Views From the Floor

In this week’s issue: China restarts its shadow banking sector, oil futures turn negative; and people are still buying the Nasdaq?!

Quote of the Week:

"The May crude oil contract is going out not with a whimper, but a primal scream."

Daniel Yergin, a Pulitzer Prize-winning oil historian and vice chairman of IHS Markit Ltd


Back to the Shadows

For those of you who monitor the supply of credit in the Chinese economy, 2019 posed something of a problem. Whilst China’s credit impulse was growing, it wasn’t stimulating growth in the economy as would be expected.

Why not?

The answer, we believe, lies in the idiosyncratic nature of the Chinese banking system: alongside formal credit channels, a large ‘shadow’ banking system operates, funnelling credit to Chinese firms. As part of wider efforts to deleverage the Chinese economy, 2019 saw a suffocation of the shadow banks, which netted off the expansion of the formal banking system to some extent.

After the advent of coronavirus, however, the policy of deleveraging appears to have gone into reverse. Figure 1 shows the formal banking system’s credit to the non-bank financing channel (the shadow banks) on both a total size and year-on-year percentage growth basis. The total stock of cUSD2.65 trillion, illustrated by the blue line, represents about 27% of Chinese GDP. However, note that this is only a portion of the total size of shadow banks as this is just one, visible source of funding in an opaque system.

March data shows a big jump higher in total stock, and after two years of contraction, year-on-year growth is no longer negative. In our view, this implies that the priorities of the Chinese government have shifted in response to coronavirus: deleveraging is over, and growth is the only priority.

Figure 1. Chinese Bank Credit to Non-Bank Financial Companies; Total Stock vs Year-on-Year Percentage Growth

Chinese Bank Credit to Non-Bank Financial Companies; Total Stock vs Year-on-Year Percentage Growth

Source: Bloomberg; as of 22 April 2020.

Black Fool’s Gold

20 April, 2020. The day will go down in history as the first time that WTI – the US benchmark price for crude – turned negative. And not just a-little-under-zero negative but a whopping USD37.63-per-barrel negative. This also guided the Brent price to tumble to its lowest level in more than two decades.

While the price has recovered slightly, the oil market is still in turmoil. So, where do we go from here? We make two observations that make the case for a damped oil price recovery.

First, the price of floating storage for oil is rocketing (Figure 2). So far, so obvious – supply gluts do tend to eat up available storage. However, what makes the short- term price likely to stay low, in our view, is production cuts that have been agreed by OPEC+ will not be able to offset the extreme levels of demand reduction across the globe. In a world of limited oil demand, the market will force rebalancing via storage at capacity. We expect continued pressure on crude grades globally as storage onshore and offshore rise to record levels.

Secondly, US refinery utilisation is cratering (Figure 3). As the global economy starts to recover from lockdown, we would expect refinery utilisation to follow the trend in refining margins, which should be led by a normalisation of gasoline inventories.

Figure 2. Floating Storage (or Lack Thereof)

Floating Storage (or Lack Thereof)

Bloomberg; as of 21 April 2020.

Figure 3. US Refinery Utilisation

US Refinery Utilisation

Source: Bloomberg; as of 21 April 2020.

Crisis? What Crisis?

If you happened to look at the QQQ ETF, the ETF that tracks the Nasdaq 100 Index, you’d be forgiven for thinking that all was ok in the global economy. Indeed, 30-day net flows into the ETF (as a percent of total AUM) reached 8%, the highest in two years (Figure 4).

Of course, with the majority of the population in lockdown, it may seem that the technology sector is the sector to invest in as necessities are ordered via Amazon and time is passed watching Netflix.

However, the Nasdaq has seen a 15% EPS downgrade since late 2018 and the index has moved from trading at a price-to-earnings ratio of 20x to 26.5x (Figure 5). Why anyone would pay more for tech now during all this uncertainty is quite a mystery to us.

Figure 4. ETF Inflows

US Refinery Utilisation

Source: Bloomberg; as of 21 April 2020.

Figure 5. Nasdaq 100 – 24-Month Forward PE (Top) Versus 24-Month Forward EPS (Bottom)

Nasdaq 100 – 24-Month Forward PE (Top) Versus 24-Month Forward EPS (Bottom)

Source: Bloomberg; as of 21 April 2020.

Eat, Drink and Be Merry

In ‘The Wealth of Nations’, Adam Smith referred to the UK as a “nation of shopkeepers”. Apocryphally, Napoleon is believed to have expressed the same contemptuous sentiments. But since coronavirus has deprived UK citizens of the chance to keep up their shops, how exactly are they filling their time?

Drinking, according to the Office for National Statistics: in March 2020, UK alcohol sales increased by 32.6% in value terms on a month-on-month basis (Figure 6). Food sales have also risen, with total food sales across supermarkets and specialist stores up 15.2%. In contrast, clothing sales fell by 28.4% (Figure 7).

Rather than Adam Smith, Britons seem to be taking a leaf out of Ecclesiastes. Having abandoned their shops, the new motto appears to be ‘eat, drink and be merry’.

Figure 6. Monthly Business Survey, Retail Sales

  Month-on-Month Growth Rate (percent)
Store Type Weight in RSI Value Volume
Supermarkets 35.3 10.2 10.3
Specialist Food 2.1 5.0 4.5
Alcohol 0.7 32.6 31.4
Total 38.1 10.3 10.4

Source: ONS; as of March 2020

Figure 7. Monthly Business Survey, Retail Sales

Monthly Business Survey, Retail Sales

Source: ONS; as of March 2020.

With contribution from: Ed Cole (Man GLG, Managing Director – Equities), Marvin Caze (Man GLG, Portfolio Manager) and Matthew Sargaison (Man AHL, Co-CEO and CIO).