Trends Watch: China

January 16, 2020

By Elana Margulies-Snyderman 

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Andrew Middlebrooks, Chief Investment Officer, EIA All Weather Alpha Partners, LLC.

What is your outlook for investing?

From our perspective as a quantitative long/short global equity investor, one area we believe that may be over-positioned is precious metals. In both gold and silver, ETF shares outstanding suggest ETF traders over-positioned in precious metals relative to recent price dynamics.

What is your outlook for the economy?

We see a nascent wave of fiscalism across advanced economies and their impacts on markets. After the next recession, we think both the U.S .and Germany will be engaged in progressive fiscal policy.

We also believe that nascent shifts in academic economics will drive the respective central banks in accommodating these fiscal impulses. This dynamic could bode poorly for bondholders, and other entities who are implicitly short inflation volatility. As we exit the regime of the dominance of the Phillips Curve, we think a lot of investors could belatedly realize they are implicitly short inflation volatility without recognizing it, even as inflation doesn't get out of hand.

However, stocks should benefit from the higher productivity growth yielding higher GDP growth, but they may “underperform” the real economy, inverse to the 2009-present dynamic.

What keeps you up at night?

What keeps me up at night is the risk that China ultimately ends the global cycle sometime around 2021, driven by a combination of its financial “pipes” being clogged plus the impact of African Swine Fever (ASF) at the same time. Despite Chinese stimulus, there is not the "pass through" as before in credit and monetary aggregates.

In 2017, before the China slowdown drove global growth lower in a synchronized way, almost one-third of Chinese auto purchases were funded by peer-to-peer lending. The shadow banking deleveraging has removed key “pipes” for credit to flow to the private sector, and Chinese policymakers are struggling in reigniting the credit cycle.

We expect any nascent global manufacturing rebound to be slower and shorter than prior “mini-cycles.” Demographics in China continue to deteriorate, and now with its credit pipes beginning to be clogged, it's nearing a “pushing on a string” regime.

We believe, after perhaps one last mini cycle, Chinese growth will lead the rest of the world's growth down with it, on the back of credit deleveraging, even though we don't expect a financial crisis.

The ASF dynamic only further complicates matters. So far, Chinese frozen pork reserves being released has stemmed the increase in pork prices from spiraling. However, we anticipate that by around the Chinese New Year in late January, the reserves will be depleted or approaching depletion. This type of supply shock bodes poorly for real consumption in China, and may prevent the typical “short circuiting” effect of lower longer-term bond yields offsetting falling risk assets. ASF is extremely virulent, since it is spread by ticks, and the virus can survive in extreme temperature and pH conditions, even surviving for years on machinery. 94% of pork-producing regions in Asia have ASF outbreaks. Chinese pork prices inflation is running over 100% year-over-year at present. Prices are expected to peak in the first half of 2020 and stabilize/reverse back down into the end of 2020. China has been attempting to boost supply by increasing subsidies to hog farmers and, more importantly (as noted above), releasing frozen pork from its frozen pork reserves. However, if the supply situation deteriorates further into and during the Chinese New Year, the frozen pork reserves may run out, dashing expectations for a 2020 stabilization in prices. This would likely bleed into higher prices for chicken and beef as well, as substitution effects grow, and this could have spillover effects to global food prices. Central banks are unlikely to respond to a supply shock like this by tightening monetary policy, especially because it could be a headwind for Chinese (and thus global) real consumption growth. This could lead to a situation where long-end yields rise across the world, and tighten financial conditions just as Chinese credit stimulus begins to roll off, setting up for a potentially rough 2021.

About Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.