Where to Invest & what to Expect in Different Asset Class

 

The biggest question which will be chasing every investor is which asset class to invest in and where the investments will be safe. What type of rebalancing needs to be adopted?  Before that, we all need to know how the different asset classes will be influenced.  

Well, Berkshire was a net seller of stocks in both the first and second quarters of 2023 and also scaled back its share repurchases in Q2 – which hints that the legendary investor is not too comfortable with valuations of publicly traded companies or his own Berkshire Hathaway stock at current levels.

The current pile of Debt of the U.S. and China is a matter of threat to the global market. Indian markets might be discounting the threat for the time being but it cannot evade the liquidity risk. One of the biggest questions which comes to mind when we look into the U.S. treasuries and the pile of debt and interest rate flow, is the only question that comes to mind when investors stop treating US Treasuries as "risk-free"?

The US spends another $73.3 billion on interest in July 2023 alone bringing YTD total to $726 BILLION. We will soon see the first-ever 12-month period with $1 trillion+ in interest expense on US debt. The banks of the U.S are significantly a risky zone as Banks have 2tillion of CRE exposure over the next 3 years, this higher for longer rates is fantasy because under the bonnet of Bidenomics manipulative economic data is a high debt economy that is unsustainable if we look at the history. The US 10-year yields hit 4.2%, the highest level since November and just 4bp away from an October level that was the highest since 2007. The US 10Y has been on the move this week, climbing back to 4.17%. Back to levels last seen last November, and before that, mid-2008.

 On the other hand, the U.S... 30-year Mortgage rates surpassed 7.5% recently, marking the first time in 23 years they have been so high. "The economy is currently experiencing a significant tightening of financial conditions, largely driven by the persisting fragility in the Treasury market".

 

Coming to China healthy interest rate cuts have already taken place followed by stimulus packages and some more significant announcements to come. But the depth of buyout of this pile of Debt Mountain will force all asset classes to go for a significant volatility ride.    The debt market volatility will impact the pension funds and retirement funds will be huge as margin calls will trigger a sell-off in equities. Industrial inflation will fall more in the coming months.

 The S&P GSCI Industrial Metals Index, which tracks the industrial metals sector through futures contracts, is down nearly 18 percent from this year’s peak. The IFO shortage indicator, a survey of German manufacturers by the IFO economic institute, fell to 31.9 in June 2023 from 80.2 in March last year, marking a “significant” reduction.  The price cut down in raw material cost is being witnessed in many companies where the benefits are being passed to the buyers. For example, LG Electronics Inc. has slashed raw material and transportation costs by 2.12 trillion won ($1.6 billion) in the first half. Another company Jinko Solar Co., one of the world’s largest panel producers, reported first-half profit surged 325% as lower raw materials costs helped the sector cut prices and spurred demand. Hence industrial inflation has already come down significantly.

Crude prices will remain elevated backed by production cuts down.   The production cutdown comes when the demand is low and hence there will not be much benefit from falling demand.

For emerging markets like India, it’s time for rebalancing and being cautious with markets. Widespread changes for investors during the quarter were a focus on resetting or upgrading the core of the portfolio in a shift “back to basics. Across the board, it being found that investor clients in ‘Portfolio Solutions’ focus on resilience, risk, and re-evaluating the core of the portfolio – getting the basics right. The rising debt pile across many economies leads to investors flocking for high-grade corporate bonds followed by sovereign bonds.  Investors in fixed income should continue to see a strong focus on investment-grade credit versus higher-yielding segments. Without rebalancing and reinvesting wealth cannot be made hence it's time to get back to basics.

More focus will shift towards quarterly earnings and cherry-picking of quality long-term stocks in India where the opportunities of growth are mapped with GDP and industrial growth of India. PLI stocks will be in big focus followed by BFSI which cannot be ignored.

ETFs will be one of the hot flavors for the market and investors across the globe. Any correction in global equities will lead to a significant inflow into ETFs. ETFs have grown enormously in popularity over the past two decades. The total amount invested in ETFs has grown from around $200bn globally in 2003 to more than $9.5trn in 2022 translating into a growth of 20% and its projected to reach $15 trillion in the next 5 years. Retail participation will grow more in ETFs which will change the climate for investment advisory. In volatile times investors will divide between ETFs and active fund management and most will prefer to Passive where economic and market volatility is high.

New investors' acquisitions towards the market it growing consistently covid times. Recently in the month of July 2023, it was found that a total of three million new demat accounts were opened which is the highest in 18 months. As the Indian market maturity increases we will find more investors joining the market.  In the last two years, Indian equity investors have grown from 2.8% to 4.8% which is below 5% currently compared to the developed economies. Whereas 13 percent in China, 33 percent in (the) UK, and 55 percent in the USA. India has therefore still got a long way to go before more of the population participates in the stock market directly. 

Well as per CDSL and NSDL, the 3 million demat account opening in July is the highest since January 2022 and about 50 percent more than the previous 12-month average of 2 million. India emerges as a beacon of stability and growth, its stock market is poised to surge at an anticipated rate of 15 percent annually.

