hedge for portfolios positioned for an amicable resolution to the US-China trade dispute is strengthened. Further, we think shorting Taiwanese semiconductor is one of those rare situations of “heads I win and tails I do not lose” — under an amicable trade resolution, marginal Chinese demand shifts from Taiwan to the US, while under a deterioration of trade relations the risk of Taiwan being annexed increases markedly.
Away from semiconductors, given the pick up in Chinese industrial activity and credit impulse and the robustness of the property market, we reiterate our call for fixed-income investors to close out long positions in long-dated Chinese government bonds.
Lighten Up On Semiconductors
Despite the slowdown in Chinese semiconductor imports, the market has bid up semiconductor stocks to record highs. The Philadelphia Stock Exchange Semiconductors Index is up 35.4 per cent year-to-date versus 16.4 per cent for the S&P 500 Index.
The index has been buoyed by recent announcements from Intel, Apple and Qualcomm.
Apple and Qualcomm announced that the two parties agreed to dismiss all litigation between them world-wide and signed a new licensing agreement, which brings to an end the long-running legal battle over how royalties are collected on innovations in smartphone technology. Qualcomm said the agreement will add about US dollars 2 in annual earnings per share. Qualcomm’s stock jumped 23 per cent on the news.
Following the announcement from Apple and Qualcomm, Intel announced that is was withdrawing plans to make modem chips for 5G smartphones. Investor’s cheered the decision, pushing Intel’s stock to 19-year highs.
Such positive news from two of the five largest constituents of the Philadelphia Stock Exchange Semiconductors Index is a pretty high bar to set for good news to clear in the near term. And the market’s reaction function to news about the on going US-China trade negotiations exhibiting more than a tinge of buying the rumour, we are concerned that an eventual agreement will close the loop by being a sell the news event.
We think it is as a good time as any to lighten allocations in the semiconductor space.
Inflationary Pressures
From The Beige Book issued 17 April 2019 (emphasis added):
Employment continued to increase nationwide, with nine Districts reporting modest or moderate growth and the other three reporting slight growth. While contacts reported gains across a variety of industries, employment increases were most highly concentrated in high-skilled jobs. However, labor markets remained tight, restraining the rate of growth. A majority of Districts cited shortages of skilled laborers, most commonly in manufacturing and construction. Contacts also reported some difficulties finding qualified workers for technical and professional positions. Many Districts reported that firms have offered perks such as bonuses and expanded benefits packages in order to attract and retain employees. This tight labor market also led to continued wage pressures, as most Districts reported moderate wage growth. Wages for both skilled and unskilled positions generally grew at about the same pace as earlier this year.
The below chart compares the National Federation of Independent Business (NFIB) time series on businesses reporting on job openings hard-to-fill to the growth in US nonfarm unit labour costs on a year-over-year basis. (The unit labour costs time series is lagged by a year, as it takes time from businesses realising that jobs are hard-to-fill to be willing to pay higher.)
As can be seen from the chart above, the disconnect between the two time series today is quite large. If we take the commentary in The Beige Book at face value, there should be some convergence between the two series, with unit labour costs rising. If that transpires, we may finally see a sustainable pick up in inflationary pressures in the US, which may also mark the cyclical top in corporate profit margins.
The acceptance for and popularity of socialism driven in part by a decade of returns flowing to asset owners at the expense of labour providers, may just be coming at very moment the structural forces are set to move in favour of labour.
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.