Month: October 2017

China’s Awakening is Shaking the World

In his address to the 19th Communist Party Congress this week, Chinese President Xi Jinping humbly downplayed China’s global standing and stated that much work is still needed to achieve the “China Dream of Rejuvenation”  and become  “a mighty force” that could lead the world on political, economic, military and environmental issues. Particularly noteworthy was Xi’s comment that China would not have a world-class military until 2050.

On many measures China clearly does trail the US by a large margin. For  example, in 2016 the per capita GDP of the United States was still over six times that of China.  Nevertheless, in a growing number of economic areas the weight of China is already the primary source of marginal demand and the major driver of performance. Moreover, Chinese influence on markets will be felt more and more over the next decade, as the world evolves towards multi-polarity and the center of gravity of the global economy shifts to East Asia. To paraphrase Napoleon, during this continued awakening, China will shake the world.

Though the U.S. GDP will remain larger than China’s until around 2027, China’s marginal contribution to global GDP is already higher than that of the U.S. According to IMF forecasts, China will add $7.15 billion trillion to global GDP by 2022 compare to $4.88 trillion for the U.S. From 2016 to 2022, China’s GDP  will go from 60% to 80% of the U.S. GDP.

In terms of GDP calculated on the basis of purchasing power parity, China’s economy is already 14% larger than America’s and will be nearly 50% larger by 2022.

Over the past fifteen years, Chinese infrastructure and real estate investments already shook the commodity world, driving a frenzy in the markets for copper, iron ore and other materials.  Astonishingly, China consumed 50% more cement over three years (2011-2013) than the U.S. consumed in the entire 20th century.

As the Chinese middle class has grown, China also became the primary driver of soft commodity markets. For example, for the past ten years China has provided essentially all the growth in demand for market pulp used for consumer goods like tissue paper.

China  is also becoming the driving force in many consumer industries. China’s cinema box office is expected to pass the United States this year; and, increasingly, the success of Hollywood blockbusters depend on the response of the Chinese public. China’s cinema ticket sales are expected to grow 5-6% annually while ticket volumes  in the U.S. decline by 1-2% a year. China now has more movie theatres than the U.S. (stuck at 40,000 since 2013) and is adding 7,500 annually. IMAX has 750 screens in China, twice as many as in the United States.

More and more, the success of global brands will rely on sales in China. On this week’s quarterly results call with investors, NIKE’s CEO Mark Parker noted that “the target population of China for NIKE is really moving towards ten times what it is in the United States, and the appetite for  Nike in China as the number one brand is incredibly strong.”

The focus of the global auto industry has also shifted to China for both traditional and electric vehicles. Auto vehicle unit sales in China surpassed those of the United States in 2010. Expectations are for volumes in China to reach 28 million units in 2017, vs less than 18 million in the U.S. Unit sales in mature markets (the U.S., Japan and Western Europe) are at the same level as over a decade ago and are expected to experience no growth over the next five years. Meanwhile, auto sales in China are growing steadily and may reach double the level of U.S. volumes by 2023.

 

The situation is similar for electric vehicles, which are being heavily promoted in China by government policy.  EV sales in 2016 in China were double the level of those in the U.S, and they are expected to ramp up in coming years.

Finally, according to government statistics, China is estimated to have 750 million internet users, compared to 300 million in the United States. Growing access to smartphones has resulted in a boom in mobile e-commerce, so that mobile e-commerce in China now dwarfs that in the U.S. The growth in internet mobility in China, places China at the forefront of many new data-driven technologies such as the “internet-of-things,” e-commerce, artificial intelligence, robotics and self-driving vehicles.

Fed Watch:

India Watch:

China Watch:

  • Xi’s glittering solutions for China (Geopolitical Futures)
  • Xi’s plan for state-sponsored quality growth (Bloomberg)
  • Xi’s bureaucratic shake-up (CSIS)
  • Xi’s conservative, greener speech (CSIS)
  • Five things to know on Xi’s speech (The Guardian)
  • Spence on China’s challenge (Project Syndicate)
  • Asia now has more billionaires than the U.S. (Caixing)
  • The internationalization of China’s capital markets (Bloomberg)
  • Why the renminbi won’t rule (Project Syndicate)
  • China’s influence on global markets grows (Bloomberg
  • China’s economy is already the biggest and growing fast (Bloomberg)

China Technology Watch:

EM Investor Watch:

Technology Watch:

Commodity Watch:

 

Energy Disruption Will Benefit Emerging Markets

The ongoing technological disruption of the energy sector is a net positive for emerging markets. The economic importance and market weight of those countries negatively affected by low oil prices (Russia, Mexico, Indonesia, Venezuela) is dwarfed by those that stand to benefit (India, China, Turkey). The rapidly declining cost of wind and solar power as well as the batteries needed to store it will provide huge opportunities for many emerging markets to improve their balance of payments, optimize electric grid efficiency and also make it easier to provide cheap power for hundreds of millions of poor people living in remote areas.

