Tag: Brazil

Will Europe be the Fall Guy in the Trade Deal?

 

“Capable, generous men do not create victims, they nurture victims.”  — Julian Assange

 

“Politics is tricky; it cuts both ways. Every time you make a choice, it has unintended consequences.”  — Stone Gossard, lead guitarist for Pearl Jam and member of the Rock and Roll Hall of Fame

 

A slightly shorter piece than usual this week as we recover from  jet lag following a ten day trip to the US. This week we discuss, the potential fallout from a US-China trade deal.

 

 

In 1978 China accounted for less than one hundredth of global trade. By the turn of the millennium, its share had increased threefold. In a decade’s time, by 2010, its share of global trade had tripled again and in 2013 China surpassed the United States, becoming the world’s largest overall trading nation.

 

As China’s share of global trade has increased so too has the number of trade disputes it has been involved in. Between 2006 and 2015, China was party to, as either complainant or respondent, in more than a quarter of the trade dispute cases lodged with the World Trade Organisation (WTO).

 

Notably, according to Harvard Law Professor Mark Wu, there has been a notable shift in the “pattern of WTO cases among the major trading economies — the United States, European Union, Japan, and China”. Up until the global financial crisis, the US, Japan and the European Union would regularly file complaints against one another. Following the crisis, however, only three cases have been brought by the three major developed economies against one another. Instead, the cases brought by the major powers have almost exclusively been focused on China — 90 per cent of the cases they brought to the WTO between 2009 and 2015 were China-related.

 

The meteoric rise of the Chinese economy and its growing influence on global trade has challenged the pretext under which the WTO was formed. The WTO has struggled to adapt and to develop an equitable dispute settlement system to counter China’s, at times, egregious trade practices. The WTO cannot, given China’s importance to global trade, make rulings or draft new rules that China sees as discriminatory or unfair but at the same time it cannot seen to be a lame duck and see other member countries turn away from it. The inability to effectively settle this dilemma has weakened the institution’s credibility.  So much so that the WTO Appellate Body no longer has enough members to hear all possible cases — the US has vetoed all appointments to the body. Many see the US vetoes as a death knell for the WTO — signalling a return to  a world where trade disputes are settled through bilateral negotiations and the WTO’s dispute settlement system is defunct.

 

The United States Trade Representative, Robert E. Lighthizer, has, since taking office in May 2017, pursued a campaign against China based on the statutes of Section 301 of the 1974 Trade Act, which allows unilateral action by the US President against trade policies deemed unfair. In effect, the US Trade Representative’s strategy sidelines the WTO.

 

The Trump Administration’s approach of using Section 301 has been seen, by many, as both aggressive and likely to lead to negative consequences for the Chinese economy.  What if, however, President Trump has come to the realisation, that also afflicted his predecessors, that the American and Chinese economies are too closely intertwined for either side to be a victor in a trade war? If so, we wonder, is Europe going to be the fall guy in the trade deal?

 

Europe’s Trade Surplus with the US

 

From the Wall Street Journal:

 

The European Union reported a record trade surplus with the U.S. last year, a development that could weigh on slow-moving U.S.-EU trade talks and comes as the Trump administration prepares to deliberate hefty tariffs on European car imports.

Meanwhile, slowing exports from Europe to other trading partners, most notably China, in 2018 suggest the flagging EU economy could cool further this year. Failure of the U.S.-EU trade talks and fresh duties from the U.S. could compound Europe’s economic pain in 2019.

 

President Trump, we suspect, is going to look for an alternative win should the trade dispute with China be resolved amicably. We suspect, Europe, with its record bilateral trade surplus, is likely to find itself in the line of fire. For it was only days before Trump’s visit to Europe last year that President Macron called for the creation of a “true European army” and agitating the US President in the process.  Moreover, Europe is in a mess —  with the small matter of Britain’s exit from Europe imminent and a leadership vacuum with Angela Merkel a lame duck in office, Emmanuel Macron too occupied trying to contain the yellow vest movement, Italy moving from one crisis to another — meaning there is little hope for a coordinated response from the trade bloc, should President Trump throw down the gauntlet.

