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Daily Agenda: China at Center of Cooling Growth

IMF guides global growth estimates lower; Morgan Stanley posts disappointing results; VIX shows highest reading in a month.

Once again, Chinese growth data takes center stage, as plunging commodities prices and increased volatility in equity markets leaves investors recalibrating portfolio risk. National Bureau of Statistics fourth-quarter 2014 GDP estimates, released yesterday, registered at an annualized 7.3 percent growth rate, higher than consensus forecasts for the period but bringing the pace for the full year to 7.4 percent, a multidecade low. Separately, December industrial production and retail sales beat forecasts marginally, while urban fixed investment showed a modest decline. Coming on the heels of December property price index levels, released over the weekend, showing a 4.1 percent year-over-year contraction for homes in 70 cities, this data suggests recent policy moves are getting the desired results. Last year Beijing instituted a round of stimulus measures designed to encourage internal consumption and prop up employment while at the same time cooling capital flows into excessive industrial capacity and real estate investment. Recent sharp intraday selloffs in Chinese equity markets, however, suggest that many portfolio managers remain uncertain if the trade-off between rapid-fire investment and sustainable growth can be achieved without weighing on corporate profits. With a global economy still attuned to demand from a rising China, the nation’s economy remains the central theme for macro and micro-focused investors alike.

IMF cuts growth projections. Commodities markets reacted negatively to new growth projections released by the International Monetary Fund yesterday. The multinational organization lowered its 2015 GDP forecast from 3.8 percent to 3.5 in its latest quarterly release, specifically citing cooling activity in China and Europe as primary drivers for the slowdown.

Activity slows in Japan. November industrial production figures released yesterday by Japan’s Ministry of Economy registered a contraction of 0.5 percent for the month and 3.7 percent versus the same month in 2013. While representing a modest improvement from initial estimates released earlier, the confirmation of a slower pace of activity in factories helped the yield on Japanese ten-year bonds fall below 0.2 percent for the first time in the history of that nation’s bond market, as the looming risk of deflation and the Bank of Japan’s aggressive purchasing haunt investors.

U.S. equity volatility rises. The Chicago Board Options Exchange Market Volatility Index, also known as the VIX, a measure of prices investors are prepared to pay for options on stocks, rose to the highest level in more than a month at 23.43 during trading on Friday before closing below 21. Trading in sympathy with oil prices, the energy equities segment is experiencing the largest selloff in more than five years with New York Stock Exchange data indicating the number of listed equities at 52-week highs or lows at a multidecade increase.

German economic indicators show mixed picture. In Germany, producer price levels for December fell by 0.7 percent for the month for a contraction of 1.7 percent versus the same month in the prior year, confirming deflationary fears for the European Union’s largest economy. Separately, ZEW economic sentiment data for January indicates a sharp improvement in mood suggesting that hopes are riding high that a widely anticipated stimulus announcement from the European Central Bank will help propel the German economy’s momentum.

U.S. earnings announcements on deck. Several public companies are posting quarterly results today. IBM will announce after equity markets close while fellow Dow Industrial Average component Johnson & Johnson reported a decrease in sales of 6 percent for the last three months of 2014 as a decrease in demand abroad more than offset an upswing in the U.S. This morning also featured data from Morgan Stanley, which became the latest major U.S. financial sector stalwart to report disappointing performance during the fourth quarter of 2014, with adjusted earnings of $0.47 per share versus consensus estimates for $0.49 with flat revenues for the period.

Portfolio Perspective: Opportunities Remain Within the Energy SectorSean Darby, Jefferies

Despite the slump in oil prices, we have run a lateral basket of shares benefiting from a relaxation in U.S. energy exports over the past two years. We feel investors may be overlooking a very long-term structural change to the economy.

The break-even cost for existing production only needs to cover operating expenses, which are generally less than $30 per barrel. Existing production declines at about 4 percent per year and needs to be replaced by new developments. The breakeven for new wells drilled in the U.S. is essentially $60–80 per barrel. Deepwater developments also fall within this range. Oil sands run at about $90–110 per barrel. The dichotomy then, is that the oil price can fall quite a bit more in the near term and not affect near-term supply, but there will likely be insufficient investment in new production sources to balance the market over a time frame of one to two years.

Away from the collapse in oil prices, two other potential game changers for U.S. energy-related shares have occurred almost unnoticed. First, following the Nebraskan Supreme Court’s split decision, the Republican-controlled House of Representatives voted to approve the Keystone XL pipeline. The Senate, also Republican dominated, is set to vote on the matter shortly. The one fly in the ointment is that President Barack Obama has threatened to veto any congressional legislation approving the pipeline. Second, just as 2014 was running into 2015, the Obama administration posted guidelines on the export of light crude oil. There had already been a softening in the legislation on ultralight crude oil exports that have gone through minimal processing called condensates. Indeed, Pemex, Mexico’s state-owned oil company, has requested for the 40-year-old U.S. ban to be rescinded.

The glacial easing of energy exports has accelerated. We believe both shipping and companies involved in building terminals ought to do well in the future.

Sean Darby is chief global equity strategist for Jefferies and is based in Hong Kong.

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