Good morning. OpenAI’s CTO (and former interim CEO) Mira Murati is out, following in the footsteps of OpenAI co-founders Ilya Sutskever, John Schulman, and a while back now, Elon Musk. Does OpenAI’s valuation, at an estimated $150bn, price in all this C-suite drama? Send us your thoughts: robert.armstrong@ft.com and aiden.reiter@ft.com.
China’s market stimulus
On Tuesday, China announced an economic stimulus package with provisions specifically targeted at boosting Chinese equities. The People’s Bank of China announced a $114bn lending pool to help asset managers, insurers and brokers buy more stocks and help companies do stock buybacks. Hong Kong’s Hang Seng index rose 5 per cent and Shanghai and Shenzhen’s CSI 300 index rose 6 per cent in the aftermath. In the past we have asked whether Chinese equities were uninvestable. Does this change the picture?
Probably not much, for several reasons.
First, the housing market is still in disarray, and real estate is the primary household asset in China. So there is little risk appetite among would-be retail investors. The economic stimulus package is not big enough to fix this.
Second, government fiddling in the private sector has become more pronounced. The government’s rough treatment of entrepreneurs and crackdowns on foreign firms amount to a second blow to confidence. Economic data becoming less reliable has only served to make things worse.
Finally, the loosening of bank regulations and cuts to policy rates support bond buying rather than equity investment. There has already been a rush into bonds that has annoyed the government. If you believe Tuesday’s rate cut is the first of several, bonds only become more attractive. Injecting liquidity into the banking system when loan demand is weak may push banks into the bond market, too. Yields on 10-year and 30-year treasuries went up briefly after the announcement but started to fall again.
There is a chance there is more stimulus to come. As Thomas Gatley of Gavekal Dragonomics points out to us, Tuesday’s jump could be investors “trying to front run a bigger support”. The PBoC has suggested it might add more money to the new lending pool for investors and companies, and there should be a Ministry of Finance meeting soon that could “give this [rally] legs . . . if the MoF is willing to be more aggressive on fiscal policy”. If the MoF interventions are transformative, there might be the beginnings of an investment case here. But if past is prologue, there won’t be.
(Reiter)
Fed epiphenomenalism, revisited
We got a lot of comments on our piece laying out the argument that Fed policy might not matter all that much in the economy or markets. Several of them were bald assertions that the Fed is not only very powerful, but also very bad. There are a lot of Fed haters out there.
Others made a critical point that, it pains us to admit, is absolutely true. The piece’s title suggested that it was about the power of the Fed in general, but the body of the piece only made an argument about the Fed’s rate-setting, ignoring the way the central bank influences market liquidity by growing and shrinking its balance sheet and through other market interventions. Quite so. We were just talking about Fed rate-setting and should have been clear about that.
Our piece was also non-committal. Do we believe the epiphenomenal view of Fed rate-setting, held by people such as Aswath Damodaran? We don’t, or not entirely. Think of the extreme case. Suppose the Fed increased its policy rate to, let’s say, 20 per cent tomorrow. That means that anyone looking to put money to work could invest it overnight at a 20 per cent annual rate through a mutual fund that turned around and invested in the Fed’s reverse repo programme (thanks to Joseph Wang for explaining this mechanism to us in very clear terms). The result would be dramatic: suddenly no one would bother providing mortgages at 6 per cent or corporate bonds at 5 per cent, when there was a risk-free, short-term option at 20 per cent. Credit of all sorts would become expensive quickly, to compete with the Fed’s rate. The economy would cool, however unevenly.
Less dramatic moves in the Fed’s policy rate probably are unimportant in themselves. But the fact that the Fed does have the power, in the extreme case, to cool or heat the economy, gives smaller rate moves power as signals of intent, which have an effect on expectations. Something along these lines is the Unhedged view.
Small caps, revisited
We recently laid out the case against the much hoped-for small cap comeback. A couple of readers disagreed. Two arguments, from small-cap managers Jason Kotik and Tim Skiendzielewski of Rockefeller Asset Management, stood out.
First, an M&A valuation premium may appear. While it is widely believed private equity has drained high-quality companies from the small-cap indices, there is a positive side to that for small-cap investors: it might keep happening. As lower rates make buyouts more economical, potential targets should see their share prices rise.
Kotik and Skiendzielewski also argue that labour tends to be a higher proportion of total costs for smaller companies. This means that if you believe the economy is set to recover, and revenues rise, there could be a lot of operating leverage in small caps.
This brings to mind another potential point in favour of small caps: labour hoarding. Surveys suggest that smaller companies may have held on to workers that they might have done without, either because of pay cheque protection programmes early in the Covid-19 pandemic or fears that it would be too hard to re-hire amid a tightening labour market. We see some evidence of this in the data, as labour and discharge statistics are still below their long-term average despite the rate-rising cycle. If you believe the economy is set to recover and revenues to rise, small caps may see an outsized benefit, as underutilised workers become more productive.
It’s long been argued that small caps are more economically sensitive than larger companies. That’s one of the reasons people expect a small-cap comeback as rates fall. It’s possible the pandemic will amplify this effect.
(Reiter)
One good read
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