FYI | Jan 27 2009
This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP
(This story was originally published on Monday January 19, 2009. It has now been republished to make it available to non-paying members at FNArena and all other readers elsewhere.)
I have been picking up some disconcerting signals of late. And they all point into the same direction: China is likely going to disappoint to the downside in the months ahead. Needless to say, if my feelers are pointing into the correct direction, and picking up the correct vibes, current renewed market optimism with regards to natural resources, and to share prices of companies that are correlated to these resources, will prove out of synch with reality once again.
One only needs to observe the share price of BHP Billiton ((BHP)) since late last year to see how much part of the Australian share market would like this stock to rally, and to do so very hard. Every time the share price gets knocked back because of negative macro-economic news, it bounces back very rapidly, only to be knocked back again.
And so the battle between those investors/stockbrokers/tipsheets/media who built their investment gains, business model and local reputation on the back of a seemingly endless commodities boom over the years past (and who simply cannot let go of the past), and the new economic reality of today’s world in crisis rages on.
Last year, I wrote a few times that BHP Billiton shares were likely going to trade between $20 and $32 for an extended period of time. Of course, I did not just pick these numbers out of thin air. Those readers who have missed out on my analysis underpinning this projected bandwith for BHP’s share price can still read it on the FNArena website (see Rudi On Thursday, December 10, 2009).
Note: the December story is not the first time I mentioned this range, it explains best why. That’s why I am now referring back to this story and not to one of the previous ones I wrote.
Since the share price has recovered from its fall to $20 (as predicted) in November, it seems to oscillate around the $30 level (trading range has recently narrowed to $28-32) and readers have been asking about whether my views had changed. Unfortunately, for those who are hoping we’re witnessing something more sustainable than a temporary bout of investor optimism, my answer has remained negative; it is still negative today.
If anything, I have grown even more convinced that BHP shares will remain captivated within the $20-32 trading range for the foreseeable future. The reason? As I said above: it has all to do with signals coming from China.
The question I have been struggling with since I warned you all about the “largest correction in commodities for as long as people can remember” in August last year is whether a quick recovery in Chinese demand is feasible given that two-thirds of the global economy (and the richest and wealthiest two-thirds of the world too) is doing it very tough. Today, nobody seems to doubt anymore the world is experiencing a global synchronised economic recession -probably for the first time ever- yet many still seem to bank on a swift and earlier-than-expected recovery coming from China.
Ask yourself the following question: if consumers in the wealthiest parts of the world are tightening their belts, and export orders at Chinese manufacturers have already fallen off a cliff, what are the chances that consumers in China, and the rest of Asia, will be taking up the slack?
The signals I have registered over the past weeks and months is that this prospect appears very unrealistic. Last week I specifically mentioned “risk” and “timing” as the key ingredients for this year’s investment strategies. A time will come when the power of global consumption will shift from the US to China and the rest of Asia, but that time is nowhere near now. I’d say, come back in a generation or so. The world is unmistakably changing, and changing a lot, but these changes take a long and gradual process to develop and mature.
If my analysis proves correct, then all that is left for investors who are banking on a swift recovery in demand for natural resources is “risk”. It could mean that your investment returns for the year ahead are “at risk” already.
Fact of the matter is the US consumer is still the key driving force behind global international trade. That’s why economies in Europe and Japan are staring down the abyss. That’s why it makes sense to assume that unless things can be stabilised in the US, the rest of the world cannot return to its previous growth path. And that’s why demand for Chinese exports cannot recover anytime soon.
The positivos in the market will tell you the Chinese government is the best organised in the world, and has the budget-power to spend big on new infrastructure projects to revive growth, and thus demand for natural resources.
The sad reality is, however, that China is also battling with a housing bubble that has deflated. Private sector spending is declining, not in the least because property developers have lost their appetite. In a real worrying sign, foreign investors seem to be withdrawing from the country. (They have been one of the key drivers underneath the country’s spectacular growth figures since 2000).
Some commentators have already pointed out it appears that Asian exports into China are drying up. This would not only indicate the thesis of Chinese consumers picking up the drop in spending by their peers in developed economies will soon prove unrealistic, but also that Asia as a whole is losing its second major growth engine (after the US).
To me, it all makes sense because ultimately, at the end of the export chain that starts with China there’s still the wallet in the pocket of the US consumer’s trousers. Unfortunately, for all of us, that consumer is being hit left, right and centre by multiple crises at once.
As such, I believe the end of the current economic downturn (and of everything else that continues trending downwards) will be achieved in the US, not in China. Here’s for the hope that Barack Obama can do much more than delivering nation inspiring speeches!
Meanwhile, I have little doubt that most in the investment community will remain focused on what happens in China. Signals coming from the country are simply not hopeful (or inspiring). Today, Sydney Morning Herald correspondent in Beijing, John Garnaut, who has been publishing timely and accurate insights into the country over the months past, is citing (non-official) Chinese economic studies predicting “mass unemployment” is about to take place in the coming year.
(For those who missed my own update on this matter, see Friday’s story “Chinese Consumers Facing The Same Batlle”, Asia).