Hence investors will be looking ahead for equities for every fall in the market and will get into investment opportunities through SIP in direct equities and MF. ETFs will find the most flavored products for 1^st timers.  Debt will lose its glory once the interest rates start coming down and all Fixed Deposit inflows will come back to equities.  

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The U.S & China Liquidity Issues is an Alarm

In continuation to the previous article https://www.ianalysis.co.in/2023/08/us-crisis-will-be-soon-global-guest.html , the global economy and the two largest economies are getting into a liquidity trap and this might impact global economics going ahead. Very soon we might find a downgrading of ratings for China and if not publicly but might be internally. The income inequality in China and U.S. are both wide enough. Chinese households retain the country’s GDP—roughly 60 per cent versus the roughly 80 per cent typical in the United States. The low household share of GDP has the same effect on demand as income inequality.  This inequality is going to create more problems for these two economies and this is the place where developing economies will grow big.

Well, we heard about Deflation in China and we made a quick comparison with Japan this week based on its macro numbers. Very soon you should all expect the authorities to ease financial and budgetary policies, housing regulations, and borrowing caps to finance infrastructure. Further, there will be here might even be measures that look consumer-friendly. This pushes the global markets into new highs and Asian markets too.  But the biggest question is that will the same help China to get out of the slowdown snowball and also how this snowball is benefitting other countries.  But sorry this time China may not be able to come out of the issues which have now turned to mountains.

Being in India or Mexico every country will pray that China should lose its power of trade and investments and the share of control should now head towards developing nations. We have heard many times that the global supply chain is changing but what we did not look into is the speed of change.

The shift in manufacturing and trade is happening much faster. For example, Mexico’s share of U.S. imports matched China’s in June. The free-trade agreement between the U.S., Mexico and Canada has made Mexico a strong contender against China and other Asian nations as a supply base to the U.S. When the dollar values of exports and imports are combined, Mexico is now the U.S.’s No. 1 trading partner, followed by Canada, pushing China to third place. Buyers are turning to Mexico, Europe and other parts of Asia for wares ranging from computer chips and smartphones to clothing. India’s share of U.S. smartphone imports reached 5.3% for the year ending in June, up from 1.8% for the 12 months ending in December.

Some of the countries that are becoming popular destinations for companies that are moving manufacturing out of China include Vietnam, India, Mexico, Indonesia, and Bangladesh. These countries offer lower labour costs, a more stable political environment, and closer proximity to major markets.

The recent Mr Biden semiconductor and chip policy is a major blow over and above the Mr Trump trade war policies.   China might come up with billions of packages and other stimulus measures but that won’t work this time of the Decade since major importing countries from China now knows the mistake of over-dependency on one country.  This time the impact on the Chinese economy will be longer despite takings several measures for revival of the business and trade within China.

Few key points to dig our why China will fail despite stimulus measures announced by its own:

• Its employment is dependent on FDI investments and any shift out from the same creates significant outflow and leads to higher unemployment

• Higher unemployment leads to significant savings by Chinese households and hence less consumption. You must remember that China does not have social measures like other countries.

•  Current consumption has generally been very subdued, especially for big-ticket items such as cars and houses, and private investment, the backbone of China’s economy.

•  When domestic consumption takes set back and people are sceptical about the job market and higher unemployment of youth creates a significant slowdown for domestic manufacturers.

•  Youth unemployment has topped 21%, or double what it is in the UK and almost three times the rate in the US.

•   Private sector of China has been spending very less as the norms are stringent and hence Private firms and entrepreneurs are not spending much on investment or on hiring people.

•   If we look at the number of employment we find that the annual graduation of 11-12 million students in the summer is aggravating an already difficult situation because of the problems of finding suitable work.

•  Pay wages are falling and as high tech and FDI are slowly moving out due to the so-called Supply Chain shift the jobs are mostly in the lower-pay, low-skill, gig or informal economy compared with higher quality jobs in manufacturing and construction.

•   Most of the housing stock, overbuilding, collapse in transactions and weakness in prices are not in big agglomerations such as Beijing, Shenzhen and Shanghai, but in hundreds of smaller cities and towns that rarely make news.

 Well, U.S Election and Mr Biden's strategy are well played for targeting to create domestic jobs at the time of elections scheduled for Nov -2024. Every Presidential election attracted some type of war and now the trade war is the new weapon. Now this strategy has been identified by Britain and the European Union who have signalled their intention to move along similar lines, and the Group of Seven advanced economies agreed in June that restrictions on outbound investments should be part of an overall.

A quick look towards the economic Numbers of China

•  Year-to-date, China's exports are down 5% compared to last year, while imports have dipped 7.6%

•  Manufacturing activity has contracted for four straight months

•  July exports declined at the sharpest rate in three years, at 14.5% annually

• The US Census Bureau reported Chinese exports to the US dropped 23.7% in June, hitting a six-month low of $42.7 billion

The recent numbers from China speak loudly- China accounted for 13.3% of U.S. goods imports during the first six months of this year, below a peak of 21.6% for all of 2017. The current level is the lowest since 12.1% for the year 2003, two years after China’s accession to the World Trade Organization.