The latest report from the International Energy Agency  (IEA)  makes it clear that we have entered the age of renewable power. According to the IEA, in 2016 two thirds of new net power capacity added around the world came from renewable sources of energy.  In 2016, record-low auction prices were recorded for solar in India, the Middle East, Chile and Mexico, with prices reaching below USD 3 cents per KW. The IEA sees another 920 GW of renewable capacity added by 2022, with solar for the first time contributing more than hydro and wind. The main drivers of future growth continue to be technology-induced cost reductions and China’s policy initiatives, but India has also become a primary source of growth. India is expected to add more capacity than Europe and is on track to pass the United States as the second largest contributor to growth in capacity.

By 2021, according to forecasts from Bloomberg New Energy Finance, wind and solar will have become cheaper than coal in both China and India, two countries that have an enormous incentive to reduce coal combustion to address horrific air pollution problems. As the cost of renewables continues to decline over the next two decades coal power will become increasingly uneconomical.

The growth of solar will accelerate even more if battery costs continue to decline as they have over the past decade. Tony Seba, an expert on energy disruption who teaches at Stanford University, believes that an enormous wave of mega-investments in battery plants currently being made by Samsung SDI, LG Chem, BYD, Tesla, Foxconn and others, will drive down battery costs by over 20% annually for the next five years, to below $100/KW by 2022-23. At this price point, disruption will accelerate and battery storage will become prevalent across all points of the electricity grid (from the plant to the home). Seba believes cheap battery capacity will mean that the electricity grids in most countries will have to convert from the current “just-in-time” framework to one based “on demand,” which will eliminate the need for very expensive “peak” capacity. The average American home will spend less than a dollar a day to store energy for use in peak hours, resulting in much lower electricity bills.

Chile provides a prime example of the transformational impact renewables are having have on a developing economy. Chile has been dubbed “the solar Saudi Arabia,” because of the extraordinary potential for generating solar power in the Atacama Desert situated in the north of the country. Because of ideal direct normal sun irradiation and the dryness of the air, the Atacama is considered the best place on the planet to generate solar energy.

With scarce hydrocarbon resources, Chile has always depended on imports for most of its energy needs, and has suffered acutely from surges in oil prices. As recently as 2007, the country went through a severe crisis when Argentina reneged on contracts to pipe natural gas across the Andes, which forced massive investments in costly emergency diesel generators and LNG plants.

Compounding Chile ‘s energy woes, in recent years it has become increasingly difficult and time-consuming to build hydroelectric dams or coal-fired plants, as these face opposition from local communities and environmentalists.  However, the Atacama now promises a future of abundant and cheap energy.

In contrast to the difficulties faced in building “dirty” capacity, in the uninhabited Atacama desert environmentally-friendly  solar investments can be brought to market in less than a year, and recent advances in technology have made these projects very attractive to private investors.

Benefitting from clear regulation and investment rules, solar production has taken off over the past four years, putting Chile near the top in global tables. Solar producers have come to dominate public auctions,  offering to supply electricity at less than half the cost of coal-fired plants. In recent auctions in Chile, concentrated solar power (CSP) plants also have underbid gas plants. CSP technology combines solar generation with giant molten salt battery towers, allowing the plant to dispatch during the night. In Chile’s last auction for power, Solar Reserve, a U.S. firm,  bid a world-record-breaking low price at just 6.3 cents per kWh ($63/MWh) for dispatchable 24-hour solar.

The speed with which Chile has developed its solar potential is reflected in the generation of over 850 MW from solar panels in 2015, up from 11 MW in 2013. Current investments will bring installed capacity to 1,800 MW.

Solar also improves the potential optimization of the national electricity grid, as solar can be maximized during the day, allowing water accumulation at the hydroelectric dams in the Andes. As the cost of storage batteries decrease in coming years, it will make more and more sense to maximize production in the Atacama.

