China real estate
Global markets got off to a shaky start in October, as investor sentiment was weighed down by concerns about rising bond yields and the embattled real estate developer Evergrande Group.
However, UBS analysts discovered stocks that could benefit as China’s local economies reopen following Covid lockdowns.
Real estate picks from UBS
Concerns are growing about the financial stability of China’s real estate sector.
China Evergrande Group, a heavily indebted company, has missed interest payments on two offshore US-dollar denominated bonds in recent weeks, roiling investor confidence and sending ripples through global markets.
These concerns were heightened on Tuesday when another Chinese developer failed to repay a bond that was due to mature this week, and ratings agencies downgraded a couple of smaller real estate firms.
“With concerns about a material loss of investor confidence in the property sector and Chinese financial assets, a ‘credit event’ for Evergrande now appears unavoidable,” said UBS analyst John Lam. “It’s darkest before the dawn, and current valuations for high-quality China property developers are unprecedented.”
“Think about increasing exposure to high-quality developers with strong balance sheets,” Lam advised, naming China Resources Land and Longfor as two such companies.
He stated that investors had been “overly concerned” about Sunac’s cash flow and credit situation, but UBS recently upgraded it to a “buy” with a price target of $25 Hong Kong dollars.
Sunac shares are down nearly 48 percent year to date and closed at 14.90 Hong Kong dollars on Friday, representing a potential upside of nearly 68 percent.
UBS: Energy Bets
According to Peter Gastreich of the investment bank, China’s “rapidly worsening” power shortage will help boost some power generation stocks.
UBS responds to investors’ toughest questions about inflation, China, and other topics.
“According to the press, power shortages have already prompted authorities to order production cuts in certain sectors in order to reduce the risks of residential power outages,” Gastreich explained. “This has been a boon for power generation stocks, a source of concern for gas distributors, and will almost certainly result in higher production costs across the board.”
Firms with a higher residential market exposure — a segment that is expected to be relatively immune to gas price increases — face fewer risks in the current scenario, he says. Those with lower earnings contributions from city gas connections are also likely to be protected from the slowdown in new home construction.
UBS named two of them: China Gas and ENN Energy.
Plays are being reopened
Analysts at UBS also looked at sectors that could benefit as China’s mobility restrictions ease, particularly those in the services sector. It comes as Beijing pursues its zero-Covid strategy, which entails strict lockdowns after the detection of just one or a few cases.
Following the recent sell-off, UBS advises investors to consider casino operator stocks in Macao, such as Sands China and Galaxy Entertainment Group.
Their stock has plummeted as a result of a double whammy of policy uncertainty and a lack of visitors from mainland China due to mobility restrictions.
Another industry is the hotpot industry. UBS said it remains bullish on Xiabuxiabu’s earnings growth prospects and prefers the stock over competitor Haidilao, where questions remain about the firm’s store expansion pace and table turnover rate.
Green energy & Tesla
The Morgan Stanley report, titled “Going Green Across the Board,” comes amid an urgent push to accelerate the transition away from fossil fuels in order to avert a climate emergency. In August, the Intergovernmental Panel on Climate Change issued a comprehensive report detailing the severity of the climate crisis, which U.N. Secretary-General António Guterres described as “a code red for humanity.”
As things stand, the world’s reliance on fossil fuels is expected to worsen in the coming decades — and it is against this backdrop that the potential investment case for decarbonization technologies has resurfaced.
Morgan Stanley names stocks poised to soar, including green hydrogen and Tesla.
Clean energy stocks ‘didn’t get the memo’ in 2021, according to BMO, but BMO believes these solar names can turn the corner.
Morgan Stanley has identified five global stocks to play the gas price crisis.
“The investment opportunity to fund the US energy transition is significant,” Morgan Stanley analysts wrote on Sept. 30. “We estimate [around] $1.1 trillion in total spend is required by 2030 in order to meet goals set in the Paris Climate Change Agreement, of which we estimate [around] $1.1 trillion is technically feasible.”
“Relatively few investors are evaluating the entire spectrum of decarbonization technologies, and we believe investors can generate alpha from such a broad-based approach, particularly as US energy policy evolves.”
Federal legislation and subsidies could further reduce costs and improve the economics of adoption, according to the analysts, who were led by Stephen C Byrd.
They named stocks with exposure to clean technologies that they believe will have significant near-term economic appeal. The bank rates all of their picks as overweight.
Picks for stocks
Morgan Stanley has identified green hydrogen as one of the most promising technologies in the space. Federal assistance could boost its outlook even more, with the bank describing the potential assistance as a “game changer” for the burgeoning hydrogen market. Oil major Chevron, industrial gas supplier Linde, and Canadian natural gas distributor Enbridge are among its stock picks with exposure to the technology.
Morgan Stanley sees strong growth in transportation electrification, noting that “electrifying mobility is a long-duration theme with many stocks with favorable exposure.” While automakers like General Motors and Ford offer direct plays on this theme as they transition to electric vehicle production, the Wall Street firm also likes “technology and supply chain providers as well as transportation fleet operators” as appealing proxies.
