Market report December 2019
International trade and trade wars
On Thursday 12/12/2019, the US and China tentatively agreed on the details of the ‘phase one’ agreement. The agreement suspends the introduction of new tariffs on December 15 and abolishes some existing tariffs, subject to increased imports of US agricultural products in China, tightening of intellectual property laws, and opening of the Chinese financial services sector. The abolition of tariffs should boost growth somewhat, although the agreement does not completely remove the uncertainty surrounding the trade war. Markets welcomed news as positive for growth, while bond yields and share prices rose.
During the Central Conference on Economic Work of China, the administration decided to further soften its policy making economic stability the highest priority in 2020. However, the announced measures do not signal plans to introduce significant relaxation, as we saw in 2015-2016. A set of policies is expected to cover the development of fiscal policies focusing on greater efficiency rather than larger size. No new government bond issue has been announced, and no tax cuts are expected. There were some signs of improvement – industrial production increased by 6% in November, which means acceleration compared to October.
US inflation rose in November to 2.1%, the highest level in a year. Although inflation has risen, it remains close to the 2% target, and for now the impact of tariffs does not appear to be very inflationary. While prices increased, the impact on demand was negative. Indeed, as the Fed left rates unchanged at its December meeting, the median projection fell slightly. In our view, an increase in rates will require progress in trade, improved confidence and boosting economic activity.
Chinese Insurtech sector
The Chinese Big Tech sector (large data sets, cloud computing, artificial intelligence, blockchain) and platform ecosystems can have a huge impact on the global insurance industry. First, ecosystems are owned or can be driven by technology giants that marginalize insurers, which can have consequences for client and data access. Secondly, Chinese players like Baidu, Alibaba and Tencent, who have already built a significant position in fintech ecosystems, can have a huge impact on other markets as well.
The highly concentrated insurance market in China has risen to 2nd place in the world and should, in our opinion, continue to grow by double digits. Since the global financial crisis in 2008, insurance premiums (excluding health insurance) have almost quadrupled to EUR 417 billion (2018), making China the second largest insurance market in the world. The potential for further growth is still high: premiums per capita in China amount to EUR 294, in all other five major insurance markets in the world people spend about ten times more on insurance. That is why we expect a double-digit increase in premiums in China also caused by demographic changes, in particular in the life insurance sector.
Regulatory obstacles to entering the Chinese insurance market have been reduced, and recent announcements are conducive to further development of insurtech companies. Growth stimulus 2018-2019 (equivalent to 5% of GDP; a further 2.7% expected in 2020), accommodative monetary policy directed at the private sector and “Made in China 2025” create favorable conditions for the development of technology companies with simultaneous encouragement of participation addressed to foreign investors. The pressure of Chinese authorities on the insurance sector SMEs can reveal hidden mid-cap gems, attractive to strategic value chain partnerships.
Compared to the US and Europe, technology companies in China are very well funded
Our data shows that there are about eight times more companies in the US from the Insurtech sector than in China. American Insurtech companies raised a total of EUR 5.8 billion in 2018, total funding in China (mainly the venture capital market) amounted to EUR 4.0 billion – more than four times more than in Europe. In China, funding through Private Equity funds or funding supported by companies in the Insurtech sector is almost marginal.
Four companies conducted a public offering (Ping An Healthcare and Technology Company, ZhongAn, Pintec and Fanhua), in the United States two and one in Europe. The dominant M&A exit channel is much less popular in China: so far only one insurtech company (Chuangxin Insurance Sales) has been taken over by another company. The generous financing available on the market can actually discourage corporate buyers or enable startups to remain independent. It may also be that high market concentration leads to a lack of corporate buyers. Either way, the lack of mergers and acquisitions in China increases the risk for investors.
China will be crucial to the world of insurance in a platform economy thanks to its scale, purpose and agility of management. Chinese consumers are a great opportunity for technology companies, and high-tech distribution channels and products will grow rapidly. Regulators and authorities have the resources and are willing to help not only domestic but also global leaders in technology and services. Global insurance giants can benefit from the dynamically developing Chinese insurance space and technology, while their experience, especially from Europe (insurance and product development, property liability management, privacy and consumer protection) may prove useful. We expect further development of strategic partnerships and joint investments between Chinese and foreign insurance entities.
China is certainly a market worth observing and learning on. China has become one of the most innovative and competitive economies in the last few years. The country is one of the largest investors in digital technologies and home to one-third of the world’s unicorns. Although Internet penetration in China is only 59%, the number of Internet users is almost three times higher than in the United States, due to China’s large population of 1.4 billion people. This digital population implements new technologies and services early, and the Chinese government also supports innovation, not only at national but also at regional level, encouraging the creation of new technology clusters. The huge size of the Chinese market enables companies to easily scale and strengthens Chinese “independent” innovations. Since the financial crisis, corporate debt in China has increased from 93% to 155% of GDP (June 2018). As a result, credit risk is greater: after an increase of + 20% in 2019, we expect another double-digit increase in corporate insolvency in 2020. However, for several reasons, the risk of a full crisis is limited: first, almost all debt is national (external debt is only 14% of GDP); second: most of the debt is in the hands of state-owned enterprises; thirdly: interest rates will remain stable (or fall) in the near future, and the government still has many options to save the economy.
