27th June 2017

Rathbones weekly review: A turning point

China won approval from global index provider MSCI for the inclusion of its mainland A-Shares in the company’s emerging market benchmark, pushing its share prices higher last week.

From next year, MSCI will include shares that are listed in Mainland China (as opposed to the Hong Kong-based H-Shares which have been included for decades). This market is huge – one of the largest in the world – yet foreign participation is tightly restricted. It’s a largely symbolic change, however: about 220 A-Share companies will be included in the MSCI Emerging Market at 5% of their market capitalisation. That means the mainland shares will make up just 0.73% of the global benchmark. The plan is to increase this gradually as China improves its corporate governance and relaxes its capital rules.

But, in a sign that state remains in firm control, Chinese regulators last week announced an investigation into four large, acquisitive companies. The China Banking Regulatory Commission (CBRC) asked lenders to disclose their exposure to Insurer Anbang, HNA Group, Dalian Wanda and Fosun. The regulator says it is concerned about these companies borrowing heavily and feels this may be causing latent systemic risk in its economy.

A few of these big-spending conglomerates have UK assets: HNA owns two Canary Wharf skyscrapers, Dalian owns Mayfair yacht builder Sunseeker and Odeon Cinemas, and Fosun bought the Wolverhampton Wanderers last year.

It seems unlikely that the government is upset with its companies owning foreign assets, per se. Chinese companies have been investing in African nations for decades, and it has been a matter of national pride that Chinese companies have the expertise to build nuclear reactors and other technical marvels that former colonial powers do not. This latest move is likely to be more about using excessive debt to do so. 

And better to try to let down the balloon now, rather than wait for it to burst.

Source: FE Analytics, data sterling total return to 23 June

Olives and oil

Oil prices continued to slump last week, falling almost 3.6% to $45.67. Supply and demand remains finely balanced. The price has been tugged lower by Nigeria and Libya, two OPEC members who are exempt from the cartel’s deal to restrict oil supply. US shale production has been creeping up – and American oil stockpiles along with it.

After about six months of trading in a corridor between $57 and $50, Brent Crude has recently become more volatile and has plunged well below its recent floor. If this is sustained, it will become a damper on global inflation. That would allow the Bank of England, caught between worries about strangling the UK economy with higher interest rates and trying to combat inflation as it shoots toward 3%, to hold off raising rates for longer.

Meanwhile, price growth in other countries has been slowing lately. US CPI growth peaked at 2.7% in February and has fallen to 1.9% since. The Euro Area’s measure is even lower at 1.4%. If prices fall much further, the spectre of deflation – where prices fall rather than rise – will return along with all the worries about lower consumption as people stop spending and hoard cash.

It’s not all doom and gloom though. Lower oil prices will be a boost for western consumers, particularly on the Continent. The eurozone is a net importer of oil and natural gas by a large margin. Any billions of euros not spent on energy can be spent elsewhere, by consumers and governments.

Like bank bailouts, for instance.

In another slightly unnerving example of European unity, Italy finally agreed a rescue plan for two of its ailing regional banks with permission to protect thousands of ma and pa bondholders. Because of a strange quirk, Italy has been slow to deal with many of its struggling lenders. Italian households have unusually high investments in regional bank bonds. This could be because of history: the Italian renaissance cities of Siena, Florence, Venice and Perugia invented bonds to fund centuries of outsourced war. Or the large bond holdings may simply be a symptom of aggressive sales tactics by modern Italian banks. Either way, it is politically untenable for the Italian government to wipe out retail bondholders along with larger institutions, and EU state-aid rules barred Italy from stepping in and protecting them. This logjam was suddenly and briskly cleared last week, after Germany appeared to offer a behind the scenes olive branch. The European Central Bank gave its blessing for Italy to wind down Veneto Banca and Banca Popolare di Vicenza. Under the potentially €17bn deal, the senior bondholders are safe and the good assets from the bank (including the branch networks and staff) will be transferred to one of the nation’s largest lenders, Intesa Sanpaolo.

The bank rescue impasse was overcome because the failure of the mid-sized lenders could have disproportionately hurt the regional Italian economy. This argument has been ringing around the halls of the EU bureaucracy for some time now, but this time German objections seem to have melted away. In some ways, it’s great to see Europe co-operating to solve lingering problems. But in other ways …

Bonds

UK 10-Year yield @ 1.04%

US 10-Year yield @ 2.14%

Germany 10-Year yield @ 0.26%

Italy 10-Year yield @ 1.92%

Spain 10-Year yield @ 1.39%

Julian Chillingworth
Chief Investment Officer

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