India is another country that stands to be a major beneficiary of disruptive energy technologies. First, India is a large importer of oil, which makes the economy vulnerable to surges in prices; second, it generates most of its electricity with dirty coal, which contributes greatly to horrendous pollution; and third, solar panels combined with batteries will provide the most cost-effective way to provide power to the nearly 250 million Indians, mainly in remote areas, that do not have access to power.

Prime minister Modi has announced bold plans to promote solar energy. The government aims to add 175 GW of renewable power by 2022, of which 100 GW would come from solar. As the cost of solar goes below coal generation over the next five years and battery storage becomes cheap, India’s is likely to rely on clean solar power for more and more of its needs.

Fed Watch:

India Watch:

  • India on the wings of digitization (Wisdom Tree)
  • India’s electrical vehicle dreams (CSIS)

China Watch:

  • The internationalization of China’s capital markets (Bloomberg)
  • Xi’s conservative, greener speech (CSIS)
  • China’s influence on global markets grows (Bloomberg
  • China’s economy is already the biggest and growing fast (Bloomberg)
  • Riding China’s huge high-flying car market (Mckinsey)
  • China, a strategy born of weakness (Geopolitical Futures)
  • 7 things we learned from China in September (WEF)
  • Buffett’s bet on BYD is working (QZ)
  • Meet China’s evolving car buyer (McKinsey)

China Technology Watch:

EM Investor Watch:

  • Five books on globalization and inequality (Five Books)
  • Investment anomalies (Wisdom Tree)
  • Anchoring Value Investing in EM (Eastspring)
  • EM Index without SOEs (Wisdom Tree)
  • Asia leading in (KKR)
  • Latin America’s slow recovery is on track (IMF)
  • Amazon expands in Brazil (Bloomberg)
  • Increasing pressure on Venezuela’s dictatorship (CSISAsia leads global recovery (IMF)
  • EM; doom to boom (Seeking Alpha)
  • Why you should care about Brazil’s stock market (Seeking Alpha)
  • Gazprom knocks Exxon off its pedestal (Forbes)

Technology Watch:

Commodity Watch:

Investor Watch:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Energy Market Disruption and Global Multi-polarity

 

Around the world, energy markets are being disrupted by a combination of technology and geopolitics. On the one hand, technology is having a huge impact on supply, with shale production exploding in the United States and alternative energies (solar and wind) becoming increasingly competitive everywhere. On the other hand, growing energy self-sufficiency in the U.S. is occurring at a time when demand for oil imports is still growing quickly in emerging markets, particularly in China. As the major importer of oil in the world, China’s future economic stability will depend on secure supplies, which is forcing it to become much more pro-active in global diplomacy. China also will become uncomfortable paying for oil imports in U.S. dollars, as has been the global custom for the past 50 years. China will increasingly insist on being paid in Chinese yuan, a trend that will slowly undermine the “petrodollar system” and U.S. financial hegemony.

Over the past decade, technological innovation has permitted the exploitation of enormous U.S. shale oil and gas deposits, leading to a renaissance for the American oil industry. This, jointly with growing output of renewable energy and higher fuel efficiency, is driving the U.S. towards energy self-sufficiency. BP in its BP 2017 Energy Outlook estimates this will happen in 2023.  U.S. net imports of oil have already fallen from 13 million b/d in 2007 to 3.7 million today.

The decline in U.S. oil imports will have important consequences for global financial markets, because the U.S. pays for imported oil in dollars and the trade receipts accumulate in the world’s Central Banks and sovereign funds and is redistributed into T-bills, bank loans and other investments. Since the 1970s the global economy has been frequently buffeted by violent changes in the price of oil, leading each time to financial instability and a sharp redistribution of wealth between exporters and importers.

U.S. oil production peaked in 1970 at 10 million barrels per day and then began a precipitous decline, reaching a low of 5 million b/d in 2008. The decline in U.S. production, coming at a time of steady increases in global demand, strengthened the hand of OPEC and led to price surges in 1974 and 1980, causing stagflation in the U.S. and eventually the emerging market debt crisis of 1981. The rise of Chinese demand during the past decade created another huge surge in oil prices, with a peak in 2008 and a rebound in 2011, with enormous consequences on global liquidity and financial markets.

Oil imports have been the primary component of chronic U.S. current account deficits, representing 40.5% of cumulative deficits between 2000 and 2012, and 55% in 2012 alone. In the early 1970’s, as the major importer of oil and the global hegemon, the United States was able to convince the Saudis to price their oil in dollars, which they have done along with other OPEC members since the early 1970s. This created the “petrodollar system” as a partial substitute for the gold standard abandoned by President Nixon in 1971, guaranteeing that the dollar would remain dominant in global trade and finance.

