The ‘Sharing Economy’ Shock…

The bedrock of economic exchange is trust, and technology now allows a reliable degree of ‘crowd sourced’ trust to be established between total strangers in order to share resources, which has profound implications for investors. As I’ve highlighted many times, a range of new online services are reducing slack and redundancy in the economic system – the internet from its inception has been about reducing search costs and price asymmetries between producers and consumers i.e a fundamentally deflationary force. These ‘sharing economy’ business models are typically zero marginal cost in terms of adding inventory, simply acting as a marketplace brokering transactions between individuals and thus have a potentially exponential growth path, explaining heady venture capital valuations.

Opportunities for these business models to tap into idle or underutilized inventory abound – the average car in a large Western city sits unused 90% of the time, and the opportunity to tap into that unused transportation capacity is the target of numerous start-ups. One of the most interesting I’ve seen recently is a grocery shopping service, that for a small fee sends a freelance ‘personal shopper’ and their car to the supermarket of your choice, to be delivered to your home. No new depots or delivery vans as captured by conventional capital spending measures and yet incremental productive capacity unleashed – this trend will make the US and other advanced economies inherently ‘lighter’ over the next decade.

We are seeing hundreds of similar ‘sharing economy’ apps from parking space rental in unused urban front drives to appliance sharing (does every garden shed really need a lawnmower?). Aside from the incremental impact of underutilized capacity being monetized over the next few years (implying fewer new hotel rooms/cars etc.), we are seeing an interesting cultural shift among the under 30s in the desirability or need for ownership, whether of a property or consumer durable.

Meantime, drivers of London’s iconic black taxi cabs (the ones that spew out noxious diesel fumes and often equally noxious political opinions if you’re unwise enough to engage in conversation with the driver) are planning to paralyse the city next month in protest against Uber’s expansion to London with its smartphone app based private car hire service. With average earnings of £40-60k depending on hours and whether they own or rent their cabs, taxi drivers pull in up to twice national average earnings for a skill which was rendered obsolete by technology a decade ago i.e. memorizing a map of London. They are likely to go apoplectic when US service Lyft (which is more of a pure sharing economy model allowing private individuals to become ad hoc taxi drivers) inevitably arrives in the UK. It’s a bit like dockside stevedores fighting the advent of containerization back in the 1960s, the hopeless battle of a closed shop against technological innovation and another bastion of premium semi-skilled incomes being demolished by Silicon Valley invaders – the overachieving geeks love nothing more than blowing up barriers to entry with some clever code.

The original sharing economy shock hit the music and media industries a decade ago, as consumers dis-intermediated the industry giants to become producers of their own content, creating huge value for platforms that rode the trend like YouTube. As covered in previous posts, the financial world is now in the cross hairs of the tech giants monetizing messaging apps as well as innumerable well-funded start-ups; we’re seeing a surge in innovation from peer-to-peer lenders such as Lending Tree to angel VC funding. Fund managers won’t be immune – for instance, online brokerage start-up Motif Investing offers professionally weighted stock baskets based on crowd sourced top-down thematic asset allocation ideas.

I’m in Silicon Valley next month visiting VC and hedge funds and looking at the next wave of these disruptive business models, which bear close watching for their impact on established industries and the confusion they are already creating in interpreting increasingly outmoded economic statistics (e.g. the freelancing/self-employment trend distorting employment data). We’re entering a world where anyone in a major city can use these platforms to freelance as an amateur landlord, taxi driver, tutor etc. and derive multiple income streams but also in the early stages of a technology driven economic shift which will have major implications for trend inflation, capex and profit margins over the next decade and should be a key investor (and indeed policymaker) focus.

Volatility Goes AWOL, For Now…

‘What about the fact that maybe most of the collateral you need for normal trading is all tied up now? What about the fact that the big investment dealers have got inventories that are 20% of what they were in 2007? When things start to move, the inventory for the market makers might not be there. That’s a particular worry in fields like corporate bonds, which can be quite illiquid to begin with.’
William R. White, former economic adviser at the BIS, in a recent interview

This point echoes one I made recently regarding HY debt liquidity risk and the BIS as the ‘central banker’s central bank’ has been one of the most prescient and objective observers of macro events in recent years from the emerging market debt build-up to the Eurozone crisis. As any bored (and increasingly paranoid) swaps trader wiping the dust from their Bloomberg keyboard can attest, the defining issue for markets currently is the lack of volatility, even in response to non-consensus US data as we saw recently. Or as famed macro investor Paul Tudor Jones put it this week, “manic depressive trading in a volatility-compressed world.” Of course, one side effect of QE was to suppress volatility by curtailing macro tail risk etc., but the Fed’s unwind has coincided with a burst of global disinflation which has at least postponed the widely expected yield spike trigger for a reversion to mean volatility shift.

Indeed, the other defining issue as covered previously is low nominal growth globally, which is capping bond yields against consensus expectations but also forward equity earnings growth. With an eerie calm having descended on key markets in recent months, it’s not surprising that investment banks have seen revenues tumble in their trading arms; the 10-year yield has moved within the narrowest range for the most sustained period since flares and the Village People were in fashion while volatility in currency markets (ex EM) has been lower only a couple of times in the past 20 years – the JPY/USD cross has barely moved over the past month. However, the underlying liquidity deterioration means that when we get a paradigm shift in investor perceptions, the move will be unusually violent.

