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Daily Intelligence Briefing

Wednesday, May 4, 2022

Identifying Change-Driven Investment Themes

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

China Launches More Stimulus Measures to Counter Fallout From Heavy-Handed COVID Lockdowns

Summary: Following the implementation of major tax cuts and financial reforms to boost lending and loosen up liquidity for its beleaguered real estate sector, China will now embark on a new round of infrastructure spending. Recent data releases indicate the country is on pace to fall well-short of the government’s annual target rate for GDP growth, largely due to a restrictive “Zero-COVID” policy that has put more than 320 million Chinese citizens under some form of lockdown.

Lockdowns have begun to damage domestic and international firms operating in the country but China has shown no sign of easing up their assault on the COVID-19 pandemic, which may be on the cusp of an outbreak in Beijing as we speak. A major infrastructure drive could be the shot in the arm China badly needs right now and will have significant implications for the global economy; particularly when it comes to prices of industrial metals.

Related ETFs: iShares MSCI China ETF (MCHI), Global X MSCI China Industrials ETF (CHII), Global X MSCI China Financials ETF (CHIX), Global X MSCI China Real Estate ETF (CHIR), Invesco DB Base Metals Fund (DBB)

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A Tidal Wave of Chinese Stimulus Measures

As MRP mentioned back in March, the Chinese government 
is targeting economic growth of 5.5% this year, setting a relatively high bar for the country’s economy, already facing a litany of challenges at home and abroad. Beijing’s target, therefore, suggests more aggressive stimulus measures will need to be undertaken to reach fulfill their economic plan for the year ahead.

Part of that stimulus will come in the form of tax cuts, with new breaks collectively saving Chinese taxpayers more than $1.5 trillion. Additionally, the PBOC and other state banks will continue to ease interest rates and support distressed real estate developers.

At the end of last month, Reuters reported that the PBOC has announced it would cut the reserve requirement ratio (RRR) for all banks by 25bps. Meanwhile, Bank of China will cut the rates for time deposits of 2-3 year tenors by roughly 10bps. Reuters reports the Bank of Communications is likely to follow suit.

China’s shaky real estate sector has already gotten some help from Beijing as banks had previously been instructed to loosen up liquidity, and cut down on delays in loan approvals of more than 100 days. Bloomberg reported in late 2021 that financial regulators told some major banks to accelerate approval of mortgages in the final quarter of the year. Further reforms handed down from the PBOC are expected to ease acquisition financing requirements when target projects are in early development stages, as well as extend borrowings already overdue if developers provide additional credit support such as pledging more assets.

Zero-COVID Lockdowns Continue to Bite

While these reforms show China is willing to take on more debt to help engineer higher growth, the biggest issue currently facing the world’s second largest economy is their “Zero-COVID” policy and the socioeconomic implications of hard lockdowns being enforced in Shanghai and other places around the country.

Zero-COVID refers to China’s hardline public health policy meant to eliminate all COVID-19 cases within the country at all costs. In the major port city of Shanghai, that meant a controversial shutdown of the entire city in April. Though many of the most extreme measures have been drawn back amid falling COVID-19 cases, more than 8.2 million Shanghai residents (out of a total population of 25 million) were still banned from leaving their residential compounds on Tuesday.

328 million people in 43 cities in China are still under full or partial lockdowns, according to estimates by Nomura. Concerns are rising that Beijing could be next up for lockdowns as cases are now rising in the capital and more than 20 million residents will undergo three more rounds of mass testing this week.

Domestic and international firms are feeling the bite of these lockdowns, which could further threaten foreign investment in the country if lockdowns become an even more entrenched strategy to deal with COVID-19. Additionally, public pushback and protests of restrictive quarantine measures within China has captured international attention and could increase the likelihood of public unrest going forward.

Growth Forecasts, New Stimulus Drive

Despite official statistics 
indicating China’s GDP expanded by 4.8% YoY in Q1 of 2022, a better-than-expected performance, skepticism around the accuracy of Chinese reporting has been growing. Even if we accept those numbers at face value, however, the outlook remains increasingly pessimistic from many forecasters.

For instance, 
a Bloomberg index tracking a set of early economic indicators plunged in April to its worst level in two years. Morgan Stanley downgraded its growth forecast by 40bps to 4.2% as Fitch Ratings cut their own projection by an even steeper 50bps to 4.3%. Fitch noted Chinese retail sales fell by 3.5% in March, the first annual decline since mid-2020. Other areas of activity, including industrial production and fixed-asset investment, also slowed noticeably. The official Purchasing Managers’ Index (PMI) for Chinese manufacturing fell to 47.4 points in April, down from 49.5 in March and the weakest outcome since February 2020, China’s National Bureau of Statistics said on April 30.

The new median forecast among nine financial firms tracked by CNBC predicted 4.5% China GDP growth for the full year, well below the aforementioned government target rate of 5.5%.

To combat what seems to be a souring of the country’s growth prospects, Chinese President Xi Jinping called for an “all-out” effort to boost infrastructure last week. While no specific spending increases were mentioned, CNN notes infrastructure investment has already risen by 8.5% in the first quarter of 2022 YoY. Prior to the proclamation, local governments had already drawn up lists of thousands of “major projects” by early April to be initiated this year. Bloomberg reports planned investment for 2022 amounts to at least ¥14.8 trillion ($2.3 trillion).

Impact on Base Metal Commodities

A re-acceleration of Chinese industrial activity could help prices of base metals rebound after a broad weakening of futures across the past few months. China is the world’s top consumer of commodities, as well as a leading producer of metals and other materials, and their economic activity has an especially significant effect on global pricing.

Aluminum and tin are down more than 17% from their recent all-time highs, largely due to a perceived slowdown in China resulting from the COVID lockdowns. A rising dollar is also playing a major factor in driving up the cost for metals exports.

As of May 2, Copper for delivery in July fell to as low as $4.23 per pound (or $9,307 per tonne) midday on the Comex, marking the lowest price since December 1. The Chinese government has noted that what they term “infrastructure” is not limited to bridges and pipelines, but supercomputing, cloud computing, artificial intelligence platforms and broadband, all tech-intensive investments that will be particularly dependent on copper wiring.

Iron ore prices bounced last week on the news of new infrastructure spending. China utilizes a significant amount of iron ore to produce some 56% of the world’s crude steel and notes prices for refined products could be supported by the country’s lockdowns and other economic measures that threaten to limit steel mill output this year. China’s tamping down of supply will be compounded by falling output from Ukraine as they deal with the invasion of Russian forces, as well as resulting international restrictions and sanctions on commodity exports from Russia.


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