"The very concept of objective truth is fading out of the world. Lies will pass into history." - George Orwell
"That "without doubt it is a great advantage to have intelligence, courage, good breeding, and common sense. These, and similar talents come only from heaven, and it is good to have them. However, even these may fail to bring you success, without the blessing of a godfather or a godmother"
- One "macro convex trade" to think about for 2016
- Container shipping and large surge in US inventories, a great cause for concern
- Final chart - Global equities: more de-equitisation to come in 2016
- One "macro convex trade" to think about for 2016
"A weaker CNY would trigger a fall in competitivity for the entire Asian region and would massively impact the retail sector of Hong-Kong with additional fall in the number of visitors from mainland China and even more pressure on property developers. Hong Kong property sales plunged to 17-month low in August amid increasing economic uncertainty in China." - source Macronomics
"The second major factor, and arguably the more important one in the short term, is what is happening on the mainland. China’s marked slowdown has taken a toll on everything from property transactions to tourist arrivals and retail sales in Hong Kong.
Chinese tourists buying up everything from Louis Vuitton bags to milk powder in Hong Kong’s shops accounted for nearly half of the city’s retail sales last year. This is slowing sharply as the economy slows and as Chinese tourists prefer to take their shopping to Korea and Japan instead. The knock-on impact is putting rents in shopping malls at risk.
The backdrop appears anything but sanguine.
But Macquarie takes a calmer view. It estimates that there is a decade worth of pent up demand (roughly amounting to 262K households) in Hong Kong that has built up as buyers got increasingly priced out of the property market. Unless there are widespread job losses it is unlikely that this demand will disappear.
If they’re right, that suggests every dip is likely to find buyers come back in even if interest rate slowly nudge higher.
Dents in the armour are showing. But 2016 may still be too early for the start of the collapse." - source Reuters
"Direct contribution to GDP on recipients of China outflows are very small for most except in “special” territories (Macau, HK), which are suffering from a Chinese tourist slump. While tourist arrivals are booming in Japan, the biggest beneficiary of strong mainland arrivals relative to the size of their economy appears to be Thailand.
A second important constraint is the overhang from the build-up of nonfinancial private sector leverage, in the backdrop of a maturing credit cycle.
While we don’t expect any disorderly deleveraging/credit crunch given stronger balance of payment/less FX mismatch risks for most (though Indonesia corporates have some issues), with room for some to pursue counter-cyclical monetary easing in contrast to the Fed rate hiking cycle, there are a few FX-managed regimes with very open capital accounts– HK and Singapore – that inevitably will see rates rise alongside the US and will need some monitoring, especially given its knock-on impact on property markets and household balance sheets. Moreover, persistent capital outflows could tighten domestic financial conditions, especially for those without offsetting current account buffers and/or had been significant recipient of those volatile types of capital flows– e.g. Indonesia and Malaysia look vulnerable here. Even if central banks keep monetary conditions accommodative through interest rate and liquidity tools, we note that many countries in Asia -- notably China, HK and ASEAN countries – have seen a notable rise in “credit intensity” of output in the post-GFC years. We think this is a sign of credit being increasingly allocated to less productive sectors that, over time, manifests itself in weakening cash flows relative to debt service payments. This dynamic will lead to two things: first, greater demand for balance sheet repair among indebted entities, which will drag aggregate demand, or second, if balance sheet is irreparable, rising default rates and loan losses in the banking system, which will then feed into tightening of credit standards and higher costs to credit. Our bank analysts see the biggest NPL risks arising in China, Indonesia, Thailand and eventually Malaysia. Thus, a more mature phase of the credit cycle will mean that even the effectiveness of monetary policy as a counter-cyclical policy easing will weaken." - source CITI
"2016 likely to be another weak year for Hong Kong, don't count on the weak base to support growth
The weakness in Hong Kong is driven by lower traffic. Total visitation is flat in 2015 ytd, but down about 7% in the last 3 months. The quality of the tourist is also lower, which is leading to lower conversion rates & basket sizes. Most European luxury companies have reported Hong Kong revenues down 15-25% in the most recent quarter. Based on conversation with Hong Kong based luxury companies weak trends have continued into October despite an easy comparison base, which included the impact of Occupy Central last year. The outlook for 2016 remains subdued.
