“I can list a dozen of the very large companies in China, banks, petrochemicals, telecoms, etc, where the PE ratio is four, five, six times and the dividend yield is eight, nine, ten upwards of 10% and that is an important change. What it means for flows is that there will be less interest on a relative basis in India because China is coming back on a lot of people’s radar screen,” says Mark Matthews, MD, Julius Baer
Exactly six weeks ago the headline was interest rates will remain high, the selloff in the global bond market was excruciating, the war had no clarity as to which way things would move and central bankers were nervous about inflation. The world has changed in six weeks. Are you delighted, are you surprised, are you happy?
I am all three of those things. To me, it was the CPI inflation reading for October that came out on Thursday which was the catalyst. It shows that for the fourth consecutive month, headline inflation is down but more importantly, it looks like core inflation is also rolling over and some of the core readings that the Fed looks at closely like the trimmed mean CPI and the median CPI that the Cleveland Federal Reserve run, those data series actually fell quite sharply on a month-on-month basis.
So the world has changed and it is because we are finally seeing what we knew all along. The many readings we were getting in the durable goods sectors and the commodity sector and in the services sector were showing that inflation was coming down but now it is starting to show up as a trend in the actual CPI inflation reading.
What are the chances that the financial markets are running ahead of themselves because it would take perhaps two or three months of back to back data to support the thesis that CPI has topped out and before that, Fed will not declare a victory against inflation. What happens in the interim where the Street would be divided on what could be the next course for the inflation print and also the Fed commentary?
I do not think we need the Federal Reserve to declare victory to be able to say that we can feel better about markets. By the time the Fed declares victory, the markets will be substantially higher than we are now. You were asking if the market is overbought? It depends on your time horizon, it is probably overbought just in the very short term but one thing I will say is that the S&P was up 5.5% on Thursday and that was the day the CPI number was reported and there have only been 24 other days since 1950 when that index rose 5% or more in one day.
If we look three months out, nine out of those 23 other times, the market was actually down but if we look 12 months out and only two out of the 23 it was down. So, three months out, I am confident we are going to be higher but if you look back historically, the odds are not very strongly in our favour but certainly 12 months out, the odds are strongly in our favour.
We have had a very strange year in that both stocks and bonds have fallen more than 10% and that never actually happened before. It is also a year that follows another year, 2021, when bonds were down. So bonds will be down for two years in a row. Never before did we have three years in a row when treasuries were down. So I say with quite a great deal of confidence that we have put in a bottom a month ago for the stock market; bonds, if they have not peaked now, the yields are very close to peaking. Next year is going to be a good year.
The kind of announcements we are now seeing from China and how it is now trying to revive the property market, we did see commodity prices go up overnight. How is that going to impact flows?
The China news is very significant and there were rumours going around starting from a month ago that they would be lifting the Covid policies but they are not lifting them; they are just loosening them. What we hear anecdotally from my colleagues here who have friends and family in China is that, anecdotally there are lots of evidence in the cities that they live in that and these policies are no longer being adhered to so tightly.
In many cases, they are not being adhered to. They might know that they had set up all these little tents across the cities across China where people had to go and get a Covid test once every two days, once every three days so that the phone had the green code on it. Most of those tents are now shut. That is just anecdotal evidence and then the property is also material.
I do not think property will come back in a big way but because the sentiment is still very depressed. They needed to send a message to people to stop buying property and keeping them empty as it is not healthy for the economy. Anyway, they have done both and that is a positive and marks an important inflection point and bottom in the Chinese market as well. It is an incredibly cheap market.
I can tell you one old axiom among value investors: if you can ever find a company whose price earnings ratio numerically is below its dividend yield, then just close your eyes and buy it because that is wrong. Usually a PE ratio should be 15 times, dividend yield should be 3%. Well top of my head, I can list a dozen of the very large companies in China, banks, petrochemicals, telecoms, etc, where the PE ratio is four, five, six times and the dividend yield is eight, nine, ten upwards of 10% and that is an important change. What it means for flows is that there will be less interest on a relative basis in India because China is coming back on a lot of people’s radar screen.
So the outperformance that we have gotten used to, the decoupling if we can call it, the fact that we were one of the best stock markets on the planet – are you saying that may not be the case going forward in 2023?
Yes, I believe that China will outperform India in 2023 because you know they moved in completely opposite directions over the last couple of years. India is up about 20% over the last two years and China is down by something like 30% and probably more. That cannot continue forever. It does not mean we do not like India anymore, far from it, but I do think next year that India will not be an outperformer because the other markets that have done so poorly will come back. It’s not just China but there is Korea, Japan where the yen is down something like 30% from where it was at the beginning of 2021.
Of course big losses in currencies in Europe and Britain as well that make those markets look attractive and if the dollar truly has peaked, then I would expect interest in them. On a relative basis, people will no longer be as interested in the places that have done very well.
What is your outlook when it comes to India in particular with respect to the liquidity situation given the reopening in China as well as what is happening with some of the other emerging markets like Brazil? How are you seeing the overall FII position for India?
There are two primary sorts of FIIs; there are the global fund managers and the emerging market fund managers. As the names imply, global fund managers invest around the world, emerging market investors just invest in the emerging markets. Between those two pools of money, global fund managers are much bigger and they are under allocated in India. With the dollar peaking, they will be looking for emerging markets to invest in and they will probably put some money in there.
But the emerging market fund managers will be moving their funds from India to China, Korea and other very beaten up emerging markets. I think probably they will neutralise each other and so I would not be that concerned about the FIIs. On the one hand, you will have the emerging market fund managers trying to find deep value in other places that look like they bottomed out but on the other hand, global fund managers will be putting new money in.
The two things which really stood out this morning was Warren Buffett’s latest buy which is a Taiwanese chip making company and also Druckenmiller. The fact that he has bought a stake in Amazon now in the third quarter and his other additions include even the Meta platforms. Are you intrigued as much by the same?
Yes, actually you are telling me news I did not know to be honest. I think it is quite interesting to see the Nasdaq putting in some firm technical support which it is and the outperformance of growth since that CPI number came out has been very stark.
I cannot speak for Druckenmiller or Buffett but what is happening is that people have lost so much money this year, they want to make some money at the end of the year. They can feel a year-end rally coming. They are buying the things that have gone down the most. Now specifically about Amazon and TSMC, I cannot really comment on those individual companies or why those two fund managers bought them but I would say one last thing which is I am very encouraged that despite the crypto currency fall out, Nasdaq and technology is holding its own very well because in June, which was the last big selloff, the correlation of cryptos and Nasdaq as almost one; it was 0.9%. This time, they are moving in very opposite directions. That is an important thing to highlight the change in the sentiment.