It looks like a classic growth scare has commenced, warns CLSA’s Christopher Wood in a “flash edition” of his weekly Greed & Fear client newsletter.
Oil, copper, gold and Baltic freight rates are all showing initial signs of topping out, he notes. But the catalysts are growing evidence of a US slowdown and the related rising risk of financial accidents, combined with growing evidence that China is upping the pace of incremental tightening.
First, there was China’s domestic oil price hike on November 1. Then came this weekend’s move on reserve requirements, when the People’s Bank of China raised the reserve requirement ratio for banks by 50bp to 13.5 per cent, effective 26 November, the ninth time this year.
[Reinforcing Wood's typically timely point, China's latest inflation figures, out Tuesday, showed inflation continued to spiral in October, further increasing pressure on the central bank to raise interest rates for the sixth time this year, reports Bloomberg.]
The timing of China’s move is hardly surprising, notes Wood. The Party Congress is now over, with the leadership re-elected for another five years. So it makes sense to move now before Olympic year.
“It is also the case that Beijing, like the Federal Reserve, will want to see a correction in oil and the gold complex to make it easier for the Fed and other central banks to ease in the context of
a US-led global slowdown.”
Beijing has no more wish to see the US economy slow sharply than does Washington. As for the anticipated growth scare, recent market action has been “somewhat illogical,” in Wood’s view.
Treasury bond yields have been declining, and western financial stocks plunging, while commodities and cyclical stocks have been surging. Ultimately, one part of this paradoxical behaviour has to break, says Wood.
If it is the cyclicals that break, as expected here, such a market move could be expected to go hand in hand with a US dollar bounce (but not against the yen). Note that the US trade deficit is already declining sharply. Thus, the US trade deficit fell by 12 per cent year on year in September to $56.5bn, the lowest since
May 2005.
The above is a tactical call. The long-term case for strong commodities and a weak dollar remains intact. But for now in Asia, investors should prefer interest rate sensitives and even cash proxies over classic cyclicals. Meanwhile, investors should continue to remain structurally short on western financials.
As noted by CLSA’s chief economist Dr Jim Walker on Monday, the liquidation of CDOs is only just beginning. Such downgrades will be issued by the credit rating agencies who have a fiduciary responsibility to recognise reality.