We track Watches & Jewellery retail sales to gauge luxury market demand in Hong Kong. In 2015 ytd HK Watches & Jewellery retail sales are down -13.1%, with September down 23% despite an easier comparison base. September volumes decreased 16.7% and average selling price was down by 6.2% in the month. This is shown in the charts below.
We believe monthly retail turnover for Harbour City & Times Square luxury malls in Hong Kong also provide a guide to market growth. Revenue is down around 9-10% in 2015 ytd, with the biggest declines since in the most recent quarters. This is shown in the charts below.
- source Bank of America Merrill Lynch
Indeed has shown in Bank of America Merrill Lynch's note, it seems the Hong Kong "golden carriage" is losing some of its appeal. We do like to track "traffic" as great macro "growth" indicators, such as Air Cargo, Container traffic and many more. What is indeed of great interest is that no new seats are being added to China-Hong-Kong flight routes for 2016 YTD:
"Hong Kong continues to lose its appealChinese consumers no longer see Hong Kong as an attractive luxury shopping destination. We think this stems from a lack of newness, increased social tension, occupy central and a strong HKD.
Total visitation is flat in 2015 ytd, but down 7% in the last 3 months, which reflects the decline in Chinese inbound tourism. However this still under-states the decline being felt by luxury companies in HK given the quality of the tourist is also lower, which is leading to lower conversion rates & basket sizes. Chart 76 shows no new seats are being added to China-Hong Kong flight route for 2016 YTD, suggesting the underlying weakness in traffic is expected to continue.
- source Bank of America Merrill LynchAnd of course the winner of the "currency war" when it comes to the "Shrinking pie mentality" we discussed in April 2014:
"When the economic pie is frozen or even shrinking, in this competitive devaluation world of ours, it is arguably understandable that a "Winner-take-all" mentality sets in." - source Macronomics, April 2014.No wonder Japan is "winning it all" when it comes to tourists and "competitive devaluation" as indicated by Bank of America Merrill Lynch:
"Japan has grown 100% in 2015, strong growth likely to continue as appeal picks up
The number of China outbound tourist to Japan has increased by more than 100% in 9m 2015. This has led to 35% growth in luxury consumption in Japan. We expect Japan to continue to take share from Hong Kong, which is still 7x the size in terms of inbound tourist from China. As a result we expect ongoing solid luxury goods revenues in Japan (+25% cFX), despite a very tough comparison base.
Chart 78 15-20% more seats are being added to China-Japan route for 2016 YTD, suggesting the increased in traffic is expected to materialise.
- source Bank of America Merrill LynchSo, from an "allocation" perspective, if you want to play the "luxury" and "tourism" theme, then "overweight" the "golden carriage" in Japan, as Hong-Kong is more likely to turn into a "pumpkin"....but we ramble again.
Also with continuous pressure on China's FX reserves which have fallen by $87.2 billion to $3.44 trillion at the end of November, from $3.53 trillion a month earlier, and in conjunction with China 's bad exports/imports data (-6%/-8%) this will further accentuate the pressure on the HKD in the coming year. The latest CNY/Yuan picture, graph source Bloomberg:
- source Bloomberg.