In commodities, Brent oil has traded in the narrowest sustained percentage range since 1985. The S&P 500 has been playing ping pong for a couple of months within about a 50 point range, despite a significant sector rotation beneath the surface. Range trading could carry on for a bit longer, but I’ve described this as the pivotal year for the QE experiment. Either it starts working in the real economy as reflected in US wages and capex accelerating (and Treasury yields break upward through 3%) or we face a crisis of confidence as inflation globally ex-Japan continues to downtrend and central bankers fall off their pedestal. One problem is that as the utilization rate in the US creeps toward pre-crisis levels, it’s been plunging in China as reflected in April’s -2% y/y PPI . Another is that the still highly leveraged US economy is very sensitive to rising long rates, as seen in the housing slowdown, an issue I covered recently and which Janet Yellen highlighted as a downside risk this week. Despite the lack of headline volatility, beneath the calm surface there has been some dramatic rotation within asset classes, notably within US equities.

The Russell 2000 small cap and Nasdaq Internet indices have slumped since March as momentum inflows reversed – Twitter having halved is still on 85x consensus 2015 EV/EBITDA, Amazon on 20x although Google and Ebay are back to about 10x, which offers a benchmark for the Alibaba IPO pricing. It’s notable that popular frontier emerging markets like Vietnam are now also starting to slide (although squaring up to a belligerent China isn’t helping). In other words, volatility has been building since March in corners of the global markets which were among the biggest beneficiaries of excess liquidity flows. The question is whether that’s simply a late cycle healthy rotation toward value from momentum strategies or a harbinger of wider volatility this summer. A trigger such as the ECB falling short of expectations in June could lead to some very crowded credit momentum trades from peripheral Eurozone sovereign debt to junk bonds reversing hard – liquidity risk in fixed income looks mispriced, particularly given that bond dealers no longer have the balance sheet capacity to warehouse risk during a spike in selling volumes.

Chinese Housing Market Risks Subsiding…

Whenever I walk around a Chinese city, I’m struck by how poor the finish can be on ‘luxury lifestyle’ new developments of bare shell flats which rarely match up to the billboard images of foreign sophistication. A key issue is that with no national building code, the quality of construction is generally very poor and sometimes downright dangerous compared to HK or Singapore (thin floor plates with exposed rebar, disconnected sprinkler systems etc.) and the depreciation rate will be far more rapid. There have been numerous cases of new towers subsiding into the ground soon after construction, and the same is now happening to prices in several markets. Average new home prices in China’s 70 major cities rose 7.7% y/y in March, slowing from 8.7% in February but activity and prices are slumping in some second and third tier regional cities.

For instance, although national home sales declined 7.7% in Q1, in the weaker provincial markets they collapsed e.g. -38% in Hangzhou, -25% in Wuxi, reflected in developers slashing prices to sustain cash flows, a trend I highlighted in a note last month. Indeed local media have reported that the cities of Changsha, Hangzhou and Ningbo have been openly discouraging property developers from cutting prices further. The coastal city of Wenzhou, which saw an SME liquidity crisis, and Ordos in Inner Mongolia where coal mining profits spawned a well-publicised boom of empty towers have seen their property markets hardest hit by the shift in sentiment. In Hangzhou (home city of Alibaba), the average selling price for residential units in the downtown area is down by over 11% y/y while as of March, 76,004 residential housing units were available for sale, an annual increase of 36%.
<New property construction starts fell 25.2% y/y to 291m square meters (the lowest quarterly amount of new floor space started since Q1 2009).

Urban real estate investment accounts for more than 10% of GDP, so ongoing weakness in the property sector would be a drag on H2 GDP growth. Some degree of policy loosening has already begun, with a few of the worst hit cities discussing removing curbs on property purchases but the key remains to boost supply of low-income rental housing (with a 7m unit public housing target this year, and 4.8m completions – the latter is actually over 600,000 fewer than last year) and accelerate the property introduction (being piloted in Shanghai and Chongqing) to curb speculative hoarding and expand the local tax base. Low income housing only accounted for 13% of total real estate investment last year (or 2% of GDP), so it can’t offset weaker trends in the wider market – the focus in any case seems to be on renovating existing 1950s/60s shantytown flats rather than Greenfield new build.

Beijing and other Tier 1 cities remain resilient although momentum is slowing; developers remain aggressive buyers with the total value of YTD land sales in Beijing reaching 102bn RMB as of last week, a level not seen until late September last year and even allowing for a moderation, the total is likely to exceed 200bn RMB this year for the first time. Meantime, commercial property investment also seems to be stalling after a huge rise in values (e.g. prime office space up 65% in Shanghai in the past 4 years, with gross yields sub 6% and flat to falling). I think indoor shopping malls (of which the country has 2,500 and still rising) remain the most egregious example of real estate over-investment and looming write-offs now that the online share of retail sales has reached 10%. At the moment the risks of a property crash look more regional than systemic, but contagion risks to Tier 1 cities bear close watching in coming months. In the meantime, with China’s total foreign debt at only about 9% of GDP and export demand still sluggish, the RMB will continue to take the growth strain.