Taiwan tensions and Caterpillar earnings
Head of Equity Strategy
Summary: Foreign investors have significantly reduced their exposure to China in 2022 as a response to the war in Ukraine, deglobalisation trend, China's economic slowdown, and worries over a potential recession. Tensions over Taiwan and the learnings from the freezing of Russian assets have also got investors to rethink portfolios and their exposure to China. Finally, we take a brief look at Caterpillar Q2 results which were strong and more importantly the outlook shows growth is still robust except in China and Europe.
Foreign investors are reducing exposure to China
In today’s Saxo Market Call podcast we focus on Taiwan as the US House Speaker Nancy Pelosi is visiting Taiwan worsening tensions between the US and China. The visit comes as the US Congress has just enacted a new bill that aims to drastically increase domestic computer chips production in the US while constraining US semiconductor firms to increase production in China for chips less than 28 nanometers. The tensions between the US and China are adding negative sentiment into equities.
For decades China and Chinese equities were a winning trade and as China opened up to the world, foreign investors increased their exposure. China was the future. However, the past five years have seen a shift in policy constraining the private sector, and especially the technology sector, and emphasizing social stability while managing the worsening relationship with the US. China is currently governed by two policies: “self-reliance” and “common prosperity”.
The first policy is more important than ever given the sanctions applied on Russian and asset freeze. To provide maximum strategic flexibility, China must be as much independent as possible from states that could go against it during a conflict. The latter policy drives its actions against the private sector and entrepreneurship which, if uncontrolled, is a potential source of disrupting society.
Russia’s war in Ukraine, and China’s subsequent and implicit backing of Russia, has forced investors to rethink globalization, which was of the dominant forces of the global economy for 40 years. The war in Ukraine has catapulted the tensions over Taiwan to new levels and the freeze of Russian financial assets have illuminated an obvious tail-risk to Chinese financial assets should Taiwan lead to a major geopolitical incident in the future. As a result, we are seeing foreign investors selling out of their CNY bond holdings with the iShares China CNY Bond UCITS ETF losing 55% of its assets despite a 5% gain in EUR terms since the war broke out in Ukraine.
China is dealing with a slowing economy, weakening consumer confidence, deglobalization with companies shoring back manufacturing, and a housing crisis. The intersection of all of these forces will lead to a painful readjustment for China, and today China’s leaders said that GDP targets are a guidance not a goal in itself. China’s investment led boom over 40 years has generated enormous amount of wealth and has lifted hundreds of million of people out of poverty, but it has also created imbalances and in many ways China is facing a “Japan issue” as Japan also suffered from an investment intensive boom back in the 1980s.
The issue with Chinese banks and the crisis in real estate has been brewing for years. The market value to total assets of the four largest Chinese banks has been falling steadily since the Great Financial Crisis in a sign that credit extension is being forced from the public side with financial markets not believing this credit will be good in the end. This is also why the credit impulse dynamic has weakened substantially in China and no longer is a viable option. Look at US banks, the market is also not convinced of the current credit extension.
Chinese equities have also underperformed the MSCI World since it peaked relatively in 2008. Global investors are increasingly indifferent to the developed vs developing equities. It was pleasant label in the post 2001 Chinese WTO inclusion years, but investors are increasingly looking at long-term technology themes instead of countries, sectors etc.
Caterpillar beats Q2 earnings estimate and confirms robust outlook
Caterpillar, the world’s largest maker of construction equipment, posts better than expected earnings with EPS at $3.13 vs est. $3.03 with revenue at $14.3bn in line with estimates. The company reports strong price realization and uptick in volume in both North and Latin America, while EMEA and Asia (primarily China) are seeing lower volume. Caterpillar’s result in Q2 confirms the slowdown in China and especially within construction. On a global basis, Caterpillar sees positive growth in Q3 suggesting growth remains robust despite inflation. Caterpillar’s result has coincided with a turn in S&P 500 futures.
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