On that matter we read with interest Société Générale's take on the subject:
"China's FX reserve data, released yesterday morning European time, had an impact on Asian markets today. The USD 87.2bn fall was a good bit bigger than expected, even if about half off the fall is due to FX valuations. Throw is some more weak trade data this morning (surplus USD 54.1bn as exports fall 6.8% y/y, imports fall 8.7%) and the stage is set for more CNH weakness. As USD/CNY edges higher again, to 6.42, the currency's stealth-like depreciation since the start of November is looking less stealthy. Once USD/CNY breaks 6.45 or USD/CNH breaks 6.50, this is likely to be a major source of concern to markets globally, let alone in Asia." - source Société Générale
"Interesting thing happens during currency wars, currency pegs like cartels do not last eternally." - source Macronomics - November 2014.We would also like to point out that, in similar fashion AAA ratings are a "dying breed" and "golden carriages" often return to "pumpkin" state, currency pegs are not eternal as we reminder ourselves in our long September 2015 conversation "Availability heuristic - Part 2":
"There is indeed a clear trend in "de-pegging" currencies in the Emerging Market world, but in Developed Markets (DM) as well, the CHF event of this year has shown that pegging a currency in the current monetary system is bound to fail at some point. The sovereign crisis in Europe has also shown the inadequacy of the Euro for various European countries with different economic and fiscal policies as well as different composition (hence our negative stance on the whole European project...).
When it comes to our recent "convex" macro musing around the HKD we also note that Asian pegged or quasi peg currencies could indeed be the next shoe to drop" - Macronomics
- source of the table - Société GénéraleMore closely to "home", in Europe that is, of course we continue to believe that Denmark will as well eventually be forced to "ditch" its peg to the Euro. On that take we read with interest Bloomberg's article from the 7th of December entitled "Currency Battle-Front Reset as Danes Seek Euro Peg Normalization":
"While Denmark won its battle against currency speculators earlier this year, there’s still far to go before the central bank can consider a “normalization” of its monetary policy.While indeed the Danish central bank has won a battle, it hasn't won the war and at some point we think, that in similar fashion to the SNB, it will lose the war but that's another story.
Governor Lars Rohde says Denmark’s benchmark interest rate will over time be closer to the European Central Bank’s. The Danish deposit rate is now minus 0.75 percent, and the ECB’s is minus 0.3 percent. Denmark pegs its krone to the euro in a tight band, forcing the central bank to track ECB policy closely.
“One might ask if minus 0.75 percent as a marginal rate is normal, and the answer is that it’s probably not and neither is minus 0.3 percent at the ECB,” Rohde said on Monday in an interview in Copenhagen.
How soon Denmark acts to reduce that spread “will largely depend” on the actions of the ECB. President Mario Draghi’s decision last week to deliver a smaller-than-expected stimulus package certainly provided relief to the Danish central bank. “It turned out to be very easy not to do anything,” Rohde said.
The ECB on Dec. 3 cut its deposit rate less than some traders and investors expected. It also extended, but didn’t raise, its bond-purchase program. The news sent the euro more than 3 percent higher against the dollar and took pressure off a number of central banks across Europe that had previously struggled to prevent their currencies from strengthening against the euro.
“The projected krone appreciation pressure is unlikely to intensify materially after the ECB left the big easing bazooka at home,” Danske Bank analysts said in a note on Tuesday. The Danish central bank “effectively delivered a small rate hike by not shadowing the ECB last week.”
Nykredit, Denmark’s biggest mortgage bank, says Denmark is now set to raise rates twice next year, following the “soft” package unveiled by Draghi last week." - source Bloomberg
When it comes to Denmark, and in particular the "game of survival of the fittest" being played in this "shrinking pie mentality" world, we previously pointed out Danish A.P. Moller Maersk as a "survivor" in the container shipping industry in our August 2012 conversation "The link between consumer spending, housing, credit and shipping":
"If you want to pick winners in this survival of the fittest contest, you have A.P. Moeller-Maersk A/S investing in fast and fuel efficient vessels (Maersk vessels are designed to operate efficiently at both high and low speeds), and so is Evergreen Group, owner of Asia's second biggest container line is as well adding more fuel efficient vessels to its fleet as well as Neptune Orient Lines Ltd" - source Macronomics - August 2012What is getting us more and more worried for the probability of the "golden carriage" to turn into a "pumpkin" is that even our identified "champion" has not been immuned to the very strong deflationary forces at play and is in fact moving towards "loss-making". This brings us to our second point of our conversation.