Aptiv, a developer of smart automotive software and systems and a key supplier to Tesla, is one of Morgan Stanley’s picks in this theme. Morgan Stanley likes EV automaker Fisker as a design and engineering partner for battery EVs, as well as renewable battery solutions provider Freyr. Given the company’s dominant position in the EV ecosystem, Tesla is the bank’s top pick for a direct play on automakers.
According to the analysts, investors seeking stocks with exposure to multiple decarbonization technologies should consider clean tech company SolarEdge and solar solutions provider Sunrun.
According to the analysts, it is exposed to energy storage and vehicle electrification. TPI Composites, a manufacturer of wind blades, was also recognized for its involvement in renewables and vehicle electrification.
The market bounce
The symptoms are increased volatility and trading volumes, a renewed focus on seeking protection, and twitchy, emotional intraday reactions.
While the market remains under pressure from a few sides, and last week’s bounce was not entirely convincing, the market has so far passed this ongoing stress test, indicating that it is more likely to be a routine correction than a damaging downturn.
The fact that the turbulence began on cue as the seasonal script became more difficult is, in a way, modestly reassuring to the bulls, the market conforming to the usual rhythms. And for the second year in a row.
Both in 2020 and this year, the S&P500 peaked on September 2, fell into the third week of the month, experienced a partial, failed bounce, and then fell further into October, all with gyrations around the index’s 100-day average and a rotation away from dominant tech stocks.
Last year, things remained dicey until Oct. 30, and the magnitude of the decline was greater at the time, and the election and the success of the new vaccine were nice upside catalysts.
Still, as this chart of the 2021 S&P500 path relative to the average annual course shows, the typical seasonal cadence is about to become less hostile. The amplitude of the moves this year has been far greater than the average, as indicated by the varying left-right scales, but the ebb and flow has been fairly consistent.
Following the close of the market on Friday, the Stock Trader’s Almanac advisory service issued a seasonal buy signal on the major-index ETFs, based on certain technical readings meant to capture the October shift from negative to positive seasonality.
Risk appetite is dwindling.
The market’s stress has taken a toll on investors’ psyche in measurable ways, which can also be viewed as beneficial in bringing about an eventual market recovery.
The long-running weekly Investors Intelligence poll of investment-advisory services recorded a drop in net bullishness to an 18-month low, which, combined with a similar drop in retail-investor optimism and an increase in protective put-option volumes, indicates that the defensive swing in risk appetites is well underway.
Intelligence for Investors
According to Deutsche Bank, overall investor positioning in stocks has declined from an extreme high to a more middling level as of Friday. “With positioning at neutral,” Deutsche strategist Prag Thatte says, “there is no longer an argument for a further selloff in the absence of clear catalysts impacting the fundamental outlook.”
Of course, such catalysts could be lurking in the form of a worsening energy squeeze in Europe, a resurgence of slowdown fears due to supply-chain disruptions, or ongoing valuation compression as corporate profit growth slows.
What are the real dangers?
However, macroeconomic stresses are not yet manifesting themselves clearly in the credit or equity derivatives markets. Throughout the equity downturn, junk-bond spreads relative to Treasuries have remained at undemanding levels.
While the Volatility Index (VIX) fluctuated, reaching the upper 20s in late September, it has now returned to the high teens. More importantly, there are no worrying contortions in the VIX futures curve looking out to the coming months, which usually reflect trapped institutions or dangerous vibrations hitting trading portfolios.
In fact, some market observers may want to see a burst of such panicked activity before concluding that this pullback has reached its proper climax.
Ironsides Macroeconomics’ Barry Knapp has called for a 10% to 12% correction to account for waning policy support, downward earnings revisions, and a Federal Reserve that may find itself rushing to combat stubborn inflation. According to him, “equity volatility markets have not yet reached a level that implies investor positioning is sufficiently defensive such that a sustainable rally is likely,” based on various derivatives indicators.
There’s no escaping the market’s ongoing pressure from a combination of shortage-driven energy price increases and ubiquitous supply-chain kinks – including, as Friday’s payrolls data revealed, a lack of available workers to fill millions of open positions.
Fast gains in oil and gas prices in the past have stoked investor concern. However, it is probably premature to assume that the US economy is approaching a critical pain threshold. West Texas crude reached $80 for the first time in seven years on Friday, but oil was above that price from 2010 to 2014, during a far more fragile economic recovery with much lower GDP and consumer incomes.
This graph depicts energy and related services spending as a percentage of total personal consumer expenditures, which is near a record low.
Haver Analytics/Bureau of Economic Analysis
FactSet reports that 15 of the 21 companies that have reported third-quarter earnings have cited supply-chain challenges in their quarterly conference calls, so the coming weeks will be a cacophony of such discussions – and a good test of whether the market has already largely discounted them.