Well that didn’t go well. The world’s technology bellwether — the global proxy for growth — reported a 23% fall in profits and a 13% fall in first quarter revenues. Selling fewer phones, making lower profits…none of that is good. Not for Apple. Not for technology stocks. Not for growth stocks. Not even for China.
Apple’s CEO Tim Cook said the company faced ‘strong macroeconomic headwinds’. He means China, most likely. And he wouldn’t be wrong. The broadest measure of credit in China is ‘social financing’. That’s bank and non-bank lending plus corporate and government borrowing. It grew by 15.4% in March, which means nothing by itself.
But in the context of GDP, it’s alarming. Total social financing in China is now $22.4 trillion — twice that of GDP, which is $10.4 trillion. Corporate debt issuance was $107.5 billion in March, according to the Wall Street Journal. That puts Chinese corporate debt at 160% of GDP, compared to 70% in the US.
Debt, debt and more debt. That’s the problem. It’s how Apple and China are connected. A world burdened by so much debt will find it hard to grow. If there isn’t enough growth to generate income to pay interest on the debt, then you have an even bigger problem. If the borrowed money isn’t put to productive use – producing assets, incomes, jobs and wages – it’s a dead weight.
For investors, let me bring it back to the point I made yesterday, via Charlie Morris, the Investment Director of The Fleet Street Letter. Growth is expensive. This is the first time in 13 years that Apple has reported a decline in quarterly revenues. That doesn’t sound like an anomaly. It sounds like the end of a growth era.
On the other hand, value is cheap. In fact, value hasn’t been this cheap relative to growth since the last time growth peaked in the late 1990s. Is value about to stage a massive comeback? Charlie thinks so. More tomorrow (including the chart I promised).
Was Shanghai a stealth Plaza Accord?
Jim Rickards was good value last night at the London debut of his book, The New Case for Gold. Since I arrived a bit ahead of the crowd, I was able to get Jim to explain his theory that the February G20 meeting in Shanghai saw an agreement between the International Monetary Fund (IMF) and the world’s four major central banks to do a managed devaluation of the Chinese yuan without actually changing interest rates anywhere.
It’s an elegant theory and it makes a lot of sense. Jim pointed out that when the People’s Bank of China (PBOC) surprised markets in August (and again in December) of last year with a devaluation of the Chinese yuan, it sent most global stocks into an instant 10% correction. A little collusion among elite friends can prevent that sort of thing. Jim reckons that’s what Shanghai was about. How does it work?
The key to the whole thing is for the PBOC to do nothing. And because the yuan is linked to the dollar, the PBOC doesn’t have to do anything. It has to simply sit there and play dumb, with the Federal Reserve, the Bank of Japan (BoJ) and the European Central Bank (ECB) doing their part. And what is that part?
You manage to make the yuan weaker relative to the euro and the yen through talk. The ECB and the BoJ give the impression that they’re done with quantitative easing (QE), negative rates, or further stimulus measures. This happened in early March. ECB President Mario Draghi and BoJ President Haruhiko Kuroda both confounded and disappointed markets when they tempered their language about more QE and negative rates.
As a result, both the yen and the euro rallied relative to the US dollar. It was odd, at the time, to see a stronger yen and euro, even though Draghi and Kuroda didn’t actually change anything. They just changed what they said. In an era of interest rate expectation management, that was enough. You got all the effects of an interest rise in Japan and Europe without an actual interest rate rise.
Thus China got a boost in its trade with Japan and Europe without devaluing its own currency. It was a ‘stealth devaluation’, where the euro and yen were made to look stronger and the US dollar to look weaker. The IMF helped orchestrate the whole plot with the Fed, BoJ, ECB, and PBOC.
Sound plausible? It would mean that there’s collaboration among the world’s policy makers over whose turn it is to grow and whose turn it is to suffer. Behind all of it is the realisation that monetary policy can’t engineer growth in the private sector. All it can do now is delay a debt of reckoning that itself was caused by excessively loose monetary policy.
By the way, the chart above shows what the original Plaza Accord did to the Trade Weighted US Dollar Index in 1985. It gave the US economy a huge competitive tailwind against Japan. The dollar weakened and the yen strengthened.
But it’s the second peak in the index that’s even more interesting in the context of Apple’s earnings news. The last peak in the index coincided with the popping of the tech bubble. The rout in the dollar led to a massive bull market in commodities and emerging markets. Global capital flows shifted to faster growing and higher yielding assets outside the developed markets.
Could that happen today? Well, if it did, it would look an awful lot like the ‘momentum crash’ Charlie Morris has been talking about all year. ‘Bad’ would rally because it was already oversold. Growth would lag. And value? I’ll ask Charlie to put it in his own words tomorrow.
And then there were two
Is the oil business in terminal decline? Definitely not. The modern world would grind to a halt and we would all starve without crude oil and refined fuels. Our transportation system (upon which our food and our just-in-time system of everything depends) would collapse without oil.
But evidence is mounting that business is getting tougher. The oil price crash has made it much harder for the big firms to plan long term. What will the oil price be in five years? 10 years? 50 years?
Big firms have to plan years out. They have to find more oil to replace annual production. Exploration is expensive. But production is even more so. Integrated oil companies (upstream and downstream) spend hundreds of billions on capital investment. Uncertainty about the long-term oil price makes the return on that capex less predictable.
Hence credit ratings agency Standard & Poor’s downgrading US energy giant ExxonMobil from its AAA credit rating. Microsoft and Johnson & Johnson are the only US companies with the highest credit rating. Software and consumer non-cyclicals, you could say, are the only businesses in the world relatively immune from structural challenges (for the time being).
Exxon’s downgrade shows that, ‘the corporate market is not immune from secular industry changes and deep cyclical troughs that materially impact the immediate-term credit outlook,’ according to Brian Gibbons at CreditSights.
What he said!
It’s a double edged sword, isn’t it? A globalised and competitive world tends to bring us more innovation, more products, more services and lower prices. But it puts a natural pressure on corporate profits. And as investors, that affects our returns. The globalisation of the labour market and the advent of robots and automation puts pressure on wages.
Income, wages, returns…all of it’s under pressure! About the only good news is that, other than UK house prices, there is disinflation or deflation in most other global consumer goods. Does that add up to a net improvement in your quality of life? Let us know what you think at firstname.lastname@example.org.
Contributing Editor, Money Morning
Ed note: Long time readers will remember Dan Denning, former Publisher of Money Morning. Dan has now gone on to the UK, where he writes for our friends at Capital and Conflict. The above article is an edited extract from that publication.
And if you would like to read more from Jim Rickards about currency wars, the Shanghai accord, the IMF, and how it all affects your investments here in Australia, check out his Aussie publication Jim Rickards Strategic Intelligence.
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