- Container shipping and large surge in US inventories, a great cause for concern
Back in March 2012 in our conversation "Shipping is leading deflationary indicator", we argued that shipping was in fact an important credit and growth indicator, but most importantly a clear deflationary indicator. We also indicated that consolidation, defaults and restructuring were going to happen, no matter what in the shipping industry, and guess what, it did! Not to mention the fact that we indicated some forced exposed players such as Commerzbank with their nonperforming shipping loans had resorted to running themselves the ships rather than recognizing the losses as pointed out in our June 2013 conversation "Lucas critique":
"In similar fashion to the extend and pretend game being played by banks relating to their real estate exposure and negative equity, some German banks, which total exposure to shipping loans amount to 125 billion USD with a nonperforming ratio of 65%, have resorted to avoid recognizing the losses by acquiring some ships in a bid to salvage their bad loans as reported by Nicholas Brautlecht in Bloomberg on June 13 in his article "Commerzbank Acquires First Ships in Bid to Salvage Bad Loans":
"Commerzbank AG, the German lender whose soured shipping loans prompted a ratings downgrade by Standard & Poor’s last month, is taking the helm as it tries to salvage some of the 4.5 billion euros ($6 billion) it holds in bad debt from the crisis-hit industry.It plans to take over two feeder ships from debtors this month, holding off on a sale until values recover, said Stefan Otto, 42, the head of the shipping unit. The vessels, which can transport as many as 3,000 standard 20-foot containers, or TEU, are the first the Frankfurt-based bank will actively manage as part of a goal to reduce shipping losses and exit ship financing." - source Bloomberg" - Macronomics - June 2013If indeed our favorite "survivor of the fittest" Danish giant A.P. Moller Maersk is turning into "loss-making", then indeed, we would caution investors to start in earnest to think about "battening down the hatches" to use a shipping analogy.
On the subject of shipping we read with great interest Nomura's Special Report on Container Shipping entitled "Counting Containers - Unprecedented action required" published on the 26th of November:
"Container shipping lines have a choice: return chartered vessels, or face the consequences
Supply-demand balance to deteriorate significantly in 2016-17E
Supply outstripping demand is nothing new in the container shipping industry, as evidenced by nominal capacity +53% during 2008-14, vs volumes +22%. What is new, however, is that slow steaming – which absorbed 26% of capacity during this period – is now reversing, adding new capacity on top of that provided by the orderbook. With nominal capacity expected to increase by 5-6% CAGR during 2016-17E, and volumes unlikely to exceed 3%, the supply-demand balance is set to deteriorate even without increased vessel speeds. If this trend continues, the industry will face an even more severe imbalance.
Freight rates can – and most likely will – decline further
With headline freight rate indices currently at historical lows, further reductions may appear unlikely. However, on a cost-adjusted basis, freight rates remain well above the trough levels seen in 2009 and 2011, periods during which the industry suffered heavy losses. With supply-demand set to deteriorate, and contract rates to be revised downwards, we believe freight rates can – and most likely will – decline further, driving the industry back into financial losses.
Maersk Line case study provides some grounds for hope…
With supply-demand fundamentals overwhelmingly bearish, container shipping investors could be forgiven for giving up hope. However, our analysis shows that, if other shipping lines follow Maersk Line's successful recent strategy – of maximising utilisation rates by returning chartered capacity to owners – the supply-demand imbalance can be rectified, with persistent losses averted.
…but only if the industry can act with unprecedented discipline
Our analysis shows that competitor shipping lines should narrow Maersk Line's cost advantage during 2016-17, but only if utilisation rates can be maintained. Returning chartered capacity to owners, culminating in a significant increase in idled capacity, provides the best means to facilitate this. Yet we estimate idled capacity would need to reach 14% for this to be achieved – materially ahead of the previous peak of 11-12% seen in 2010. Whether the container shipping industry has the discipline required to achieve this, only time will tell.
