Global equities are downhill today as the US president at the Economic Club of New York said that tariffs on China would be “raised very substantially” if the “phase one” US-China trade deal did not go through. It’s clear that behind the glossy comments in October about a tentative agreement from both sides that things are not progressing as well as initially thought. In addition, the protesters in Hong Kong are becoming more and more violent adding to risk-off sentiment. The STOXX 600 Index in Europe is down 0.8% and safe-haven assets such as JPY and JGBs are bid overnight. This seems to be the never-ending story of US-China trade deal.
The ongoing
tensions between the two largest economies are beginning to have a serious
impact on businesses’ willingness to invest.
A recent
study released yesterday by the German Chamber of Commerce in China
indicates that 25% of German companies operating in China are planning to
source production elsewhere. This follows the same trend from US companies
putting more on the Chinese economy. Yesterday, the OECD also released its global
leading indicators (CLI) and they showed that growth momentum eased for the 20-straight
month in August. While the global leading indicators show sign of stabilizing the
US leading indicators are worsening with no imminent sign of stabilizing. This highlights that the current macro
environment remains extremely fragile and sensitive to the slightest shocks.
China
issues are not only related to the US-China trade war but also a seemingly
broken credit channel. The Q3 earnings releases from Chinese banks have allowed
us to update our market cap to total assets ratio for the four largest
commercial banks in China. The ratio hit a new all-time low of 5.8 in Q3 driven
total assets growing annualized 8% in Q3 while market cap of the four banks
declined. Our interpretation is that Chinese
investors are not valuing these new assets as high quality and the most likely
dynamic in China right now is that the current credit expansion is just
offsetting the rise in bad loans. The net effect is zero credit transmission to
the real economy in China constraining economic growth.
There are
also positive stories most notably in Italy where the FTSE MIB Index has been
very strong lately as evidence shows that the ECB’s new tiering system for
excess deposits is doing considerable redistribution inside the euro area. Italian banks are benefitting the most with
banks moving excess reserves from Germany, Belgium and the Netherlands as
excess reserves above the limit staying in those countries would be penalized
relative to move them to Italy. Italian banks deposits with the ECB have increased
by €37bn to €138bn and thus reduced the net claims inside the euro area. In
addition, recent data from Bank of Italy showed that non-performing loans are
declining in Italy improving balance sheets and credit quality. On top of these
good news for Italian banks several Italian companies including Enel have
delivered better than expected earnings. Italian equities are up 33% year-to-date
making them one of the best performing equities globally this year. Adding to
the attractiveness of Italian equities is the fact that they are valued at a
40% discount to global equities. The risks in Italian equities are heavy debt
financed companies, low profitability and a constant uncertain political
situation.
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