Author Archives: Félix López Martínez

The new darlings of Wall Street: The folly of oil fracking investing


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[Acknowledgment: Thanks to Edward Worsdell for helpful comments on an earlier draft of this post.]

In a recent post we took a deep dive into the debate over whether the US stock market is expensive or not. We concluded that i) the market is indeed quite expensive, ii) the market is not in a ‘bubble’ territory, but rather higher equity valuations on average should be considered the new normal (on the proviso that this new normal state of affairs should not be used to justify current equity valuations), and iii) historical standards can be a deceptive guide in predicting future equity returns and should be used with caution.

However, the market, taken as a whole, has a wide range of investment opportunities. We can find situations where a sector is cheap for a particular reason (e.g. the US retail sector) or situations where a company is trading at mind-blowing multiples because the market is discounting unrealistic expectations about future growth prospects, as in the case of Tesla, with a market capitalisation now higher than well established competitors like Ford or General Motors.

But this post is not about the fate of investors in a single company like Tesla or whether this is an attractive investment or not (we think it is not). Rather, this post will zero in on a sector that has been gaining increasing media attention, a sector that is considered to be the new pride of American industry, one that is highly leveraged and in which Wall Street investment banks have so much at stake in it. Continue reading

Our reading of Pettis’ reading of the FT article ‘glimpse of China’s economic future’


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Michael Pettis has recently published a post discussing an article that appeared in the FT some weeks ago, authored by Gabriel Wildau, Yuan Yang and Tom Mitchell, which discussed the economic dilemmas China will have to face in the (near) future given the current high levels of corporate debt and (still) high levels of corporate investment. We found both Pettis’ post and Wildau et al. article very interesting and quite similar in spirit to what we have written several times (here and here), and because we have not published anything on China for several months, we thought it could be a good time to provide a brief update of our views.

But first, it may be useful for our readers to explain briefly the main arguments posed by Wildau et al. and Pettis, respectively. The main goal of the FT article is to go through three different counterfactual rebalancing scenarios, discussing also the extent to which they could happen or not. Although the hypothetical scenarios are discussed in a heuristic way and the article does not crunch any numbers in detail (as we usually do, or for that matter, Pettis), we cannot but agree on the importance of that approach. Because several economic variables are, in principle, politically determined by Beijing, the dynamics of the Chinese economy are more ‘deterministic’ than in any other economy of the world, so the paths that the rebalancing process can take can be reduced to a handful of possible scenarios.

The first possible scenario proposed by the FT article (the most optimistic one by any standard), which we can dub ‘the conventional wisdom up to now’, posits that because consumption and the needs of the Chinese population (holidays, healthcare, education, and so on) are growing, there is an ‘unlimited demand’ for everything. According to this scenario, we are told that the growth in consumption will fill the void left by investment, and that the rebalancing process will proceed smoothly with high GDP growth rates and no major financial disruption. Continue reading

The Meaninglessness of Bottom-up Estimates and a Reverse Engineering Exercise for the S&P500


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Last week Deutsche Bank sent an internal note arguing that, well, it may be about time for the Fed to raise rates, claiming that ‘in fact, it looks more and more like the Fed is behind the curve’. For such a claim, the note reviewed a series of inflation indicators (e.g. PCE, CPI), but the really interesting chart was the last one, in which the analysts’ consensus for the S&P500 earnings per share was plotted, conveying the message that because the consensus expected higher earnings in the future, at some point wage growth would also follow suit, thus bringing higher levels of inflation in the future.

Beyond the dubious claim that the Fed should raise rates (which we think it should not), the really amusing part is to look at the analysts’ consensus estimates for the next 8 quarters. They are as follows:

S&P500 EPS and Consensus 3Q16-2Q18

S&P500 EPS and consensus’ estimates 3Q’16-2Q’18. Source: Bloomberg.

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The rebalancing and the flat decade in the Chinese stock market


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[this is the translation of an article originally published in FundsSociety]

Some days ago, Bloomberg published an article featuring a comparison between the stock market valuations of the Shanghai Stock Exchange against the valuations of other major exchanges in the world. The key message of the article was that, despite  falling 40% from the peak reached in June 2015, the index was still dear according to the median PER – in China, such a measure reached 60 times, in comparison to 20x and 13x in the US and Japan, respectively. To conclude, the article presented several opinions that stressed the low visibility for corporate profits in the short-run, given macroeconomic uncertainty and the difference in valuations and opportunities between the old economy (raw materials, industrials and real estate) and the new economy (technology, leisure, healthcare, etc.).

