China Crisis

China recently recorded a deficit of $11.8bn in foreign investment in the three months to the end of September, the first time since records began in 1998.

In essence, foreign businesses appear to be withdrawing money out of China at a faster rate than they have been putting it in. Big multinational companies are not pulling out of China, but in terms of new investment, they do appear to be re-allocating production to alternative markets such as India or Asia.

This shift really started to gain momentum in 2017, following Donald Trump’s election as US President and his ‘America First’ policy to re-onshore manufacturing jobs in the US. Subsequently, the global pandemic lockdown demonstrated the dependence of the West on transport and just-in-time supplies from China. This was further highlighted when China implemented one of the world’s strictest lockdowns through its ‘zero-covid’ policy.

Increasing geo-political tensions, notably between the US and China over Taiwan and technology, have also led many businesses to review their global supply chains. Putin’s invasion of Ukraine and the imposition of sanctions on Russia have also provided a view of what might happen if China ever invade Taiwan.

A growing crisis in its property sector and a slowing of growth in the world’s second-largest economy will inevitably create a drag for the wider global economy. Analysts expect further economic stimulus measures to be announced before the end of 2023.

For many businesses, China remains a very important market and it is currently expected to grow by around 5% per annum for the next few years. However, given the various risks described above, more companies, while investing and growing their business in China are taking out excess cash to invest elsewhere in the world. Presidents Joe Biden and Xi Jinping recently met with the aim of putting a floor under their troubled relationship. While a positive development, it would not take much for things to deteriorate again. Until businesses and investors feel they can navigate with more certainty, the drag on foreign investment in China is likely to continue.

What have we been watching?

A quiet end to last week with the US Thanksgiving Holiday. Most markets have recovered well so far in November after a challenging October, as investors continue to believe that interest rates have peaked. Central banks continue to try to dampen expectations for interest rate cuts looking into 2024. Meanwhile, markets appear to have shifted once again to a ‘bad economic news is good news’ mode with the pain of higher interest rates. The US 10-year Treasury yield has moved back to 4.4% from October’s high of almost 5%. With no central bank comment or inflation data last week, UK investor attention turned to the Autumn Statement, with some political pundits suggesting it may herald a general election as early as May or June with others going for October. Elsewhere, there was more disturbing news from China.           

There were more signs of the fighting in Gaza spreading across the region. Iran-backed Houthi rebels hijacked a Japanese-operated cargo ship in the Red Sea, claiming it was Israeli. Meanwhile, the long war of attrition in Ukraine continues with both appearing to be in stalemate as we enter winter, with Russia once again carrying out drone attacks on Kyiv to weaken Ukrainian resolve.

Brazil has recorded its hottest ever temperature 44.8C which has been attributed to climate change and the El Nino phenomenon. However, El Nino could be welcome news for energy prices and inflation. The US Henry Hub natural gas price has remained below $3 (per million British Thermal Units) due to high inventories and forecasts of a milder-than-normal winter due to El Nino.

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The UK Autumn Statement was the government’s first attempt to claw back a 20% deficit with Labour in the polls. Chancellor Jermey Hunt unleashed £14.3bn of stimulus next year, including two major tax cuts amounting to £11.4bn. The permanent ‘full expensing’ of qualifying business investment is a welcome move that should boost capital expenditure, while the 2% reduction in employee’s National Insurance also looks like a bold step. However, despite all the talk of tax cutting, the tax take as a percentage of UK GDP could rise to almost 38% by 2028/29. However, while the OBR raised its 2023 GDP forecast from -0.2% to 0.6%, it revised its 2024 UK GDP forecast lower from 1.8% to 0.7%. The OBR has lowered its forecast of the UK’s national debt to 94% by 2028/29 with government borrowing at just 1.1% of GDP, which if achieved, would be the smallest deficit since 2001/02. However, the new projections show government net debt interest costs of over £100bn a year over the forecast period. The Chancellor will present his main budget in the spring and how much pressure he comes under to cut taxes further remains unknown, but it is difficult to envisage him with much more firepower.

From the Bank of England’s perspective, the Chancellor’s stimulus is unlikely to trigger a further increase in interest rates, but it may incline it to further push back on early expectations for a cut. In the meantime, while one swallow does not make a summer, the ‘flash’ UK composite PMI business activity indicator moved back into expansion in November with a reading of 50.1, up from the previous month’s 48.7. Manufacturing reported the biggest improvement over the month, increasing from 44.3 to 47.9, while the service sector improved from 49.5 to 50.5. Sterling edged above $1.25.

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A German court ruling has blocked the coalition government from transferring €60bn in unused funds from the pandemic towards green initiatives and industry support. Economists expect the decision could drag Germany’s economic growth down by as much as half a percentage point in 2024. Meanwhile, veteran anti-Islam populist leader Geert Wilders has won a dramatic victory in the Dutch general election, which is likely to send shockwaves across Europe.

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The US ‘flash’ November PMI manufacturing activity indicator dipped slightly to 49.4 but was countered by a slight improvement in the service sector to 50.8. As a result, composite ‘flash’ business activity just about remains in expansion at 50.7.

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What is going on in China? Is the country’s troubled property sector creating a domino effect? Chinese officials have launched an investigation into Zhongzhi, one of its biggest shadow banks. It has lent billions to Chinese real estate firms and is reported to have $38bn of excess liabilities. Meanwhile, the WHO has requested more information from China about a large outbreak of a flu-like illness in the north of the country among schoolchildren. Perhaps the first winter after the lengthy lockdown, which must have reduced the circulation of respiratory infections and hence decreased immunity to endemic bugs?

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Brent oil was stable around $80 as OPEC+ postponed its weekend meeting until later this week.

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Finally, if you want to get ahead, get a hat! A bicorne black beaver felt hat belonging to Napoleon Bonaparte recently sold for £1.7m at an auction in Paris. Perhaps astute timing by the seller, with the auction coinciding with the screening of Ridley Scott’s film Napoleon? If you missed out , do not  worry as a number of props from the TV series The Crown are to be auctioned soon, including Princess Diana’s ‘revenge’ dress, a golden state coach and the door of 10 Downing Street together with black-painted iron railings!

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.