DATA DIVE - From China to Deflation

Before we go over some Data I want to briefly highlight something which happened late last week, which may not be getting the attention it deserves.

The US has released a sweeping set of export controls which will have major implications for China's chip manufacturing industry as well as its broader tech industry.

The new policy bars any US or non-US company from supplying listed Chinese companies with hardware or software containing US technology in its entire supply chain. US companies will be barred from exporting critical chip manufacturing equipment to China.

Furthermore, US citizens will no longer be able to work in the Chinese semiconductor industry or face the risk of losing their citizenship.

The policy has the potential to paralyse and impair the Chinese semiconductor industry, as well as the high-tech industry dependent on these chips, for years to come.

This major policy shift from the US is significantly more damaging than anything done during the previous administration, where despite new trade restrictions, waivers were generally granted and business could continue almost as usual.

The Hawks are clearly in control of US Trade Policy, and the timing of this announcement, just ahead of the Chinese Communist party conference, in my opinion only serves to raise tensions between the two major powers.

What's more, the China-Taiwan risk is back in the news this week with President Xi reaffirming his intent to unify the two countries at the Chinese Communist Party Conference and US Secretary of State Antony Blinken stating that China has decided to seize Taiwan on a "much faster timeline" than previously thought.

While I will not pretend to be a foreign policy or trade expert, as an investor I must acknowledge that the semiconductor policy and any retaliation that are likely to come from this will prove economically damaging to both countries.

Moving on to some data I want to start with the UK where the economic slowdown is increasingly becoming obvious.

UK GDP declined -0.3% in Aug, and is likely to do so in Sept as well.

UK Industrial Production declined -5.2% in Aug, the 10th straight month of declines.

UK manufacturing also had its largest decline in 12 months

Meanwhile, UK unemployment claims picked up for the second month in a row in Sept

While the number of employed people dropped for the first time this year.

With the economy deteriorating and interest rates rising, UK Housing data is now starting to show signs of slowing. While this is not showing up in prices yet, I would expect that to increasingly be the case over the coming months.

As you can see from the chart below, the number of people reporting an increase in house prices has topped and has turned down, but it is not yet negative.

A similar trend is visible in Ireland where the YoY increase in residential house prices has started to roll over, although is not yet in contraction.

The US is slightly ahead in this regard and is beginning to see the first signs of price declines.

This is not surprising given that 30-year mortgage rates are now at 7% resulting in the number of mortgage applications declining to 25-year lows

Note that much of the UK and US housing price data is released on a lag, and thus does not reflect the situation in real-time.

But builder confidence is more current and the US NAHB housing market Index, which is based on a monthly survey of home builders' future sales expectations, declined in October for the tenth straight month to new lows for the year.

Meanwhile, in Germany, we have a more real-time data series from Europace, and the peak and decline in house prices is more evident.

That said if anything the chart above shows that there is a long way to go yet, with prices having more than doubled in the last 10 years.

Moving on from housing I briefly want to touch on inflation, mostly because I want to make a forward-looking point, as these backward-looking prints are now understood and arguably priced in.

US Core inflation accelerated to 6.6%

While CPI slowed to 8.2%

I have said for a while now that starting from Oct (released in Nov) I expect inflation to slow at a faster pace, which means that over the coming months CPI is like to have a 7 handle in front of it.

Look at the chart above chart (RED ARROW) and notice the base effects which run from Oct to March, there is a 2.3% wall to climb if inflation is to remain at current levels.

With the economy slowing, unless we get a major energy shock, I do not expect this to happen.

So expect inflation to slow between now and Q1.

The process is still likely to be frustratingly slow and inflation with a 7 in front of it and maybe a 6 by spring of next year, is still far above the Feds target.

I think it is important to reiterate that inflation slowing is not a valid investment thesis, just as deflation as a product of a slowing economy, is not a reason to buy equities.

While the food and shelter costs are still increasing and likely to remain the more stubborn components of the basket, there are other higher frequency prices which are starting to roll over.

Average used car price declined -10% in October according to Manheim. Remember rising car prices were a leading indicator of inflation post-Covid.

Container prices from Shanghai to LA have declined -13% in the last week and are down -76% YoY

And Volumes of Imports into the port of LA have declined significantly

Air freight prices per KG have declined to pre-2021 levels

And US Truckload prices have also declined and are heading back to normalisation.

KNX, one of the largest trucking companies in the US, missed earnings on Wednesday and guided down for the next quarter.

These higher frequency prices are a testament in my opinion to slowing demand and trade on a global scale.

Any decline in inflation resulting from this should not be taken as a positive, but quite the contrary points to a weakening consumer.

I also came across this curious study by Inflation Insights that looked at the contribution of health insurance to CPI. Health insurance has contributed around 2.4bps to Core CPI each month over the last 12 months but is expected to decline and start removing about -5bps month over month starting in Oct.

On a YoY basis, the study expects Health insurance to go from adding 38bps to CPI to removing -80bps by September next year.

But don't get too excited folks because inflation in Europe is still making new highs, couple that with the declining EUR and GBP and we are likely to see aggressive rate hikes by both the ECB and BOE over the next two meetings.

UK inflation is now in double digits, and similarly to the US, the increase in rents is the major contributor.

Inflation in Italy rose again in September to a new high of 8.9%

German YoY inflation jumped 2.1% to 10%, the highest level in over 60 years!

If you have not read "When Money Dies: The nightmare of the Weimar Hyper-Inflation" by Adam Ferguson, I highly recommend it.

I think the German institutions still have a memory of this and are not likely to want a repeat of history. Thus German Hawks are likely to keep the pressure on the ECB to do more, not less.

Let me close this note by saying that ultimately Central Banks continue to tighten monetary conditions and remove liquidity from the markets while a very clear economic deterioration is occurring.

So while flows and sentiment can lead to counter-trend moves, I would expect this gradual stair-stepping down in equities to continue for a while longer.

Thank you for reading,

Antonio C. Nobile

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