When it comes to "hope" being a bad "strategy" such as expecting a "golden carriage" not to return to its initial "pumpkin" state, we reminded our thoughts from January 2013 from our conversation "The Fabian Strategy":
- source Nomura
"People are trading on hope: "Please make Mario Draghi keep his word", we could posit in similar fashion to what we commented in our September 2011 conversation "The curious case of the disappearance of the risk-free interest rate and impact on Modern Portfolio Theory and more!""So far the devil's best trick has been to persuade us that risk-free interest rates did exist. It ain't working anymore and that is a big cause of concern." - Macronomics.
We could not resist but we chuckled when we read the following comment from a credit desk:Looking at the growing divergence between "hope" (equities) and reality (US High Yield), we wonder when "reality" will settle in. Could it be that in 2016 we will see the return of the "pumpkin"?
"Equities = Hope, Credit = Reality, unfortunately, Reality follows Hope until the Hope dies, then Reality settles in."
When it comes to the "reality" that can be assessed from Shipping, demand outlook is not favorable as pointed out by Nomura in their special report:
"Demand outlook remains tepid, at best
The world has changed. Let’s accept it and get on with it
The days of 3-4x GDP multipliers are gone – possibly forever
The 3-4x multiplier of GDP at which global container volumes used to grow is well known – for instance, with the volume CAGR of +12.5% seen during the period between China joining the WTO in December 2001 and the start of the global financial crisis (GFC) in 2008 equating to an average GDP multiplier of 3.8x.
Since this time, the high growth rates of 14.9% seen in 2010 and 7.4% in 2011 were driven by the end of destocking, which occurred towards the end of 2009, rather than underlying strength. When global inventory levels had returned to more normalised levels, the volume CAGR of 3.5% seen during 2012-14 equated to an average GDP multiplier of 1.4x.
2015 will likely be the first ‘normal’ calendar year to see a multiplier <1 b="" x="">
We often find that investors and industry commentators alike take a global container GDP multiplier in excess of unity for granted. Yet a multiplier of 1.0x was recorded for 2013, and for 2015 we expect volume growth of c+0.8%, equal to just 0.3x of the 2.9% increase in global GDP that is forecast by the OECD.1>
This would be the first time, on our records, that the global container volume multiplier has fallen below unity during what we consider to be a relatively ‘normal’ calendar year of economic activity.
…but this is not unprecedented on a rolling 12-month basis
On a rolling 12-month basis, the global GDP multiplier has already fallen below unity during what we classify as a ‘normal’ period without any major macroeconomic fluctuations or inventory swings – specifically, the 12-month period to 4Q13.
Although this weakness was only temporary, we do consider it to be important, given that it demonstrates that, even during a period of steady-state economic conditions, a global container GDP multiplier of less than 1.0 x is not unprecedented.
Looking ahead, ‘GDP plus a bit’ feels about rightAlthough forecasting global container volume growth will never be a precise science, we continue to believe that a growth rate of ‘GDP plus a bit’ remains an appropriate rule of thumb. We assume a multiplier of 1.1x for 2016-17, consistent with the 1.0-1.3x range that we consider to be reasonable during steady-state economic conditions.
In reality, fluctuations during this period are inevitable, but for reasons that are difficult or impossible to forecast (eg, inventory movements, currency swings, technological changes, among others). As such, we do not attempt to incorporate such factors into our mid-term forecasts." - source NomuraConclusion: secular stagnation is here to stay and one can expect "rates" to stay lower for longer and demand to be weaker as well. "Mind the gap" between effective capacity and total demand as it is widening...because "demand" is not outstripping "supply". Another illustration of the "shipping glut", is that for the first 10 months of 2015, Chinese ship builders saw orders for new vessels plunge 62% from to same period last year, for a total of 20.3 million tons, according to data from the China Association of the National Shipbuilding Industry (CANS)
Apart from "weaker demand" another concern which has been highlighted justifiably so is the current US level of inventories. This worrying trend has been as well clearly highlighted in Nomura's recent Shipping special report:
"US inventories peaked in February 2015, at a level that warrants major concern
Although our analysis suggests the destocking that has prevailed in Europe during 2015 will soon moderate, the situation in the US suggests concern for import volumes in 2016. As shown in Fig. 43, the total business inventories-to-sales ratio spiked up sharply during the several months to February 2015, and showed smaller increases during the months leading into September 2015.