 

With any resolution of the US-China trade dispute likely to come with conditions for China to increase purchases of US goods and services, China is likely to reduce purchases of European goods and services in response. This is will only compound Europe’s problem further.

 

We think there is little reason to be overweight, or even equal weight, European equities at present.

 

Extending the same line of thinking, we think China is likely to increase its purchases of agricultural commodities from the US by reducing purchases from Brazil. For emerging markets exposure, we would underweight Brazil.

 

Semiconductor Leadership

 

 

Were the above tweets a wink to the national security hawks in the Trump Administration to end the pursuit of Huawei and stop placing export controls on US semiconductors producers?

 

If so, we think $SOXX should continue to be amongst the leaders in the US market. If, however, if there is sudden weakness in the semiconductor space we would be concerned about the prospects of an amicable trade resolution.

 

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.

 

 

 

 

Investment Observations

 

“People’s minds are changed through observation and not through argument.” – Will Rogers

 

“If you make listening and observation your occupation you will gain much more than you can by talk.” – Robert Baden-Powell

 

“The important thing is not to stop questioning. Curiosity has its own reason for existing.” – Albert Einstein

 

Autumn months are more volatile; 2017 was an aberration

October is, on average, the most volatile month of the year for US equity markets. From 1993, the year the VIX index was launched, through 2017, the average level for the VIX for the month of October has been 21.8 per cent.

In October 2017, the VIX averaged 10.8 per cent, which at the time was the lowest monthly average for any month on record since the VIX index was launched. The complacency witnessed in capital markets last year was an aberration and should not be the yardstick by which investors manage their portfolios.

 

US mid-term elections: History is on the side of equity markets

Regardless of how midterm elections turn out, equity investors tend to be the big winner. At least that is what history suggests.

The S&P 500 index has climbed in the twelve months following each of the midterm elections going back to 1946, with an average return of 16.7 per cent. That is eighteen elections irrespective of who won and what changes were wrought on the balance of power.

Do not let the typical level of volatility witnessed in months starting with the letter ‘O’ put you on the wrong side of history. Stay long US stocks.

 

Treasuries: “The dog that didn’t bark”

If stocks go down, treasuries go up. Rinse and repeat. This is the axiom on which strategic asset allocations of institutional investors and quantitative investment strategies, such as ‘all-weather’ and ‘risk parity’, have been built.

Yet this past month we have seen treasuries fail to bounce even though global equity markets have sold off. This failure is even more surprising given that speculative short futures positions across the US Treasury bond curve are at or near record highs. The inability of bonds to rally in the face of an equity market sell-off gives credence to the argument that the short bond positions are not speculative but rather hedges to long positions held by institutional investors and / or hedge funds.

 

Gold: Risk-off rally?

Unlike treasuries, the recent sell-off in stocks has coincided with a strengthening of the price of gold. This is all the more surprising when we consider that the US dollar has not weakened but rather strengthened as well.

 

Is gold the new hedge to stock market volatility? We are not sure. The recent rally might just be a case of unwinding of oversold conditions or of speculative investors closing their short gold positions in response to redemptions or margin calls caused by their declining long positions.

Alternatively, we wonder if a new bull market in precious metals is getting underway. It is, we feel, too early to tell and with gold miners remaining weak despite the gold price holding strengthening, it should give anyone bullish on the prospects of precious metals some pause.

For example, Newmont Mining, one of the few ‘blue chip’ gold mining companies, reported solid third quarter earnings yesterday that handily surpassed consensus estimates but still saw its stock price decline by almost 7 per cent. (Admittedly, at the time of writing some of yesterday’s weakness has been reversed today.)

 

SoftBank’s Vision Fund and the race for venture capital exits

Over the last twelve months there has been little to no incentive for venture capital backed companies to go public. They have had a much better alternative that does not come with the scrutiny faced by a publicly listed company: sell to SoftBank’s Vision Fund.

The Vision Fund, the largest ever venture capital fund raised anchored by capital commitment of US dollars 45 billion from Saudi Arabia, has been deploying capital at record pace with, what appears to us at least, limited consideration for valuation and due diligence.

