Conclusion: We recommend both caution and patience to those using [potential] Chinese stimulus as their bullish catalyst for equities or commodities at the current juncture. Moreover, we think that, if eventually signed into law, Chuck Schumer and Sherrod Brown’s trade legislation is likely to leave the U.S. economy worse off.
China Won’t Bail Consensus Out At These Prices
A lot of speculation is bouncing around the halls of consensus about Chinese stimulus potentially providing a positive force for the global economy. We’d be cautious to fade that – for now. Yes, China relaxing monetary and fiscal policy would indeed be very bullish for the Chinese economy and very supportive for the global demand curve, but getting from point A to point B could wind up being quite painful.
We’ve been calling for China to eventually shift to a stance of marginal dovishness in the latter half of this year and eventually cut rates as inflation slows closer to the government’s 4% target – which, according to our models, could be sometime in 1Q12. This outlook is supported by our continued conviction in our Deflating the Inflation thesis – an explicit call to short/sell commodities – as well as conviction in our soon-to-be released King Dollar thesis, which extends that call into 4Q11.
As we've pointed out in our recent research on China, there are a number of things China has introduced or implemented on the fiscal and financial policy fronts that will be supportive to Chinese consumption growth in 4Q and beyond (email us for the most recent analysis). These are, however, not nearly as supportive as rate cuts would be to ease the credit crunch many Chinese corporations are facing. Monetary easing would also go a long way towards easing the liquidity headwinds currently squeezing Chinese property developers; at ~48%, fixed asset investment is nearly half of Chinese GDP, so it’s rather important for global growth and commodity prices. And given the credit quality headwinds facing China’s banking system, we think it is unlikely they pursue a large-scale fiscal stimulus/credit extension program like the CNY4 trillion package introduced in November ’08 – a full four months before the S&P 500 bottomed!
All things considered, it could be a while before China pulls the trigger on the monetary easing front. Merely using 2008 as a semi-comparable reference, we saw that China waited a full six months for confirmation of flat-to-down sequential CPI growth and a -380bps reduction in YoY CPI before cutting interest rates in early September of that year. We’re not quite there yet and we don’t reckon we’ll get there absent seeing the deflationary forces we’ve been calling for continue to exert downward pressure on the commodity complex over the intermediate term. And as the math continues to tell us, that outcome is likely not positive for equities in the short term (the trailing 3yr positive correlation between the S&P 500 and the CRB Index has an r² of 0.86). Eventually, deflated commodity prices will be a bullish catalyst – particularly for global consumer stocks. Eventually.
Needless to say, we recommend both caution and patience to those using [potential] Chinese stimulus as their bullish catalyst for equities or commodities at the current juncture.
Chuck Schumer Doesn’t Get It
Much to-do is being made about the passage of S-1619, the [slightly] bi-partisan bill recently introduced by Senators Chuck Schumer (D-NY) and Sherrod Brown (D-OH). The bill, which now moves on to the Republican-controlled House Ways and Means Committee, is anticipated by some to fizzle out in the House; this is crucial because all U.S. trade legislation is controlled within this chamber. The intra-party debate between Dave Camp (R-MI), who voted for similar legislation last year, and the duo of House Speaker John Boehner (R-OH) and House Majority Leader Eric Cantor (R-VA) should indeed create a spirited internal battle over the legislation.
As it stands now, the bill, if signed into law, would allow U.S. companies to seek duties on imported goods after the Treasury Department identifies whether a particular currency is undervalued. Such non-compliant regimes (i.e. "China", as argued by the bills supporters) would face dumping duties and/or a ban on federal procurement within the U.S.
Critics of the bill – including the Peterson Institute, the U.S. Chamber of Commerce, the National Retail Federation, the Financial Services Roundtable, and over 50 other business groups – claim that even if passed, it won’t have a “substantive effect” on U.S. companies due to the long lag time between filing complaints, government action, and economic results. In addition, they mock it for its “pro-U.S. jobs” claim, saying retaliatory action by China is perhaps a greater price to pay than what is currently perceived as being paid for doing business with the Chinese.
We think this bill reeks of the recent spate of misguided dogma that D.C. continues to force upon the domestic and global economy. As the title implies, Schumer doesn’t get it. Passage and implementation of this legislation would likely be very detrimental to U.S. corporations and consumers in the form of import price inflation and a closing of the Chinese domestic market to U.S. exporters – a key growth market for U.S. multinational corporations like YUM, MCD, and WMT. Remember, China can always turn to the Germans for products in the event the U.S. forces itself out of this important market. Recently, the PBOC issued on their website a stern rebuke supporting our view:
“Passage of the legislation may lead to a trade war that we don’t want to see… The [legislation] won’t solve U.S. problems of insufficient savings, a trade deficit, and an elevated jobless rate.”
Moreover, expedited yuan revaluation is especially punitive in the short-to-intermediate term as production capacity isn’t easily moved. For example in 1Q11, COH said that it would take four years to shift production from China to Vietnam. In the meantime, companies will have to incur both rising CapEx expenses resulting from expanding capacity into other low-cost countries and higher import costs in the interim from any resultant yuan appreciation.
As a courtesy "newsflash" to Chuck Schumer, it’s worth reminding him that U.S. labor costs are too exorbitant to economically manufacture footwear, apparel, and other consumables on a large scale. As such, we’re not sure how they come up with their "2.8 million U.S. jobs stolen by China” estimate. Moreover, the resultant capacity constraint on the global supply of low-cost, working-age labor could be very inflationary/really bad for margins for corporations all over the world. It’s worth noting that China has a larger working-age population than the next two largest non-U.S. countries combined (India and Indonesia).
Net-net, we think that, if eventually signed into law, Chuck Schumer and Sherrod Brown’s legislation is likely to leave the U.S. economy worse off over the short, medium, and long terms.