China is in the middle of another round of leverage for the enterprise sector. A fiscal and monetary line for mid-cap companies is essential and can change the technology structure to make room for smaller companies. This is especially important for foreign insurers in their strategy of entering the Chinese market and seeking opportunities in the insurtech space.
Chart: Bank private credit and nominal GDP growth in China
Source: ITC, WTO, RCieSolution Research
Looking at the financing options, a high percentage of venture capital is visible in China. Private Equity or corporate funds are marginal in China. Both the US and Europe offer a much more diverse funding landscape. However, if the collected amounts are analyzed, the picture will change: more than 90% (US) or 80% (Europe) of all funds are obtained through venture capital. In China, the share of venture capital is less than 10%, thanks to successful public offerings of Ping An Healthcare and Technology Company and ZhongAn (refinancing).
What drives the activities of the ECB?
Starting from 2018, inflation returns, explaining an accommodative attitude to monetary policy. The main task of the European Central Bank is to strive for price stability, which is defined as an inflation rate below 2% in the medium term. The analysis shows that the criterion of inflation and the output gap partly explain the ECB’s position on monetary policy over the last decade. Since 2016, output and inflation gap measurements have been in some contradiction with the ECB’s increasingly accommodative attitude in monetary policy conceived according to the Taylor standard rule. We reviewed selected extended Taylor rules, adding explanatory variables and analyzing their contributions over time to clarify the ECB’s monetary policy position. State risk premiums (sovereign), indicators of financial stress and volatility, measures of economic policy uncertainty and results of banks’ return rates on the stock market have seemed important for the ECB’s decision-making process over the past ten years. Their importance, especially in the case of peripheral spreads and financial stress indicators, reached the highest level during the debt crisis in the euro area.
In order to examine the extent to which the ECB’s position in monetary policy can be explained by concerns about financial stability, we select a specific set of variables:
- We include VSTOXX as a measure of stock market volatility. The equivalent of VIX for S&P 500, VSTOXX extracts the volatility arising from the options for EURO STOXX 50.
As a result of the analysis of the collected data, we find that in the last two years the inflation gap has an increasing impact, explaining up to 50% of the shadow rate* in a few months in 2018. Return of the inflation target is visible in all regression models and is explained by a sharp increase in the associated ratio.
- To take into account the systemic risk arising from movements in various financial markets, we also consider the national financial stress indicator (CLIFS).
The ECB appears to be guiding monetary policy with systemic risks in financial markets in times of financial crisis, but the recent period of monetary stimuli is mainly due to alternative factors.
- To check the extent to which the ECB takes into account the “Italian factor” when determining monetary policy, we add the difference in the yields on Italian and German 10-year government bonds.
Compared with the baseline scenario taking into account sovereign spreads (i.e. the investors’ expected loss of default and risk premium, the latter reflecting how investors value risk) it can be considered that the proportions of the impact of the constant and output gap on the implemented policy make sense when at the same time significantly reducing the size of the relative contribution from the inflation gap. We can interpret this result because the ECB attaches less importance to the inflation target in order to address the problems of Italian public debt instead.
- We include the bank stock index (DJ EURO STOXX Banks) to measure the extent to which the ECB has responded to concerns about the state of the European banking sector.
We believe that the bank share price index contributes statistically and economically to the monetary policy stance in the entire sample analyzed. It seems that considerations regarding banking capital had a negligible impact on the monetary policy implemented during the 2008/2009 financial crisis. Perhaps the reason is that the bank’s shares have withdrawn globally due to a loss of confidence in the financial system, not the idiosyncratic weakness of the European banking sector.
* The concept of “shadow rate” was developed to determine what should be the short-term interest rate, in the face of the expansive policy of central banks, consisting of reducing to zero (below zero) interest rates in order to stimulate the economy (zero bound). Black (1995) introduces a so-called “shadow rate”, which is the short-term interest rate that would accurately reflect the monetary policy stance in absence of the outside option of holding currency. The shadow rate can be positive or negative.
- The ECB may have felt the need to support the European economy through an accommodative monetary policy stance in times of high uncertainty. That is why we are also considering the EU policy uncertainty indicator, which takes into account changes in political risk.
While the constant and output gap have a negligible impact on the policies pursued by the ECB, political uncertainty is strongly linked to the Bank’s political position throughout the eurozone crisis, including after 2016. We include the EU economic policy uncertainty indicator. This index measures uncertainty about economic policy based on press articles from France, Germany, Italy, Spain and the United Kingdom.
The Inflation gap is the difference between ECB macroeconomic staff projections for one-year ahead Euro area inflation and set the inflation target of 2%.
The Output gap is the difference between ECB macroeconomic staff projections for one-year ahead Euro area GDP and the growth rate of potential output.
Global stock markets
Global stock markets, respectively in terms of 1 week (1 WEEK), 1 month (MTD), calendar year (YTD) and the last 12 months (1 YEAR), are shown in the table below:
The table includes rates of return in terms of pound sterling (GBP), local currency (Loc.) and relative (Rel.) / 17.12.2019
Source: RCieSolution Research
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The views expressed in this document do not constitute research, are not investment or commercial advice and do not necessarily reflect the views of all management teams. They change over time.