Market Thinking

making sense of the narrative

Gradually, then Suddenly

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A Short note today – just moving into a new office. Mainly a focus on recent developments around some of our developing themes.

First is the ongoing story of Evergrande, which has gone viral, with the whole world apparently just ‘discovering’ something that has actually been going on for years. The use of pre-sales to fund not only working capital but also to pay for future land has been well known for many years and will definitely cause something of a reset now that the music has stopped, but it seems likely that the Government will make good on all the working capital shortfalls and continue to ensure there is enough liquidity in the system.

Despite the fervent desires of many western commentators, it is unlikely that this will bring down the Chinese economy, nor its government. Indeed, we see it as part of an ongoing and deliberate policy to create a sustainable financial sector in China, which means deleveraging as quickly as it is safe to do so. China has already done a lot to shut down the various aspects of the shadow banking system in the last five years and the move to ‘allow Evergrande to go bust’ looks intentional rather than accidental – and as we pointed out last week it really shouldn’t be much of a surprise. In the words of Hemingway, this has been happening gradually, now it is happening suddenly.

How did you go bankrupt?” Bill asked.

“Two ways,” Mike said. “Gradually and then suddenly.”

Ernest Hemingway’s 1926 novel, The Sun Also Rises.

As we also discussed last week, the focus is going to be on protecting the Chinese consumer rather than the western investor, although how they treat the Chinese owners of the ‘wealth products’ structured around Evergrande Debt remains to be seen. It will also be interesting if they treat HK owners of wealth management products full of Evergrande paper the same as owners from, say, Shanghai.

Second is the emerging ‘Energy Crisis’ in the UK, which is another slow motion train crash, as successive governments have avoided taking long term decisions on energy security while more recent ones have obsessed about the unrealistic promises of renewables and actively shut down existing base load and gas storage. The fact that the UK government appears to have finally woken up to the fact that Nuclear is the only realistic option for base-load, (if they are going to comply with their own ‘rules’) as announced over the weekend is important for investors as well. We already know that the biggest energy consumers in the world – China, India and the United States – are going down the nuclear route and, importantly, that there is no credible push back from the environmental lobby. This is obviously good for Uranium and related stocks as well as raising the important issue of stranded assets; what is more likely to be stranded, an Oil refinery when the world fails to go fully electric in under 10 years time, or an expensive and unreliable ‘alternative energy’ installation when everyone is building small nuclear?

Third, we have the German Election and the end of the Merkel era. What a lot of the laudatory articles about Merkel tend to overlook is that she was always at the head of a coalition, which is the ‘natural’ order of things in Germany, even if the country as a whole continues to vote largely on old East/West lines. Such coalitions allowed for one ‘leader’ to bypass more traditional ‘term limits’, but it is unlikely that this will happen again – certainly it is difficult at the moment to see any of the current party leaders emerging as multi term Chancellors. This increase in instability comes at a time when other elections – such as France next year – but also in Australia, both State and Federal and of course the US mid terms may well turn out to be more of a plebiscite on the way increasingly authoritarian governments have handled Covid than the incumbents may be thinking.

It also increases the focus on how Europe sits between the emerging Shanghai Co-operation Organisation bloc of China, Russia and India to the east and the Anglo Antlantacist Bloc to the west (and South if we include Australia). Macron clearly wants more autonomy for Europe (and is very upset by the submarine debacle) while certain members of the upcoming German coalition appear (at the moment) to be more closely aligned with US political aims. Meanwhile the dependence on energy from Russia is making the US ‘with us or against us’ rhetoric very awkward for European politicians needing to keep the lights on. The Great Game continues

Finally, we note that, just as Evergrande pulled the secondary listing of its electric car division, which at one point had it ‘valued’ at more than Ford, even though it hadn’t actually produced a single car – Ford themselves are investing $11bn in new manufacturing plants for its Electric F150 pickup, which should be a wake up call to those backing rivals such as Rivian, as we discussed earlier this month, as well as the ludicrous Tesla Cybertruck. Even though cars are effectively ‘supercomputers on wheels’, the reality is that start ups based on software are a lot easier to get off the ground than those built on hardware. A software IPO is thus usually more likely to (not) run out of money than a hardware one.

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