Rise fuels more rise

In this post, we briefly talk about Black Friday sales in the US, which look promising for the shape of the consumption locomotive. After that I’ll present an anecdote about how a rise fuels more growth in the stock market. Finally, we look at the collapse of China's real estate sector and the economic data pointing to a recession in the eurozone.

Miscellaneous stuff

First, let’s look at Black Friday that’s important for retail from the viewpoint of investors. Let's leave the question of sustainable consumption and whether it makes sense to hoard new things to other channels. In the US, the world's consumer powerhouse, almost $10 billion worth of goods were sold online on Friday, according to analytics from Adobe. This is 7.5% more than last year.

In general, retail sales, which give an indication of the direction of private consumption, have developed moderately, helping the economy to remain in expansionary mode. Retail sales are well over $600 billion a month and are still growing year-on-year in nominal terms. Taking inflation into account, the number of goods sold is slightly lower.

About two-thirds of the $28 trillion US economy is made up of private consumption. In other words, the American consumer alone would be the largest economy in the world on the scale of China in dollar terms. If the American consumer stops shopping, the rest of the world stands still. 

This next observation from Ryan Detrick is at least an amusing anecdote, if not a solid fact of statistical inference due to the paucity of data. A rise feeds more rise. The S&P 500 has risen four weeks in a row, a total of more than 10%. Over the past 60 years, there have been ten such instances, and on eight occasions the stock market was on average 18% higher a year later.

China is flirting with a financial crisis 

One negative wild card for the global economy is the digestion of what is reportedly the biggest real estate bubble in China's history. Over the past decades, huge amounts of fictitious paper wealth have been created by endlessly building up real estate with leverage. With real estate prices promising eternal rise, a huge amount of economic activity has been organized around construction. Now the economy has to adjust to a harsh reality.

Some indication of the scale of the problems is the size of the portfolio of one of the country's biggest property developers, the trouble-ridden Country Garden. The company's property portfolio has as many square feet under development or completed as 413 Burj Khalifas would have. Or the equivalent of two Manhattans. And the company is just one of many developers in China. 

When the bubble deflates, it’s unclear who will take the losses. The traditional pattern in such bubbles is for the state to eventually take the losses, bailing out indebted banks, construction companies and households.

If the cycle isn’t broken, there is a risk of an outright financial crisis.

If China were to stumble badly, it would have serious consequences for the global economy. The good news is that in a communist command economy, the central government, which has dictatorial characteristics, has no interest in allowing the crisis to escalate. Among Finnish listed companies, e.g., KONE has massive exposure to China. Many other companies trace the source of demand for their products back to the People's Republic. Thus, the economic news from China matters for Nasdaq Helsinki.

Although the digestion of the real estate bubble began with a conscious decision by the state to limit the reckless indebtedness of real estate developers, support measures for the sector have so far been lax but ever-increasing.

The latest move is to allow banks to lend money to cash-strapped property developers without collateral. Because if developers don't have the money, they will be forced to sell homes at fire sale prices. This naturally creates a negative spiral. Or they can’t complete the estimated €400 billion worth of housing still under construction. Construction and its spillovers are estimated to account for up to a quarter of China's total economy. Moreover, the wealth of Chinese households is tied up in plasterboard, so a sharp collapse in the sector will hit the whole economy. This partly explains the muted recovery in domestic demand from the COVID pandemic.

Naturally, banks are taking more risk. The Chinese banking sector isn’t famous for its health anyway. Eventually, Beijing will probably be forced to resolve the crisis by taking on the debt, but for the time being, this final solution is being kicked down the road like a can down a hill. Until then, we hear repeatedly about problems in the real estate sector, and I will bring them up in my posts as new developments emerge. 

Speculators seem to be anticipating an easing in construction as the price of iron ore, an essential ingredient in steel making, has crept up recently. China is trying to control iron ore prices and demand is now weak, but investors clearly expect the situation to improve. 

 

Eurozone drifts closer to recession

Despite the rapid rise in interest rates and the energy crisis, the eurozone that is Nasdaq Helsinki’s main market has been surprisingly resilient so far. For example, the European Central Bank predicted in the summer that the economy would avoid a recession and continue to grow at a reasonable 1.5% by European standards. Now the forecast is for the economy to stagnate or stop growing at the end of this year, but no real recession is yet in sight from the ivory tower in Frankfurt.

However, the latest PMI data for November suggests that a recession is approaching, or at least that Europe is flirting with one. The services index, based on a business sentiment survey compiled by S&P Global, hovers at 48.2 points and manufacturing at 44.1 points. A reading below 50 indicates a decline in activity compared to the previous month, October. The good news is that the company sentiment deteriorated less than in the previous month. The real turnaround will only be seen when the numbers bounce above the 50 level, but even the easing of the decline in activity is already a promising development.

 

A few noteworthy observations: geographically, the weak performance is particularly concentrated in the eurozone's largest economies, Germany, and France. German GDP contracted by 0.8% y/y in the third quarter.

For the first time in two years, employment started to fall in manufacturing. In addition, the level of inventory continues to fall. The inventory cycle fooled investors during the pandemic, when suddenly all customers wanted to stock up to be on the safe side. For a while, this made the normally slow-growing listed companies look like super-growers. Harvia, for example, was able to communicate to investors that a pandemic-era peak in demand isn’t a sustainable level of growth. Investors, however, did not hear this message.

Price developments were two-way. In manufacturing, both purchase and sales prices are falling. In turn, the service sectors, which are a larger part of the economy, continue to see upward pressure, especially on wages and prices for services continue to rise. This is awkward for the ECB, because weak economic data would provide a good reason to cut interest rates, but if price pressures don’t ease, the weakening economy will have to be further punished by high interest rates. All the same, it would be a miracle in the light of current data if the policy rate were to be raised any further from its current level.

PMIs are a fairly accurate indicator of the state of the economy and, given these developments, it’s a wonder if the eurozone weren’t in a small recession. The good news is that at least a mild downturn shouldn’t be news for equities. The results and earnings forecasts of listed companies have been falling for some time. The survey shows a slight improvement in the optimism of manufacturing companies about the future. Investors look at the world through the future. A good mental game is to imagine moving forward in time 1.5 years and imagine what the economy will look like then. As the economic data is already poor and possibly bottoming out, one would expect it to be greener in 1.5 years' time. Stocks will soon start to anticipate this, if they haven’t already done so. After all, European stock markets already bottomed out last year, although Nasdaq Helsinki decided to offer investors more discounts this year. Germany's DAX index and the MSCI Europe index for Europe as a whole are hitting near all-time highs. The German stock market has a nice exposure to cloud migration through companies such as Sap, a green shift with Siemens and a recovery in travel with Airbus, limiting the impact of a weak domestic economy. However, the German stock market also has a rare nasty exposure to the Chinese economy, but that doesn't seem to bother investors. German companies are expected to continue to set records in the future.

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