In fact, although making a one-year corporate profit forecast is a tough task, it is less hard if we make a ten-year forecast. Such a claim, although it may sound counterintuitive, is due to the macroeconomic dynamics that China will have to face in the medium-term. By this, we mean the rebalancing process, which implies reducing the investment share in GDP (and increasing the share of consumption) from roughly the current 50% down to 30% or less. That the rebalancing process implies moving resources from investment to consumption is already a well-known fact, and the investment community is starting to benefit from this insight recommending taking positions in consumption-related sectors and shying away from investment-intensive sectors – although, on the other hand, given analysts’ interpretations on the macroeconomic data published in May highlighting the supposedly ‘low growth’ of investment of around 9%, one wonders whether the analysts have yet understood even the basic concepts of the rebalancing process.

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El reequilibrio y la década plana en el mercado bursátil chino


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Acaban de publicar en FundsSociety nuestra visión sobre los retornos del mercado bursátil chino durante la próxima década. Puede consultarse aquí. En resumen, creemos que los índices chinos estarán en el mismo nivel de aquí a diez años (en el mejor de los casos, asumiendo múltiplos de valoración constantes), ya que el proceso de reequilibrio no sólo implica mover recursos de la inversión al consumo, sino también de los beneficios a los salarios.

Dado que la participación de los beneficios en el PIB tiene que caer a la mitad si se quiere completar el proceso de reequilibrio, y teniendo en cuenta que en el mejor de los casos el PIB en términos nominales crece al 7% en la próxima década, los beneficios en términos absolutos quedarían igual que hoy. Una aplicación muy elegante de la ecuación de beneficios Levy-Kalecki.



The Chinese Fiscal Policy for the Rebalancing Process


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Chinese policy makers were gathered at the National People’s Congress (NPC) a couple of weeks ago to discuss the economics goals for the next few years. Given the recent turmoil in Chinese financial markets, it was an important meeting for international analysts.

Several issues were addressed at the NPC, but the most important one was the strict commitment of the Communist Party to keep sustainable (and moderately high) growth rates. For this year they have abandoned fixed targets and they have opted for some flexibility in their goals (e.g. 6.5% – 7%). ‘More active’ fiscal policies, through higher current and investment expenditures and tax cuts, were also put forward in order to achieve deficits around 3% of GDP – which is in stark contrast with the government position of the last years. But as we will see in a while, these goals (6-7% nominal GDP growth plus 3% of fiscal deficits) do not meet People’s Bank of China projections for government debt, unless other ‘extraordinary’ government operations (bailouts of banks and local governments in particular) are brought into the picture. Finally, the Communist Party has also suggested higher levels of inflation (around 3%) than in recent Chinese history.

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On the Chinese rebalancing timetable: a reply to professor Pettis


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Professor Michael Pettis has recently published another brilliant post on the Chinese rebalancing issue. We regularly follow Pettis’ views on the Chinese economy, which we consider valuable if one wants to understand the macro management dilemmas China will have to face. In his post, Pettis does not address how the rebalancing process should be ideally done (something which he has explained on several occasions), but rather how much time China has in order to accomplish it successfully. Pettis says that:

Credit growth in China is too high as are current debt levels, and the sooner Beijing gets credit growth under control, the better. This latter statement in itself is not controversial of course, but my simple debt model shows just how urgent it is for Beijing to get credit growth under control. It clearly does not have ten years or even seven years. It might have five years, but only if the markets – Chinese investors, businesses, and savers, both wealthy and middle class – are convinced that it is moving in the right direction.

In other words, the current high levels of debt can derail the rebalancing process if it is not done quick enough. In order to understand the link between debt levels and GDP, Pettis proposes a simple model that captures their dynamics over the long run (up to 2023). In his baseline scenario, Pettis assumes (following the trend of the last few years) that nominal debt initially grows twice as fast as nominal GDP (notice the use of nominal values), but gradually converging in a linear way to the growth rate of GDP by the end of 2023 – at that moment the economy reaches a steady-state position, and GDP and debt grow at the same pace. Depending on the GDP growth rate assumed, Pettis’ model projects debt-to-GDP ratios from 251% (with a 3% growth in GDP) to 274% (with a 6% growth) by the end of the period, too high in comparison to other economies. He then proposes alternative scenarios, but the result is the same: unless Beijing advances more radical measures to curb debt growth and improve the efficiency of the financial system, the growth in debt will derail the rebalancing process.