The main economist featured in Garnaut’s China story, Tsinghua University economics professor Yu Qiao, is critical of the Chinese government’s stimulus package because it mostly revolves around capital-intensive construction, leaving service industries (that would deliver more jobs) in the cold. And even then, the professor believes the downturn in the Chinese building sector is so severe that even the government’s stimulus package will only deliver a temporary boost. He believes the build-up of excess supply is so big that demand will remain weak for years to come.
I have a suspicion the Chinese economy has become a more integrated part of the global economic system than many commentators have realised and as such the Chinese government seems to be battling the same adversaries as governments elsewhere. I also think it seems rather unlikely any government can win this battle without the full support from the private sector (who is, at the end of the day, a much more powerful jobs creator than the government is, even in China).
No wonder Chinese authorities seem to be preparing the world for increased social unrest in the country, in itself another worrysome development.
But what really caught my eye was a market update, on Friday, by Societe Generale global strategist Albert Edwards. Edwards might not be a household name for most readers of this weekly editorial, but he has rapidly amassed somewhat of a cult-adoration inside the global financial community since he and his colleague at SocGen, James Montier, predicted the world would come crashing down when everyone else was still talking new highs and another year of positive investment returns for 2008.
Similar to Nouriel Roubini’s predictions of doom and gloom, Edwards and Montier’s projections have proved closer to what actually happened in financial markets than any other strategist at a major financial institution. Hence the cult-status, the admiration (both were voted top class by their peers last year) and my interest.
To put it simple: Friday’s global strategy update by Edwards almost makes one to run for the hills and seek shelter. Edwards and Montier are (in)famous for their call that the S&P500 index in the US still has another large correction in front of it, which could possibly take the index as low as 500 (the index is currently more than 40% higher at 850).
Equally important, I think, is the fact that Edward’s market update on Friday singles out China as the provider of the next big investor shock. In other words: overall market optimism has risen over the weeks past and Edwards believes this is partly based upon a widely endorsed assumption that China will surprise to the upside this year. If it turns out the opposite is true, the market is likely not going to take this lightly.
Enter: the S&P500 index on its way to 500.
Edwards does not mince his words: he predicts Chinese economic growth is going to “collapse” this year, not just slowing down or finding a new growth pace at more sustainable levels or anything similarly positively worded: “collapse”.
Another word he regularly uses to describe what is happening inside the country is “imploding”. Edwards describes the Chinese economy as “imploding”. Hence why growth will “collapse”.
Thus, he says, investors should consider what would happen if China descends into social chaos. And what will happen if the authorities repeat what they did in the past under similar circumstances: devalue the national currency.
The latter could easily trigger a repeat of many things that went wrong during the thirties and ultimately created the Big Depression, Edwards warns: Do you really trust the politicians to “do the right thing”?
His eight pages of analysis come with graphs, charts, indicators and insights about why investors should not be fooled by any Obama-inauguration inspired share market rally. Says Edwards: “The year 2008 has surely taught investors to think the unthinkable. In 2009 it is not the mounting risk of depression in developed economies that will come as a major surprise; it is economic implosion in China and the global and geopolitical risk thereof. Unthinkable you gasp! But you probably said the same thing about my forecasts at the start of 2008.”
What has caught Edwards’ attention, and what is one of the major ingredients for his gloomy view on China, is the fact that electricity usage in the country has been declining for the past three months. This is an ominous sign, he believes.
(Special note: Many economist is standard rather sceptical about the accuracy of data released by the Chinese authorities, suggesting the Chinese have a long history of dressing up their data if and when necessary. As such, upcoming data may not necessarily reflect what is truly happening inside the country. This is why many economists put more value in knowing what the numbers are for electricity usage throughout the country.)
Edwards points out that recent data from countries such as South-Korea and Taiwan suggest a sharp drop in exports from those countries to China. This would be in line with falling electricity usage in the country. Ultimately, if correct, all this will prove that China is very much part of an integrated global economic and financial system, that Chinese consumers are still relatively poor compared with their cousins in the developed world (but battling similar headwinds nevertheless) and that current market expectations for growth in China, and the rest of Asia, will need to be scaled back.
It will also prove we should all keep our fingers crossed the ascendency of the 44th President of the United States this week will be a truly world-changing event.
On a happier note, Edwards admits in Friday’s update he has been trying to play the bear market rallies despite remaining structurally bearish on immediate prospects for global equity markets. This delivers us the following hilarious insight:
“Despite being structurally bearish I try to participate in the rallies, while my colleague, James Montier, tut-tuts disapprovingly and tries to switch off the power to my computer with his foot.”
Both strategists increased their weighting to equities after the sell-down in October; not because they believed a bottom was in place, but because they anticipated a technical rebound. Edwards now believes it is again “time to bail out of equities”.
China will release several key economic indicators this week, including Q4 GDP data (exact dates of releases still unknown). BHP Billiton will release its production report for the December quarter.
With these thoughts I leave you all,
Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by the Ab Fab team of Chris, Grahame, George, Andrew, Joyce, Pat and Greg).
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