This upward movement bucks the downward movement in US inventories-to-sales that has prevailed over the past 20+ years, and after controlling for this trend by considering inventory-to-sales in terms of the number of standard deviations from the trend line, the recent upward spike in inventories is even more apparent. Specifically, inventories-to-sales are more than 1.5 StDev from the trend, not far off the peak of 2.0 StDev seen in January 2009, around which time US imports fell precipitously.
Irrespective of the sector, US inventories appear ominously highFigs. 45 and 46 summarise the split of US Business inventories (measured in US dollars) between the retail, manufacturing and wholesale sectors. The current share is remarkably uniform, with manufacturing the largest sector with a share of 36%, but retail and wholesale not far behind on 32%.
- source NomuraYou can expect this level of inventories to be a drag on fourth quarter GDP when the Fed is about to "hike" in a weak demand environment. It looks like the "fairy godmother from the Fed" aka Janet Yellen is about to pull the spell which has so far being "levitating" the "golden carriage".
When it comes to continuing with the "golden carriage", one thing we are certain in 2016 is that the global "de-equitisation" process will continue to run its course and generates further instability into the financial system as per our final point.
- Final chart - Global equities: more de-equitisation to come in 2016
"The "de-equitisation" process is a cause for concern as it creates increasing instability in the financial system. It will as well reduce significantly the recovery value in the next credit downturn with rising defaults we think." - Macronomics, June 2015.The above debilitating effect on corporate balance sheets was already highlighted in October 2013 in our conversation "Credit versus Equities - a farming analogy" we indicated the following:
"The increasing recourse towards bond issuing by companies will be increasing "difficulties" at the end of the on-going credit cycle, when entering a recession or depression.What is concerning is that ZIRP has accentuated the "de-equitisation process fueled by "cheap credit". This has also been again indicated by CITI in their Globaliser Chartpack from the 30th of November 2015 and is our chosen final chart:
What has made the resounding success of the US economy throughout many decades was its capitalistic approach and recourse to equities issuance for financing purposes rather than bonds.
We believe the global declines in listings is indicative of growing instability in the financial system and increasing risk as a whole" - Macronomics, October 2013.
"Global equities: more de-equitisation?De-equitisation should remain a key global investment theme for the next 12-18 months; the most represented sector in the screen is Consumer Discretionary (13 out of 50), followed by Industrials (9)‘More de-equitisation’, declares Global Strategist Robert Buckland, ‘for deequitisation should remain a key global investment theme for the next 12-18 months.The cost of equity remains high relative to the cost of debt, so it makes sense for companies to de-equitise – use cheap financing to buy back their own shares. Since 2011, global non-financial corporates have bought back over $2.2trn of their own shares (equivalent to 9% of average market cap over the period). The most represented sector in the screen is Consumer Discretionary (13 out of 50), followed by Industrials (9). Share buybacks is currently a very US-heavy theme; we also note positive momentum in Japan. Names like Ahold, Boeing, Xerox, Allstate, Adecco and Yahoo! feature’." - source CITIIn 2013 we concluded our 2013 conversation as follows:
"We can therefore make this over-simplistic yet provocative conclusion that:Although the "fairy godmothers from the Fed" did put a spell on for many years, we think we are indeed coming closer to midnight and the "Cinderella" investors of the world would be well advised to "hedge accordingly" before they are left holding the "pumpkin", as it looks increasingly clear to us that 2016 will be indeed a very challenging year.
Equities = Freedom
Debt = Road to serfdom"
"A powerful idea communicates some of its strength to him who challenges it." - Marcel Proust, French writer