Saxo Bank MENA – Weekly Market Report (22nd May 2023)
Market Quick Take
Summary: The US debt ceiling showdown simply refuses to go away as a factor in the current market environment, with the latest talks collapsing on Friday as President Biden was at the G7 summit in Japan and overshadowed the notable developments there. Still, markets are taking the news in stride as US equities continue to trade near the top of the range and USDJPY merely suffered a significant wobble. Looking ahead, headlines from the US debt ceiling drama will dominate until a solution is found.
What is going on?
Debt ceiling fears back at the forefront, but talks resume for now – Debt ceiling talks between Democrats and Republicans broke down on Friday while President Biden was in Japan for the G7 leaders’ summit. US House Speaker Republican Kevin McCarthy said he is not seeing progress while the President is away, and the White House “moved backwards”. Statements from Democrats also hinted that “negotiations are going in the wrong direction” and “Republicans’ demands keep going further to the right.” With risks of default back, Treasury Secretary Yellen warned once again that June 1 is the “hard deadline” when the US can pay its bills and that the chances of reaching June 15 (when further tax receipt income is due) are quite low before the government runs out of money. As both sides try to get the most out of this deal, there is a lingering risk that talks will extend until the last minute, and risks of a liquidity crunch following a deal (due to the huge new issuance needs for the US Treasury) are also massive suggesting the need for downside protection.
China to ban some Micron chips after security review – After a cyber-security review, China’s Cyberspace Administration of China ordered that Chinese companies dealing with critical information stop buying chips from US-based Micron Technology. The review said that Micron’s chips posed “relatively serious cybersecurity problems” that could “seriously danger the supply chain of China’s critical information infrastructure.” The move was widely viewed as a retaliation against recent US limitations on exporting high-end chips and chip-manufacturing equipment to China. A US Commerce Department spokesperson said the move has “no basis in fact”. Mainland China and Hong Kong revenue exposure is around 15% of total revenue for Micron Technology
Fed Chair Powell’s comments remained balanced – After some comments from Fed officials last week saw June rate hike pricing climb higher to ~40%, Fed Chair Powell’s comments on Friday brought it back to close to 10%. Powell started the discussion saying inflation is far above its target, and the Fed is strongly committed to returning it to the 2% goal. However, he noted subsequently that policy rate may not have to rise as far as otherwise due to the tightened bank credit conditions. He noted we can afford to look at data and the ongoing outlook, adding the risks of doing too much vs doing too little are becoming more balanced. Minneapolis President Neel Kashkari was also heard late on Sunday, saying that he is open to a June FOMC rate hike pause, but not convinced that the Fed is done yet.
G7 meetings focused on Ukraine and China’s “economic coercion” – The G7 has issued its strongest condemnation of China as the world’s most advanced economies stepped up their response to what they called rising military and economic security threats posed by Beijing. The G7 members said they were “seriously concerned” about events in the East and South China Seas, and also called for a “peaceful solution” to tensions across the Taiwan Strait. However, the unannounced in-person appearance by Zelenskiy stole the show as he attempted to garner support for his 10-point plan to end the war, as well as using the opportunity to lobby non-G7 attendees like India and Brazil. Zelenskiy said Ukraine will receive F-16 fighters from G-7 allies, but proposed a peace summit to begin in July marking 500 days of full-scale war.
Chinese authorities urge market discipline amidst USDCNH surge – As USDCNH hit as high as 7.0750 last Friday, a level not seen since early December last year, the China Foreign Exchange Committee (CFXC), an entity sponsored by the People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) convened its first meeting in 2023 on Friday. In the readout of the meeting, CFXC emphasized the importance of market participants adhering to self-discipline in order to maintain stability in the foreign exchange market and curb excessive volatility in the renminbi’s value against other currencies. Furthermore, it pledged that the PBOC and SAFE would reinforce their oversight and guidance of market expectations and intervene as deemed necessary. Subsequent to the release of the meeting’s summary, USDCNH relinquished some gains, concluding the week at 7.0230, only to ascend once again and reach 7.0370 on Monday.
Wheat and corn prices slump on Ukraine grain deal – Chicago corn and wheat futures both dropped around 5% last week, with corn hitting an October 2021 low, while wheat touched an April 2021 low below $6 per bushel. Driven by expectations of ample global supplies after a deal to ship Ukraine grains was extended for another two months last week. Poor export demand amid fierce competition from South American exporters of corn and Black Sea exports of wheat both weighing on prices. Focus on the pace of US planting currently underway as well as potential poor harvest prospects in US Plains supporting the price of Kansas hard red winter wheat.
Deere lifted its FY outlook again – Deere reported Q2 fiscal quarter EPS of $9.65 up from $6.81 a year ago lifting its FY outlook on net income to $9.25-9.50bn from previously $8.75-9.25bn driven by robust demand for the rest of the year.
Peter Garnry, Head of Equity Strategy, published a new article “Japan and Greece: the two comeback countries”
Summary: Japanese and Greek equities are part of this year’s comeback story with these two equity markets up 16.5% and 31% respectively in local currency terms. Japanese equities are the talk of the town after strong endorsement from Warren Buffett highlighting the low equity valuations in Japanese equities. Greek equities are rallying 7% today as the market is excited about the re-election of the country’s centre-right Prime Minister Kyriakos Mitsotakis.
The rise of the Japanese equity market
Back in April we wrote the equity note Will the sun rise over Japanese equities? highlighting Warren Buffett’s renewed commitment to Japanese equities which Berkshire Hathaway dipped into during the early days of the pandemic. Berkshire Hathaway wanted exposure to commodities but through a specific group of Japanese physical commodity trading companies due to strong market position and very low equity valuations. The bet turned out to be correct by Berkshire Hathaway and Japanese equities are overall up 16.5% this year in local currency terms and around 10.7% in USD terms. Warren Buffett’s marketing campaign for Japanese equities has worked well putting attention to this equity market in way we have not seen since Abenomics was introduced in late 2012. Japanese equities have delivered 270% total return in JPY terms since Abenomics was introduced. The long-term total return chart also shows how Japanese equities are now pushing hard into new territory.
The continuous tit-for-tat tactics between the US and China, with the latest being China’s ban of some of Micron’s memory chips, are also adding tailwind to certain “winner countries” that will benefit from fragmented supply chains. Japan has a good chance of being part of this group of winner countries together countries such as Mexico, India, Vietnam, Thailand, Indonesia, and Malaysia.
As we highlighted in our equity note back in April the Japanese equity market has healed from its bubble back in the late 1980s and since 1995 the Japanese equity market has gone from offering a 2%-point lower dividend yield compared to US equities to now offering almost 1%-point more lifting the expected return for Japanese equities. Measured on 12-month forward EV/EBITDA Japanese equities are also almost 50% cheaper than US equities adding the further upside potential of valuation multiple expansion which historically has been the rocket fuel of equity returns.