Month: June 2018

Last August, when looking at the monthly Bank of America Fund Manager Survey, we pointed out a “paradox” in Wall Street sentiment that could only be attributed to schizophrenia (or merely another example of how central banks have broken markets): on one hand a record number of investors said that stocks are overvalued (they were correct), even as most investors admitted they – or their peers – are long tech stocks (they were also correct).

Fast forward to today, when the same “schizophrenic”paradox is back as the latest, June, Fund Manager Survey reveals a set of responses that make little intuitive sense when juxtaposed.

On one hand, of the 235 survey respondents with $684BN in AUM, a record 42% of investors said companies are over levered, far exceeding the 32% peak in 2008; overall an all-time high of net 34% think corporate balance sheets are overleveraged.

According to BofA CIO Michael Hartnett, “this implies downside for equities versus government bonds” as the net percentage of “improve capex”  tracks global equities and bonds closely.

Paradoxically (again), 64% of respondents think the US has the most favorable outlook for profits, a 17-year high; all other regions have net negative profit outlooks, making the US the cleanest dirty shirt once again.

In other words, the smartest traders in the world no longer worry about debt. Why? Because as the following chart from Goldman shows, with net leverage rising to all time highs the market refuses to reward strong balance sheet companies and instead continues to pile ever more cash into “weak balance sheets” for the simple reason that the Fed has pushed all investors into the worst possible sources of alpha (or beta) and if things turn south, the Fed will just bail everyone out again as usual.

So with record debt “clearly” no longer a risk, investors are flocking to the one place in the world where there is still some growth (thanks to Trump’s fiscal stimulus, and even more debt): the US. In fact, BofA goes so far as to take out the “decoupling” narrative out of cold storage, and that’s how Hartnett describes respondent re-allocation to US equities, which climbs 16% to a net 1% overweight, the first time investors surveyed have gone overweight in 15 months…

… with 2/3 investors saying US has the best corporate profit outlook, a 17-year high.

“Investors have their eyes on the US this month,” said Michael Hartnett, chief investment strategist, “with a record high favorable outlook for profits and a return to US equity allocation. Decoupling is back in vogue.”

Meanwhile, expectations for faster global growth continued to fade, with just net 1% of investors indicating they think the global economy will strengthen over the next 12 months, barely above the boom/bust threshold and still at their lowest level since February 2016. Surely a time to chase the all time highs in the S&P…

Of course, since it is very late in the cycle, it’s not just equities, and according to the ssurvey, allocation to commodities hits a new 8-year high, rising 1ppt to net 7% overweight, the highest since April 2012 when WTI was $105/bbl.

But the clearest indicator that Wall Street again has entered the paradox zone, is that with respondents once again dumping all their cash into high growth, “story” tech stocks, Wall Street admits that “Long FAANG+BAT” remains the most crowded trade identified by investors for the fifth straight month and most crowded trade outright since “Long USD” in January 2017; the top three in June are rounded out by “Short US Treasuries” (16%) and “Long USD” (9%).

Finally, for those curious what keeps (schizophrenic) Wall Street up at night, in June the most commonly cited tail risk to the markets is a trade war (31%), followed by a Fed/ECB hawkish policy mistake (26%) and a Euro/EM debt crisis (23%); trade tensions have been the dominant macro concern for investors in 2018

 

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Two days after Trump trade advisor Peter Navarro unleashed verbal hell on Canadian PM Trudeau:

“There’s a special place in hell for any foreign leader that engages in bad faith diplomacy with President Donald J. Trump and then tries to stab him in the back on the way out the door…that’s what bad faith Justin Trudeau did with that stunt press conference.”

During a Fox News interview:

Peter Navarro: “There’s a special place in hell for any foreign leader that engages in bad faith diplomacy with President Donald J. Trump and then tries to stab him in the back on the way out the door…that’s what bad faith Justin Trudeau did with that stunt press conference.” pic.twitter.com/KtqKXizBEc

— FoxNewsSunday (@FoxNewsSunday) June 10, 2018

He has apologized for his outburst.

