Market update with Shaw and Partners, September 2021

Interviews

by Clive Tompkins

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Shaw and Partners Chief Investment Officer Martin Crabb discusses Evergrande, the Chinese economy, implications for the Australian equity market and monetary policy.

How the world changes in one month! So, we're sitting here a month ago and two months ago, saying, you know, how it's synchronised global growth and equity markets are looking good and all that sort of stuff. Just in the past few weeks, really, we've seen a market deterioration in sentiment in equity markets, and it's not just one market, it's sort of been pervasive. So, this month, so far, most regional indices are in the red, China being the notable one, where a combination of regulatory crackdowns on a number of industries, including technology and education, as well as the recent concerns about Evergrande…

So, just a few moments on Evergrande to put this into context. This is the largest property developer in China. They produce about 5 per cent of all the apartments that are sold in China every year, and they've got a lazy US$300 billion in debt outstanding. They're one of the biggest issuers into the foreign bond markets and US dollar bond markets, and they comprise over 10 per cent of all high-yield debt in China. Chinese property companies, in general, are by far the largest component of the Asia high-yield market, making up over 40 per cent of that index. And their composition in the world high-yield index is greater than that of the US real estate market. So it is a big deal, this Evergrande, and there are echoes of what happened during the GFC when Bear Stearns and then Lehman... Bear was bailed out, but Lehman wasn't, and there's a pervasive view in the market right now that the government will bail out Evergrande. And if they don't, obviously the repercussions are quite significant.

But it's not just about Evergrande. Evergrande's a symptom of what's been, I suppose, a deeper change within the Chinese government and their treatment of their economy. So, as we know, they were the first to go into lockdown and the first to come out, and obviously they pump-primed their economy quite significantly, as everyone else has, but they had some overheating. One of the constraints that China has, that maybe a lot of other economies don't have, is their environment. They're a very heavy polluter. Anyone who's been to Beijing or Shanghai in recent years will testify to how bad the air quality is. So, they can't run the economy flat out for fear of the inflation, they can't run it flat out for fear of the damage that it does to the environment and the quality of the air and so forth.

So, China is committed to beautiful China, and so they do, when they run into a bit of a... They run too hard, they create too much pollution. So, they have been slowing their steel sector and their property sector, which is, I suppose, part of the Evergrande malaise, but also the concerns around their consumption of raw materials. So, they are the biggest consumer, by far, of things like copper and iron ore and so forth. And so, as they've slowed that economy down, those commodities with abundant supply, such as iron ore, have felt the brunt. So, we've seen that crack. That's below US$100. It's sort of testing US$90 as we speak in the futures market. And that's down from about $240 not that long ago.

So, that has significant implications for our market, because it was the driving force behind earnings growth for the past couple of years. So Fortescue (ASX:FMG), Rio (ASX:RIO), BHP (ASX:BHP), collectively, and mineral resources collectively, make up somewhere around 20 per cent of the market by capitalisation. So, as their earnings are revised down, and Shaw and Partners revised down this morning on lower iron ore prices, that drags the overall earnings profile of the market down. Now, most Aussies know that, but a lot of foreign investors just look at the overall market, and they look at the tendency of earnings, and if they're heading south, they might tend to avoid it.

So, there are economies that are coming out of the lockdown that have got better earnings outlooks. Thinking of Europe, the UK, Japan, China, the US. These countries are clearly coming out of lockdown earlier than we are. And yes, we're all, fingers crossed, going to be back out at restaurants and bars some time in November this year in New South Wales, and maybe December in Victoria and other States, but a lot of these countries are already doing that. Anyone who follows the English Premier League will see 60,000 fans enjoying watching their teams play.

So, if you're a global investor, you're probably looking at Australia now, going, "Well, hang on, China's slowing, so I don't need to be in the minors. You know, the banks don't... The property market looks pretty fully priced and maybe even overheated, so I don't need to be in the banks. And then you've got the domestic, defensive stocks, the supermarkets, etc. They've had their post-Covid day in the sun. So I'm really now looking at the global cyclicals, the CSLs, Macquaries, James Hardie. Well, I can find global cyclicals in any market in the world."

So, we do think we'll see some de-weighting of Australia in global portfolios as people come to grips with the fact that the world is slowing somewhat. Probably in portfolios maybe just favouring global equities. I mean, there are obviously exceptions to that broad macro. Most of the companies you're hearing today are not necessarily dependent on the economy. They've got growth, organic growth, or new products, new markets, that's where they're getting their growth from. That's totally different to what I'm talking about. I'm talking about the big stocks and the ones that are exposed to the macro economy.

So, that probably leads me on to the second point, really, which is what's happening with monetary policy. Which is, we've got most central banks producing some sort of meeting or symposium this week. So ,we've just seen the Reserve Bank minutes from the last meeting issued today, and as we know, quite dovish. We have the FOMC meeting which is taking place today and tomorrow, so we'll hear about that Thursday morning our time. This will be a dot plot meeting. Every three meetings the Fed has, they produce the dot plot, the infamous dot plot, where they provide their estimates on where they think rates, inflation, unemployment and growth are going. So, we're going to see, for the first time, 2024 dot plots.

So, there's three things to take away, or to watch. One is the tapering. Are they going to do it now? Are they going to leave it till November? Given what's happening in the world markets, maybe they're going to leave that till November, but they're going to reduce the pace of purchases. Secondly is are they going to hike rates next year? Last month we saw seven out of 18 governors looking for a rate hike next year. Will we see more governors looking for a rate hike next year? And thirdly, we're going to see 2024 dot plot for the first time, so what is the monetary policy look out in 2024?

So between what's happening in China, what's happening in the US, and obviously our own domestic economy, there's lots on the minds of investors. We're just starting to see people take a bit of money off the table to start hedging risk in portfolios. But, having said all that, you can still find good companies with good growth, regardless of the macro environment, and hopefully we will hear some of those today. Back to you in the studio, Clive.


Ends

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