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Ingeniería inversa del PIB chino


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Los servicios financieros han crecido considerablemente en el tercer trimestre de 2015, de acuerdo a las estadísticas oficiales chinas

Otro post sobre la situación económica China. Van apareciendo muchos en este blog. Pero como va a ser el predecible tema estelar económico mundial de los próximos meses este post no será el último… ni el penúltimo. Desde nuestro post junto antes del desplome de la bolsa china (timing preciso), en el cual adelantábamos la imposibilidad de un aterrizaje suave de la economía China (léase crisis económica grave -caída del PIB- antes o después) empiezan a abundar los análisis sobre el estado de la economía china: algunos ya contemplan la posibilidad de que el crecimiento esté realmente reduciéndose, en contra de las cifras oficiales de un mantenimiento del crecimiento de alrededor del 7%, dudándose así la fiabilidad de los datos de la contabilidad nacional china. Los últimos datos aparecidos hoy, correspondientes al tercer trimestre de 2015, con un crecimiento del 6,9% del PIB, no hacen sino confirmar lo que comienza a ser algo bastante recurrente.

En el anterior post ya tratábamos de estos temas, haciendo hincapié en un informe de Macquarie sobre el deterioro financiero de las empresas chinas en los sectores más directamente involucrados en el sector de bienes de inversión (industria de construcción y sus materiales -cemento, acero-, bienes de equipo, viviendas, etc.). Para lo que queremos explicar ayudan también las estimaciones de los beneficios de las empresas del sector de inversión compilados por Christopher Balding, profesor de la Universidad de Pekín, y que lleva varios años evaluando la fiabilidad de las estadísticas chinas – y que, sin ir más lejos, ha escrito hoy un post interesante cuestionando los números publicados por las agencias chinas hoy. Continue reading

Las cuentas y los cuentos de las balanzas fiscales catalanas


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En vísperas de las elecciones al Parlamento de Cataluña que se celebrarán el próximo 27 de Septiembre, Josep Borrell ha publicado recientemente un libro titulado “Las cuentas y los cuentos de la independencia”. Como menciona, una de las tesis sobre las que se ha apoyado el independentismo ha sido la idea de que la independencia es económicamente positiva – idea materializada en el eslogan “España nos roba”. Dicha idea ha venido siendo analizada a través de las “balanzas fiscales”, instrumentos contables aparentemente no politizados que recogen (como veremos, de un modo u otro) las relaciones económicas de Cataluña con el resto de España. En este post se explica qué son dichas balanzas, cómo se han venido haciendo en España y por qué la más usada por el independentismo catalán es metodológicamente incorrecta.

Ante todo, debe mencionarse que la elaboración de balanzas fiscales es una actividad muy limitada a una serie de países. No puede decirse que exista una metodología mundialmente aceptada para la realización de las mismas, como las que existen para la elaboración de las cuentas nacionales (realizada por las Naciones Unidas) o la balanza de pagos (realizada por el FMI). En los pocos países donde se han venido realizando balanzas fiscales (como Canadá, España, Bélgica, Reino Unido y Australia) los enfoques son diversos, pero los investigadores se decantan en su mayoría por el enfoque llamado “carga-beneficio”. Pero de nuevo, no existe nada que se pueda denominar “oficial” y que pueda ser el germen para la creación de un estándar internacional propiamente definido al que se puedan adherir posteriormente otros países. La razón es que la mayoría de estos estudios son, en el mejor de los casos, semioficiales, realizados por organismos públicos nacionales y regionales pero sin ninguna pretensión de sanción oficial. En el caso de España, el Instituto de Estudios Fiscales (IEF) ha sido el encargado de “oficializar” la manera de cómo computar las balanzas fiscales en este documento – sobre la bochornosa historia del documento hablaremos en otro post más adelante. Continue reading

Further considerations on the Chinese rebalancing


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The last few months have witnessed a series of ever-increasing problems for the Chinese economy. The stock market crash, the devaluation of the currency (and the prospects for additional rounds), the lacklustre performance of the Chinese export sector and the likely deceleration of the economy, just to name a few problems, have provoked general turmoil in financial markets and have created a widespread sense of skepticism in the global media. It has also propelled the idea that a major Chinese slowdown could have serious consequences for the global economy. However, most of these articles get very specific about this or that problem, and they miss the real and broader problem that the Chinese rebalancing process poses. In this article, we will see that the implications of the stock market crash and of the devaluation of the renmimbi for the rebalancing process are not as important as many believe.

The stock market crash has been the most prominent phenomenon in the financial press. The Shanghai Index, for instance, stood at 3,350 points at the beginning of 2015, peaked around 5,100 in the middle of June and since then has lost the staggering amount of 40% (yesterday closed at 3,170). For Western standards, that correction has been brutal. But it is also widely known that government ownership in many companies is high and that households have invested very little in stocks so far. So, beyond firms that may have posted some shares as collateral for their loans, the direct impact of the stock market on the Chinese economy should be very limited- actually, a bulk of the losses have already been anticipated by international investors. We think that the stock market crash should thus be interpreted as a sign that the perception of the Chinese economy is changing, rather than as a first cause for further financial distress. Continue reading