During an interview at The Wall Street Journal’s CFO conference, Navarro said:

“I used language that was inappropriate, and basically lost the power of that message. That was my mistake, those were my words.”

“I own that… We need to focus on policy differences.”

We are sure the calls for his resignation will not stop.

#JusticeForJustin

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A man who reportedly is claiming to have a bomb has taken two people hostage near the center of Paris, local media is reporting. According to the Mirror, the Rue des Petites Ecuries, where the incident is taking place, is on lockdown as police, fire trucks and ambulances rush to the scene. People nearby have shared images of the armed police presence on social media.

Paris 10: un homme armé retranché avec deux otages https://t.co/TKp3j8SKUX pic.twitter.com/IXzKETJHBY

— BFMTV (@BFMTV) June 12, 2018

This is a developing story. Check back for updates…

 

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At the turn of the century, virtually all cheaply-made, imported US clothes and shoes were made in China. Since then, however, things have changed drastically, and as Chinese labor costs have rise, China’s market share of US imports of apparel and footwear slumped, replaced by Vietnam, Indonesia and Bangladesh, and is declining at an accelerating pace.

What happened?

Well, as Deutsche Bank writes in its latest Konzept magazine, when future economic historians look back at China, they might see the years 2014-2015 as a turning point. This was the time when the total working age population peaked…

… sending China into a new phase in which its pool of workers will likely shrink by between two and three million people each year. This shrinking labor force is one of the biggest long-term challenges for China, according to Deutsche Bank.

How things change.

Not long ago, China was still seen as an economy with an abundant supply of cheap labor, similar to Korea and Japan in their early stages of development. Over the past four decades, China’s large pool of working-age labour, combined with its relatively small share of young and old non-working population enabled the economy to rapidly grow. This has now changed: the dependency ratio bottomed out in 2010 and is expected to rise rapidly, as the population ages.

A cross comparison shows that China’s demographic dividend period, that is, the period when the dependency ratio continued to decline, lasted for a shorter time than its East Asian peers. As a result, China reached the demographic turning point at a relatively low per capita income level of $9,400 in terms of purchasing power parity. That is just one-third the income level in Japan and Korea when their dependency ratios were at the lowest point.

On top of population ageing, workers are moving away from labor-intensive jobs in the manufacturing sector as part of the evolution of the economy towards services. Employment in the secondary sector (mining, manufacturing and
construction) is declining at a rate of two to three million jobs per year. In contrast, the services sector adds between ten and fifteen million jobs each year. To be sure, manufacturing job pay is increasing: in the textile industry, hourly wages doubled between 2006 and 2010, and doubled again over the next five years. At $3.30 per hour in 2015,  wages are much higher than in Vietnam at $1.90 per hour. Yet some two million workers have moved away from the textile industry over the past decade. A restaurant or delivery job may pay just as well, if not better, and does not require working night shifts.

Not surprisingly, China is losing competitiveness in labour-intensive goods. The country’s market share for footwear and apparel in the US was 48 per cent in 2010. It has now declined to 39 per cent. In contrast, Vietnam’s market share doubled to 16 per cent over the same period.

To cope with rising labour costs, Chinese manufacturers must either invest in machinery and equipment that reduces the dependence upon labour, or move outright away from labour-intensive industries into more capital-intensive ones. Both approaches require a significant investment in industrial automation.

That push towards automation is already happening. Some key details from Konzept:

The Chinese government has made automation a top priority. The ‘Made in China 2025’ plan, issued in 2015, envisages the value added/output ratio in the manufacturing sector will increase by four percentage points by 2025, and labour productivity will grow at an annual rate of seven per cent in the coming decade.