This shift out leads to a big hole for the Chinese economy since, over the past 2 decades they have created a huge mountain of debt unprofitable and un-commercial infrastructure and real estate, empty apartment blocks and little-used apartments and transport facilities, and excess capacity in, for example, coal, steel, solar panels and electric vehicles. Now these facilities are going to be turned into ideal and youth unemployment will create major setbacks. Further Chinese domestic investments will not rise so early nor can fill up the GAP created under the current circumstances.

We will witness commodity prices will fall which might trigger margin calls in commodities and industrial inflation will be on the lower side giving immense benefit to developing nations. Financial and liquidity crises from China might come up and most of the funds will be used for bailout.

The global risk is now for liquidity crisis and in certain ratings getting upside down across various sectors and assets class. The debt market will witness a major setback in coming late 2023.  

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U.S Crisis will be Soon Global Guest

 

Many people across the world have been shocked to find that Mr. Biden economic policies have been a miracle where despite increasing interest rates inflation is not yet under control (as per the Fed Benchmark) but the job creation numbers are on the higher side. Let’s look at the numbers where inflation has come down to 3% in the US in June, down sharply after peaking at more than 9% last year as global commodity prices came down significantly across the globe and the same inflation also came down across all countries. Well the truth is hidden and it is snowball getting preapred for late 2023 and early of 2024.

 Whereas the interest rates need no numbers to be explained how expensive it has become in living cost. Most of the US jobs are created in the contraction industry ( excluding real estate) as federal investments in infrastructure (Infrastructure Investment and Jobs Act), semiconductor chip plants (CHIPS and Science Act), and green energy construction.

Based on recent data shows that the combined U.S. credit card balances have passed over $1 trillion, which is for the first time in the US economy. The buy now pay later (BNPL) has taken a significant quantum jump within the economy. Further, it has been found that Credit card balances during the 2023 second quarter rose by $45 billion to a series high of $1.03 trillion, according to a report this week from the New York Federal Reserve Bank. Retail credit cards and other consumer loans climbed by $15 billion during the quarter. The average credit card currently charges a near-record 20.53% interest rate. This category of debt also has the highest 90+ day delinquency rate at 5.08%. Well, credit card delinquencies are at an 11-year high, as measured using a four-quarter average, the data showed.

Getting deeper it's being found that the Millennials are having around total balances hit more than $4.2 trillion in the fourth quarter of 2022, a 27-percent jump from late 2019. Adding more to this it has been found in a survey that 57 percent of American consumers say they are living paycheck to paycheck. More than 72 percent of people making less than $50,000 a year live paycheck to paycheck, while 60.9 percent of people making between $50,000 and $100,000 annually live that way.

This speaks very loudly that with current high levels of interest rates in the US the cost of paying interest on the same will be manifold high as compared to any historical number and any default on the same will suck out liquidity from the US banking industry. This time it seems that the retail banking crisis is well prepared to be reserved on the table. Well, this credit card debt is not enough to make the global economy cry for liquidity but we have a few other segments to add full momentum to get a complete dry down. Total household debt increased by $16 billion in the quarter, totaling around $17 trillion. The cost of serving debt items is many like auto loans, student loans, mortgage loans, and business loans which finally leads to a retail debt trap. Further Federal student loan borrowers have not been required to repay their debt since 2020. The payment pause will resume in October, and the resumption of student loan payments will be a huge test for many cardholders and the economy as a whole. The impact on the living cost and consumption will be huge.

More importantly, we need to know that U.S. overall household debt has spiked by $2.9 trillion since the end of 2019.The high-interest cost serving is going to be a major reason for getting the whole retail market getting under collapse. 

The long-term impact of this high debt and high-interest rate will be:

• Banks will have to write off these loans and take a hit on books
• Retail consumption from the US will slow down impacting GDP and stocks.
• Consumption numbers will come down
• The bubble of job creation will get halt
• Unemployment numbers in the U.S and other countries will increase as the liquidity crisis will spill over.
• Federal Funds are to be deployed for the revival of the banks
• US federal income will take a hit resulting less investments within the economy
• Borrowings will go up for the US government impacting more interest rate demand by the lenders.
• Banking M&A will begin in the US and in other countries where interlinked trades and businesses are holding these assets
• Emerging markets assets will find sell-off
• Markets across the globe will correct and might take some time to revive back based on different economic parameters.

This is the place where interest rate cuts down will be faster to save the US economy and the global economy from the liquidity crisis. The US bond market will face more tough times in the coming months as the spike in yields and the decline in bond prices will impact the banks. We all know that Lenders are traditionally big buyers of government bonds, so when the value of those investments declines, it can spell trouble. Well, find more liquidity crises emanating from the US and spreading to different parts of the world. We will find more rating cut-down in different banks in the US which will slowly place pressure on inter-related trades and papers held by other countries' banks. 

The recent rating cut down by different Agencies might get again revised in the coming months as the median debt-to-GDP ratio of AAA-rated sovereign debt issuers is currently 39.3 percent; for AA-rated issuers, 44.7 percent. The current US debt-to-GDP ratio is 112.9 percent. This high level of retail debt and repayment is a matter of concern that might turn out to be a headache for the global markets and economy.

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