CF Eclectica Absolute Macro Fund commentary for February 28, 2015.
CF Eclectica Absolute Macro Fund: Performance Attribution Summary
- The CF Eclectica Absolute Macro Fund recorded a net gain of +2.9% in February, bringing the year to date return to +10.3%.
- European equity holdings were the main drivers of strong performance, contributing +3.2% in aggregate as stock markets across the continent surged higher.
- Gains came from DAX index futures (+1.6%), as well as more micro driven strategies within pharmaceuticals (+0.9%), telecoms (+0.4%) and our Italian banks RV position (+0.3%).
- Equity holdings outside of Europe added a further +1.9%, with positive returns from Japanese robotics (+0.8%), global tobacco stocks (+0.6%), and Chinese index positions (+0.5%).
- US dollar exposure cost -0.5% and, in fixed income trading, our holding in the US 30-year Treasury gave back -1.3% as yields moved sharply higher during the month.
CF Eclectica Absolute Macro Fund: Manager Commentary
So much is written about China, and of late very little has been bullish. The notion of impending renminbi devaluation has taken root as traders worry that the dollar rally has pulled its reluctant Chinese counterpart higher, especially against the euro and the yen. Indeed, it seems that shorting the renminbi has become the new equivalent to the JGB short in macro circles. But having shared these doomsday prophecies back in 2010, when the consensus was less negative, I have recently become less concerned about China. Here’s why.
First China has recalibrated its growth model. Between 2001 and 2011, China had a very comparable decade to the US economy during the 1920s. Both boomed on surging
productivity, high returns on capital, massive gross fixed capital formation and a fervent desire by the rest of the world to participate. We know that both economies should have boomed; indeed they did. However I would contend that they should have boomed even more.
That they didn’t was because of hawkish macro policy. In the 1920s, the Fed refused to allow the high powered money entering its economy via the gold standard to boost credit further. The Chinese discriminated against their household sector: the currency was never allowed to appreciate as much as the boom justified; wages never fully captured the dramatic gains in productivity; and real interest rates were consistently negative. Together, these measures robbed the household of anything between 5% and 7% of GDP per annum, statistically depressing income’s share of GDP and hence boosting involuntary saving. No one really complained, everyone felt better off, but they could have done even better.
However, with the rest of the world now languishing from insufficient demand, the policy is no longer practical and policy makers have acted consistently and repeatedly for the last two years to change this. The hand brake on Chinese household incomes has been lifted as the country pursues a different growth model. Clearly the currency is no longer deemed undervalued, and the surge in both the dollar and the renminbi has produced a tremendous redistribution in the global economy enriching US households and mainland Chinese consumers. Real and nominal interest rates are now high, and wages have been capturing more of the productivity bounty. Consumer spending is strong and probably underpins something like 4% GDP growth on its own. Why should policy makers undermine the one reliable motor of economic growth by choosing to devalue their currency? It just doesn’t add up.
Second, at the macro level not all countries are born equal. A select group of nations – the US, core European countries, Japan – belong to an elite ‘Tier One’ macro community. These countries have large non-tradable sectors and as demonstrated by the adoption of QE, have the firepower to determine interest rates without being constrained by the fear of inflation from a weakening currency. The appeal of China today rests on its graduation to this community. China is no Mexico, an oil exporting country feeling under pressure to raise interest rates in the face of a slowing economy and worsening terms of trade precisely because it fears the consequences of losing control of the peso. Rather, China seems to belong in the same camp as the US, Europe and Japan, the countries with the scope to determine their own monetary policy.
Nevertheless, economists have fretted as the renminbi has appreciated alongside the US dollar. The fear is that this will hit an already vulnerable domestic economy with a sharp reduction of the trade surplus. Valuing currencies is notoriously difficult as I tried to explain in my November report. Nevertheless I find it hard to demonstrate that the currency issubstantially overvalued at a qualitative level. To start with, the trade surplus has gone on to reach a record nominal high. You may observe that this can be partly put down to a fall in the price of imports (of which more below), but China’s competitiveness in export markets seems to remain strong with its market share of global exports continuing to rise. Domestically, unemployment remains low in the major conurbations, and the GDP growth rate, whilst slowing and subject to the great bluster of its politically motivated national accounts methodology, still seems much healthier than elsewhere in the world.
Perhaps it is more useful to look at the terms of trade. It has certainly done a good job at explaining the differentiation of emerging market currency moves over the last 18 months. The huge decline in China’s raw material costs, especially the slump in both iron ore and oil, have massively improved the country’s standing and the trade weighted currency has appreciated in tandem; it may be as simple as that. The same can be said for India where only the central bank’s accumulation of foreign exchange reserves has prevented further appreciation. In contrast, the free-fall in the currencies of Russia and Brazil seems to match the devastation in their terms of trade as their important raw material exports have suffered from tremendous deflation with no meaningful offset in other inputs.
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