To achieve this, the government has stepped up efforts to promote investment in areas such as intelligent manufacturing and industrial robots. Some 200 pilot projects in intelligent manufacturing were singled out in the two years to 2017. This year, the government has committed to raising tax benefits for machinery and equipment investment, and building pilot industrial zones for intelligent manufacturing. At the Communist Party’s Congress last year, President Xi’s speech suggested that supply side reform priority has shifted from reducing capacity to promoting advanced manufacturing. He also emphasised the promotion of “disruptive innovation”, which suggests the government may support innovations even if they cause disruptions to existing players.

Needless to say, the scope for investment in industrial automation is enormous in China. Manufacturers in the country are still far away from the production frontier. Production efficiency, measured by output per manufacturing worker, is only one-fifth of the frontier occupied by Japan and is comparable to Korea’s productivity level in 1990. The use of industrial robots in China is still at a very early stage. Robot density, measured by the number of industrial robots per 10,000 manufacturing workers, is only 68, compared with over 300 in Japan and Germany and over 600 in Korea.

Even so, that is a huge improvement compared to just 7 years earlier, in 2009 when automation barely had a foothold in China.

A simple calculation highlights the market potential for Chinese automation:

Take the 300,000 industrial robots that were sold globally in 2016, of which 30 per cent were sold in China. Assuming China’s market share increases further to 40 per cent, it will still take more than a decade for China to reach a robot density of 200. That is still far behind today’s levels in Japan and Korea. And this does not even account for the need to retire and replace old robots.

This suggests two things.

• First, that China’s automation will take many years and,
• second, that the market for industrial robots, as well as other advanced manufacturing equipment, will have to expand to accommodate China’s demand.

While there is limited research on the systemic impact of automation in China. But the anecdotal evidence shows great potential. For instance, Foxconn, the world’s biggest contract electronics maker, has been developing and deploying industrial robots as it targets 30% automation at its Chinese factories by 2020. It reportedly cut the number of workers by more than half, from 110,000 to 50,000, by deploying robots in an Apple factory. The factory was located in Kunshan, a coastal city one hour’s drive away from Shanghai, where labour costs appear to be rising.

Separately, Midea, a top appliance manufacturer in China, is also increasing the use of robots in its factories. By deploying over 200 robots in its Wuhan factory, it increased production capacity by a quarter while reducing the number of workers by more than half. Midea recently announced it will set up a joint venture with German industrial robotics manufacturer Kuka to expand its automation business in China.

China’s fast-track adoption of automation is only set to accelerate:

In Foshan, a satellite city of Guangzhou, a recent government survey of 200 firms suggested that almost half of them now use industrial robots. This has improved productivity by between 10 and 30%, thereby reducing labour demand. One report noted that a toy factory halved its employment while maintaining the same production level. Against this disruptive backdrop, Foshan’s average wage level almost tripled in the decade to 2015.

What will be the macro impact of all of this? For one thing, automation will help China avoid a sharp decline in potential growth beyond 2020, unless of course the associated plunge in employment results in social unrest and the dreaded by the Politburo middle-class revolt.

DB concedes that “employment in the manufacturing sector will likely drop, but it will be more than offset by an increase in productivity. The increase in labour productivity will also support continued wage growth in the manufacturing sector. The spillover effects will hit the services sector which will see a continued increase in employment.”

Ultimately, the rise in automation will delay the decay of competitiveness in labor-intensive industries. Or that is the upside case in Deutsche Bank’s thesis.

We doubt it, but even is DB is correct, it admits that this pervasive spread of robots will have a major deflationary impact. This is important as the high level of corporate leverage is a major concern. As for why we are skeptical, the reason is simple: whereas Deutsche Bank tried to put a favorable spin on its “robotics take”…

… moments ago the FT reported that Citi is making quite clear what the true impact of pervasive robots everywhere will be:

• AUTOMATION COULD CUT 10K JOBS IN CITI’S INVESTMENT BANK: FT

And if banker are no longer safe, nobody is.