 

However, the conditions that led to the replacement of the gold standard by the petrodollar system no longer exist in 2017. The U.S. is approaching energy self-sufficiency, while China is now the dominant oil importer in the world, with demand for imports expected to reach nearly 10 million b/d in 2018.

This is happening at a time when U.S. hegemony is on the decline, and the world is seeing multi-polar leadership, with growing Chinese and European importance.

One of the Chinese government’s expressed objectives is to increase the international influence of the yuan. In a direct challenge to American economic hegemony, China has already started using oil imports to propagate the yuan. Breaking ranks with OPEC, Nigeria in 2011 and Iran in 2012,  both started accepting yuan for oil and gas payments and accumulating yuan Central Bank reserves. Russia did the same in 2015. For both Russia and Iran, the yuan payments allow them to skirt U.S. sanctions, and for Russia this also achieves the objective of undermining U.S. dollar hegemony. Moreover, last month, Venezuela, which owes China $60 billion, announced it will price its oil in yuan.

Also, in September the Nikkei Asian Review reported that China is on the verge of launching a crude oil futures contract denominated in yuan and linked to gold. This contract would be settled in Hong Kong and Shanghai and allow Asian importers to bypass USD denominated benchmarks and could greatly strengthen the financial infrastructure necessary to promote the yuan in Asian trade.

In another interesting development, China appears to be intent on solidifying diplomatic ties with Saudi Arabia. This is of critical importance, given the crucial role the Saudi’s have in maintaining the petrodollar system. As reported by Bloomberg,  the Saudi’s are looking to tighten energy ties with China by investing $2 billion in Chinese refinery assets in exchange for China taking a major stake in the upcoming ARAMCO IPO.

All of this oil diplomacy, comes at a time when China is already achieving success in expanding the role of the yuan in global financial markets. One years ago, the International Monetary Fund agreed to a long-standing Chinese request to give the yuan official Special Drawing Rights status, joining the U.S. dollar, euro, yen, and British pound in the SDR basket. China has also successfully lobbied the MSCI to increase the weighting of Chinese stocks in its Emerging Market Index by including locally traded “A” shares, a first step towards a major integration of China’s financial market into global financial markets which will further the propagation of yuan assets in global portfolios.

Fed Watch:

  • Rajan’s view on unconventional monetary policy (Chicago Booth)
  • Low returns expected long term for U.S. stocks (Macrovoices)

India Watch:

  • Tencent wants its share in India (Caixing)
  • India’s electrical vehicle dreams (CSIS)

China Watch:

  • 7 things we learned from China in September (WEF)
  • Buffett’s bet on BYD is working (QZ)
  • Meet China’s evolving car buyer (McKinsey)

China Technology Watch:

  • China’s airplane delivery drones (China Daily)
  • China, from imitator to innovator (Forbes)
  • China leads the world in digital economy (McKinsey)

EM Investor Watch:

Technology Watch:

  • Adidas robots (Wired)
  • Acemoglu on robots (AEI)
  • Germany has more robots and stable jobs (VOX EU

Commodity Watch:

Investor Watch:

 

 

 

 

 

 

 

 

Global Competitiveness In Emerging Markets

The Global Competitiveness Index (GCI) ranks countries according to how hospitable they are to promoting economic growth and prosperity. The rankings have been published by the World Economic Forum since 2004, allowing for a measure of how countries are progressing in terms of their relative competitiveness in the global economy.

The GCI seeks to evaluate 12 different factors in three main areas: the quality of physical infrastructure and institutions; the ease of doing business (macro-economic stability, and open and flexible markets for goods, labor and capital); and the quality of education and ability to innovate.

The GCI 2017 report (WEF) and an analysis of the trends of the past five years provide some interesting insights on prospects for different emerging market countries. The chart below shows the 2017 rankings for most of the significant emerging market countries and the evolution over the past five years.

