This will be a quick blog post insofar as it represents a departure from the intended purpose of this space, which is to discuss my investment philosophy and practice in a general, informative sense.
As the week has worn on, I've been increasingly focused on two particular news stories, both of which represent watershed moments for the capital markets. It is not surprising, if it is a little frustrating, that while neither has gone unnoticed, the headlines have been buried somewhat by the ongoing coverage of the Covid-19 pandemic, the U.S. Presidential twitter feed, and the literal, tragic watershed moment experienced by Michiganders on Wednesday. Candidly, I don't have all the answers, so I'll keep my editorial commentary and analysis brief, but I felt it would be well received if I call my readers' attention to a couple items that might loom much larger in retrospect than they seem to at present.
(1) Below the fold on page B1 of Thursday's Wall Street Journal: Bill Would Force China Firms to Cede Listings ... wait what?
On Wednesday, the Senate actually passed, UNANIMOUSLY, a bill co-authored by Sen. John Kennedy (R., La.), and Sen. Chris Van Hollen (D., Md.), which would require any firms listed (via American Depository Receipt or ordinary shares) on an American stock exchange to be audited by an auditor subject to the oversight of the Public Company Accounting Oversight Board. Since the U.S. Auditing firms are subject to such oversight already, and public companies are required to file audited financials, this might seem redundant, but it's not. It has become commonplace for Chinese companies to skirt their home country's restrictions on foreign direct investment in order to list shares on U.S. exchanges by creating Cayman Islands-based holding companies which maintain a variable interest in actual Chinese corporations through contractual obligations of questionable legal enforce-ability. These companies are universally audited by Chinese auditors or the Chinese branch of American big four auditing firms, which are NOT subject to PCAOB oversight, and fraudulent activity has run rampant (See: Luckin Coffee Inc., $LK).
There are numerous Chinese-company ADRs which present investors with a credibility question, to a greater or lesser degree. Fresh off their successful $LK expose, Muddy Waters Research (@MuddyWatersResearch on twitter) has put out a piece calling into question the veracity of GSX's revenue growth claims and financial reporting. One recent Cayman ADR-IPO, Kingsoft Cloud Holdings lists explicitly in its prospectus that investors should be aware that they assume the risk that financial statements are reviewed by an auditor who is not subject to PCAOB oversight, and that short sellers may attempt to discredit management or impugn the credibility of their financial statements, to the detriment of equity holders. But even the equity of extremely large, well known, and widely held companies like Alibaba ($BABA) fail to meet the criteria for exchange listing under the terms of the bill passed in the Senate yesterday. This represents a substantial risk to current shareholders of Chinese corporate equity in the form of ADRs listed on U.S. exchanges, and could put a damper on $1.8T of market cap currently listed in the U.S. that would theoretically be in violation of the law under this regime. To my knowledge, there is, as yet, no bill in the House of Representatives coinciding with the one passed by the Senate yesterday, so it's not clear that it will get any further down the road to becoming law. That said, the administration appears willing to engage in political fisticuffs with the Chinese political and socio-economic elites, and the bill that went to the Senate floor shared unanimous, bi-partisan support. Stay tuned.
I came across this podcast by Quoth the Raven (@QTRResearch on twitter) wherein he interviews Carson Block of Muddy Waters on all things investing, short selling, and China (including China short selling): https://quoththeraven.podbean.com/e/quoth-the-raven-185-carson-block/ I will warn, the podcast is rated "M:Mature," primarily for profanity, which is a bit "off brand" for Antrim Research. But I would say I have a great deal of respect for the work Mr. Block has done on this space. His commentary about the impact of (potentially) de-listing Chinese equities starts shortly after the 1h 15m mark.
(2) On Monday, May 18th, German Chancellor Angela Merkel and French President Emmanuel Macron announced a joint plan to set up a $500B coronavirus pandemic relief fund to be administered by the ECB.
It doesn't require uniquely penetrating insight to understand that the European Union is a tenuous one. After all, Britain left on January 31st of this year (more than three years after the referendum that set Brexit in motion). I've long simplified (in my own mind) the complexities of Eurozone fiscal and monetary policy by interpreting almost everything through the lens of the central monetary disagreement in the region: Germany is a fiscally responsible, monetarily conservative government, overseeing a strong, export driven economy, fundamentally at odds with a number of fiscally irresponsible, monetarily undisciplined, democratic socialist countries with weaker economies, and a general inability to meet their fiscal obligations through tax revenue. Greece, for example, has been in technical default on its financial obligations for over 50% of the time it has existed as an independent country. It's hard to say how much better Potugal, Italy, and Spain are doing. And lest it be forgotten, there's a bit of lingering animosity between Germany and France.
All of that seems pretty self explanatory. Common sense would suggest that Germany, having been responsible with their policy decisions since World War 2, is loathe to bail out neighbors who they view as irresponsible younger siblings. BUT, Germany is an export driven economy, which implies that insofar as they benefit from a weak Euro relative to other global currencies, they've been stealth beneficiaries of the profligate spending by weaker Euro member nations. If that's an A-Ha! moment for you, it was for me too. They kinda WANT to bail out the little guys, they just want to moan about it for a bit while they do because they like a little inflation and a little irresponsible money printing and debt issuance, but if they don't continue to be the voice of reason, confidence in the whole region could collapse. It might appear to be a bit of a high-wire act if you look at it this way.
So what gives now, and why would they cooperate with the French? Well. (1) The pandemic is really, really, bad. Like, it's bad, and everyone, Germany included, knows it - and everyone, Germany included, knows the stimulus announced to date won't be enough, so let's get more stimulus. (2) The U.S. Fed has opened the checkbook in a BIG way. It's been enough that many analysts (your humble author included) have begun recommending investors to precious metals and warning of coming USD inflation. Well... that's not good for an Export Economy, which generally desires that US Dollars increase their purchasing power in Euro terms. (3) If the economic collapse is too severe for the weaker members of the Eurozone, the whole union could collapse, which would take away ALL the benefits Germany has enjoyed as a Euro member, overnight. So... the answer is simple - there's plenty of room to stimulate and bail out by issuing Euro debt and subsidizing weaker member nations. The $545B (US, 500B Euro) facility announced is a FRACTION of the fiscal and monetary stimulus offered in the United States. And, Germany definitely doesn't want deflation. And, Germany wants to instill confidence in the region.
What could instill more confidence in the authority of the ECB to govern the Eurozone through another economic crisis than cooperation between Germany and France on a bail out initiative operated by the ECB, and a bilateral willingness to accept the bank's policy decisions?
At the risk of overdosing on confirmation bias - I think this is a big moment for the Euro, which instills a level of post-Brexit confidence in the longevity of the Union that was by no means guaranteed heretofore. I think that it will prevent runaway deflation in the Euro, and that it represents yet another round of fiscal and/or monetary stimulus, globally, that can't help but provide support to precious metals prices. But I think it is unlikely to substantially weaken the currency vs. the U.S. Dollar. And lastly, I think it means that the European political elite is really, really, worried about the depth and duration of this economic crisis, and we should be too.
I hope this was a welcome distraction from the ongoing twitter debate between Cliff Asness and Nassim Nicholas Taleb.
Disclosure: I am short GSX, and long the gold miners' ETF, GDX. This is but a humble blog post, and as such, is not intended as investment advice.