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In a case that has all the merger arbs watching with rapt attention, federal district judge Richard Leon will deliver his ruling Tuesday afternoon on the long-awaited DOJ lawsuit to block telecoms giant AT&T’s push to buy Time Warner, a deal that would transform AT&T into a combined telecom-media giant similar to rival Comcast. The lawsuit has been the subject of wide-ranging speculation from the start, given President Trump’s rhetoric, stretching back to the campaign, when he first came out against the deal. And proponents of the deal haven’t been able to stop themselves from speculating about whether Trump’s views may have influenced the DOJ’s decision to pursue the case.

The arbs are feeling undeniably optimistic about AT&T’s prospects, seeing as they’ve pushed Time Warner’s share price closer to the $102.87 a share offered by AT&T. That’s driven the market-implied odds that the deal succeeds higher.

The list of firms with the largest exposure to Time Warner shares is about what one might expect, with massive fund managers like Vanguard and BlackRock clocking in as the two largest investors.

Judge Leon is expected to announce his decision on the long-delayed $85 billion deal at 4 pm ET on Tuesday in a Washington DC courtroom that will likely be packed with journalists, lawyers, investors and others. The chaos will be exacerbated by the parade celebrating the Washington Capital’s Stanley Cup win, which is slated to conclude at 3 pm just a few blocks from the courthouse. Leon is a venerable judge who has served on the bench since 2002. But Leon has a reputation for being unpredictable in his decision making. And the revelation that AT&T paid Michael Cohen $600,000 for “insight” into Trump’s thought process has lent a patina of shadiness to the whole affair. And regardless of what he decides, Leon’s decision will have a major impact on M&A case law, because before the DOJ sued to block the merger, there just weren’t that many deals like AT&T-Time Warner, which is notable because of its so-called “vertical” nature; typically, deals involve the takeover of one competitors by another.

With that in mind, here are three possible outcomes of today’s decision, courtesy of Bloomberg:

Leon is expected to deliver remarks from the bench before his final ruling appears on the court’s docket. He may read extensively from the legal reasoning that went into his decision, so beware of premature conclusions based on his review of each side’s case.

He can rule in AT&T’s favor and deny the government’s request for an injunction, side with the Justice Department and block the deal on antitrust grounds, or rule it illegal, but allow it to go forward by meeting conditions aimed at protecting competing pay-TV companies that want access to Time Warner programming.

The government has suggested an alternative to blocking the deal: requiring AT&T to sell its DirecTV unit or preventing it from acquiring Time Warner’s Turner Broadcasting.

In a twist that lends an academic dimension to the case, both AT&T and the DOJ centered their cases around the arguments of two economists.

A central component of the trial was competing economic theories. The Justice Department offered Professor Carl Shapiro of the University of California at Berkeley, whose report formed the backbone of the Justice Department’s suit. AT&T countered with University of Chicago Professor Dennis Carlton who was called to the witness stands to poke holes in Shapiro’s arguments. AT&T Chief Executive Officer Randall Stephenson, a serial acquirer with 33 takeovers completed in his 11-year run at the helm, got to pitch for his career capper.

Of course, if Leon nixes the deal entirely, an outcome that would likely send TWX shares lower (while benefiting shares of T), the arbs will get crushed, and there will be a lot of unhappy investors leaving that courtroom. It would also rob AT&T CEO Randall Stephenson of what would’ve been a career-capping deal after the serial acquirer has presided over 33 takeovers in his 11-year run at the helm of AT&T (still, some might say Stephenson’s ability to hang on to his CEO post in the wake of the Cohen revelations, which claimed a scalp when AT&T’s policy chief, Robert Quinn, was ousted, is a career-defining victory in and of itself).

Bracing for the possibility that Leon could throw Trump a bone and require Time Warner to spin off Turner Broadcasting, Buzzfeed reported earlier this year that CNN was already shedding employees to make the cable news network more marketable should it soon find itself on the auction block.

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