  • Several important countries are secure in the top quartile segment of the ranking. Taiwan, Malaysia and South Korea all have reached elite status and are stable.
  • China continues to gradually improve its ranking, from 29 in 2013 to 27 in 2017, and is likely to secure its place in the top quartile. China has followed in the path of its East-Asian neighbors, making this region one of the most competitive in the world and increasingly the center of gravity of the global economy. China’s continuous positive evolution is driven by improvements in education and innovation, which is in line with the country’s strategy to move up the industrial value chain.
  • Both Thailand and Indonesia have shown impressive progress over the past five years, moving into the top quartile.
  • India, on the back of Prime Minister Marendra Modi’s reforms, has improved its ranking dramatically, from 59 to 40. The areas of greatest improvement have been confidence in public institutions, infrastructure and macroeconomic stability.
  • In the EMEA region (Europe, Middle East and Africa), Russia is a surprising positive highlight. Russia has moved from 67 to 38 over five years, approaching the top quartile, as President Putin’s “order and progress” regime has gained traction, reflected in improved infrastructure and public services. On the other hand, South Africa has taken a spill, moving from 52 to 61, as declining public services and corruption have impacted business confidence. Turkey has also suffered an alarming decline, from 43 to 53, the result of political instability and a growing estrangement from Europe.
  • Latin America can be singled out for its relative decline, particularly compared to comparable middle-income economies in Asia and Eastern Europe. Though Chile has secured its ranking as a top quartile “elite” economy,” Brazil has had the worst collapse of any country, moving from 48 to 80. The rest of the region is stable in its mediocrity, with Argentina the worst and Mexico the least bad. Peru has seen a concerning decline from a ranking of 61 to 72. The region of late has been severely impacted by recession and corruption scandals, resulting in declining public trust in institutions and low business confidence.

India Watch:

  • India’s electrical vehicle dreams (CSIS)
  • India’s Industrial policy (Live Mint)
  • India’s imminent economic crisis (Live Mint)

China Watch:

  • Buffett’s bet on BYD is working (QZ)
  • Meet China’s evolving car buyer (McKinsey)
  • Beijing praises patriotic entrepreneurs (SCMP)
  • Reconnecting Asia (CSIS)

China Technology Watch:

  • FT has lunch with JD.com’s Liu Qiangdong (FT)
  • China leads the world in digital economy (McKinsey)

EM Investor Watch:

  • Gazprom knocks Exxon off its pedestal Forbes

Technology Watch:

Investor Watch:

Ray Dalio on market valuation:

Do you see a disconnect between the U.S. stock markets being at an all-time high, while at the same time the economy continues to grow slowly?

No, I don’t. Markets, in general, are driven by the interest rate. As interest rates go down, as they have, that’s helped. Second, the purchases of financial assets by central banks have pushed asset prices up. Third, the expected returns of bonds and equities going forward are at relatively normal premiums to the existing short-term interest rate.

What are the implications of all that?

People buy profits, not the economy. So if the corporate tax rate is cut, a company is worth more even though the economy might or might not pick up on that. If regulation is reduced, that stimulates business. It might have other consequences, but it causes profits to rise.

Any other critical reason for what’s happening in the economy and market?

Technology, which is improving profitability, is also worsening [employment]. That worsens the economy because technology is replacing people [in jobs]. Improving profitability [through technology] is good for companies but not good for the economy as a whole because the people losing jobs are also the people who are more inclined to spend income. I call that group the lower 60%. So technology helps profits but hurts employment and helps to cause a slower economy at the same time it has caused companies to be worth more.

Has the U.S. ever been in a situation like that before?

We had a similar one between 1935 and 1940. I would say that 1937 [during the Great Depression, two years before the start of World War II] is most like the year today. We had the same sort of debt crisis; interest rates went to zero and the central banks printed a lot of money and bought financial assets, which went up in price. We had the same sort of wealth gap and the same sort of populism around the world.

So is there a lesson from 1937?

It’s very important that the Federal Reserve be very cautious and slow to tighten monetary and fiscal policy because we have asymmetrical risks: many more risks on the downside than on the upside. And be cautious about how political and social conflict is handled. Can we work together, or are we going to be split? Even though the stock market is at its peak and the unemployment rate is at a low, for the bottom 60% it’s a bad economy. We must not have an economic downturn.

What’s your take on the long-running debate about active vs. passive management and the move toward ETFs and other passive investments?

The question is: How much alpha can I buy by going to [a manager]? That alpha game is a zero-sum game. So don’t expect, on average, to get alpha because when somebody buys, somebody else has to sell. It’s like at a poker table: somebody will take money from somebody else — and there will be better players. There will always be smart people who will be able to make better decisions and pursue alpha. The challenge is to find them because those who are good at it are largely closed to new investors.