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  1. Home
  2. / Investing
  3. / Stocks

It Was All About the Stimulus, Not Fundamentals

China's massive spending spree evident in the first quarter is in the past now. Here is what it means.
By MALEEHA BENGALI
Apr 23, 2019 | 06:26 AM EDT
Stocks quotes in this article: BHP, RIO, ANFGF

The market has rejoiced with great enthusiasm at the returns posted in the first quarter, but has anyone taken the time to really understand what instigated the rally in the first place? It is as the old adage goes, "Better to be lucky than smart." After the depths of recession witnessed in the fourth quarter of 2018, central banks around the world panicked, with China injecting trillions of yuan in liquidity to jump start its economy.

After the credit boost, it is obvious that Chinese macro indicators have seen a jump in PMI, and other measures of economic growth. No sell side boutique house or bank called it, but all are commenting on how there are green shoots everywhere.

Suddenly now every salesperson and analyst is calling for higher prices and stronger growth, when the same people were calling for doomsday scenarios only a few months ago. Rather than chase what has already happened, for the job we are actually paid to do, why not instead look at the data and ask ourselves "what caused it and where does it go from here?"

It is true that asset classes, especially equities had gotten whacked way beyond their fundamentals in December last year. There is always a fair value, and movement around that mean. Fundamentals always come into play, even if they are ignored momentarily as market psychology takes over.

It is very simple. As money is injected by central banks, it finds its way into the system, which then feeds into various asset classes. The power of liquidity! When money is taken out of the system, like in the first half of 2018, as the U.S. fed started draining the excess reserves with Quantitative Tightening (QT), asset prices fell gradually.

On April 19, China's Politburo held a meeting to discuss the state of the economy. After stellar economic numbers and a massive surge in total social financing, the meeting confirmed "economic performance year to date has been better than expected, market sentiment has shown visible improvement, key economic indicators are within the comfort zone, and the economy is broadly stable."

What does this mean? Well I certainly don't speak Mandarin, but reading between the lines, it means they are ready to take their foot off the pedal. China's strategy has always been to grow around 6% GDP growth, plus or minus 0.5% around the mean. If it gets overheated, they start withdrawing liquidity by deleveraging. If it starts to fall too much, they inject to get it back to target. This has been their game for years now. Their goal is for a stable exit and to delever the economy of fiscal and monetary stimulus so that it can stand on its own two feet, preventing a hard landing.

This fact was reiterated in their statement: to reduce debt by structural deleveraging. The massive spending spree evident in the first quarter is truly in the past now. This will have implications for all asset classes, especially ones tied to Chinese growth and liquidity, namely copper and base metal prices -- and cyclical equities.

Copper equities are over extended and copper is more than fairly valued at $6600/tonne, given demand and supply. It has support around $5000/tonne, as demand is still robust, but so is supply. We had a false break in copper as traders chased it above $6600/tonne, only to see it fall back below as there is no follow through.

Miners like BHP Billiton (BHP) , Antofagasta (ANFGF) and Rio Tinto (RIO) are all looking toppy, for now. Await a better entry point. If you were opportunistic in getting long in January, say thank you, lock in 25%-35% returns and stay in cash for now.

That is your year's performance done, why bother trying to make a measly few percent more?

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At the time of publication, Bengali was long Antofagasta.

TAGS: Commodities | Economic Data | Economy | Federal Reserve | Fundamental Analysis | Futures | Investing | Markets | Stocks | World | Metals & Mining

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