Take for instance Benchmark Capital’s partial exit in Uber. The venture capital fund was able to monetise one of its most successful investments without a trade sale or public listing. Benchmark sold 14.5 per cent of its holding in Uber for around US dollars 900 million to the Vision Fund. Considering that Benchmark originally invested US dollars 12 million in Uber, the partial exit is quite the coup and something, we feel, that would not have been possible without a public listing were it not for the Vision Fund

Given the recent events surrounding Saudi Arabia and deceased Washington Post columnist Jamal Khashoggi, there is likely to be little appetite in Silicon Valley to accept  Saudi Arabian money henceforth. For example, Ari Emanuel’s media and entertainment group Endeavor is considering terminating a US dollars 400 million investment into the company by Saudi Arabia’s Public Investment Fund.

SoftBank’s Vision Fund is synonymous with Saudi Arabian money.

Masayoshi Son, SoftBank’s founder, was as recently as August talking up the prospects for a second Vision Fund with Saudi Arabia once again the cornerstone investor. Talks of the second fund have died down given recent events.

Given recent developments and Silicon Valley likely to shy away from engaging the Vision Fund any further, we suspect many venture capital backed “unicorns” are actively soliciting proposals from investment banks to help them go public.

We expect a flurry of tech-led IPO activity in the first half of 2019.

 

Brazilian election: Fears of a Latin Rodrigo Duterte

Brazil held the first round of general elections on 7 October, 2018 to elect the President, Vice President and the National Congress.

Rio de Janeiro congressman Jair Bolsonaro came first in the first round of the election. The run-off will be between him and former São Paulo mayor Fernando Haddad.

Fernando Haddad represents the Workers’ Party – the leftist party that has won the last four elections held in Brazil.

Former army captain and seven-time congressman Jair Bolsonaro is the right-wing candidate representing the Social Liberal Party. Barring a late twist, Mr Bolsonaro is expected to be elected as Brazil’s next president on Sunday. Mr Bolsonaro has ridden a wave of populism and angst against the incumbent party to put himself in pole position.

Since Mr Bolsonaro’s victory in the first round of the elections, Brazilian assets have rallied even as other emerging markets struggled. Market participants do not want the Worker’s Party back in power – fearing that the leftists will undo the reforms that have stabilised the Brazilian economy in the aftermath of the 2014-16 recession. Moreover, there is hope that Mr Bolsonaro will continue on the path of reforming the Brazilian economy.

Mr Bolsonaro’s proposed economic team, should he come into power as expected, will be made up of technocrats under the leadership of University of Chicago-trained financier Paulo Guedes. Mr Guedes is an advocate of deep public spending cuts and deficit reduction with the seemingly incongruent goals of reigniting consumer and business confidence. He has advised Mr Bolsonaro to push ahead with painful reforms, should he be elected, from the very beginning of his term. In particular, Mr Guedes is pushing for social security and pension reform that would trim benefits and raise the state retirement age to 65 for men, and 62 for women to be at the top of Mr Bolsonaro’s agenda.

While right-wing candidate’s economic agenda appears to be encouraging, his social agenda is eerily reminiscent of the type of opinions expressed by Philippine President Rodrigo Duterte. Mr Bolsonaro, to quote the Financial Times, “is known as an apologist for the 1964-85 military dictatorship, for endorsing torture and for making disparaging remarks about homosexuals, women and black people.”

We are concerned that Mr Bolsonaro will try to prolong the wave of populism as much as possible by prioritising his social agenda over economic reforms. In particular, we would be surprised, if he makes the unpopular social security pension reforms his key priority early in his presidential term. In fact, during his campaign, Mr Bolsonaro went as far as criticising current president Michel Temer’s planned social security system reforms as well as the tax changes proposed by Mr Guedes.

Brazilian assets may continue to rally should the country elect Jair Bolsonaro as its 38th president on Sunday. We, however, prefer to tread carefully until there is more clarity on Mr Bolsonaro’s priorities once he is in office.

 

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.