- RevPAR trends are softening
- We are projecting 4-5% Q4 RevPAR growth in the US for the Upper Upscale segment
- The Street and company guidance looks too high for 2013 – MAR guided to +5-7%. We don’t share their optimism.
Takeaway: We still think the industry will fall below the low end of MAR’s Q4 RevPAR guidance of 5-7%.
Takeaway: The Chinese property market is likely to remain under pressure, portending negatively for both Chinese and global economic growth.
In continuing with the themes of today’s Early Look (i.e. the Manic Media and the Chinese economy), we highlight the following headline from yesterday morning:
“Chinese developers led junk bond sales in Asia to a five-month high in September as speculation the world’s second-biggest economy will ease housing curbs and boost stimulus measures caused yields to drop to a record low.” (Bloomberg)
The articles goes on to describe the recent surge in Chinese property developer international debt issuance (10x MoM to $1.15 billion) is an indication of Chinese property developers front-running a relaxation of the existing policies designed to curb speculation in China’s property market, citing Premier Jiabao’s recent statement that the curbs have achieved “obvious” results as an indication that Vice Premier Li Keqiang will be inclined to ease the measures shortly after taking control of the premiership early next year.
We couldn’t disagree more with this interpretation. From our vantage point, we view the recent acceleration of debt issuance by Chinese property developers as a function of increasing illiquidity on their balance sheets amid a slowing sales and declining price environment. Furthermore, if Chinese property developers were, in fact, gearing up for a meaningful acceleration in demand, it is unlikely that growth in Building Starts and Land Purchases would be contracting in the YTD as they are currently (i.e. they are not accelerating investments).
YTD growth in sales of buildings and floor space is trending at multi-year lows through AUG (+2.3% and -4.1% YoY, respectively):
On our 20-City Nominal Properly Price Index, Chinese property prices came in at -4.7% YoY in AUG – the second-lowest reading in the YTD (refer to the bottom of this note for our index methodology):
YTD growth in starts and land purchases is also trending at multi-year lows though AUG (-6.8% and -16.2% YoY, respectively):
Growth in total funds in the Chinese financial system available for property development is also trending at multi-year lows in the YTD through AUG (+9.1% YoY):
Rising illiquidity on Chinese property developer balance sheets could potentially lead to declining prices if they are broadly forced to slash prices to help clear the market. It’s worth noting that floor space under construction and floor space completed are trending up +15.6% and +20.2% in the YTD through AUG. Growth in incremental supply – both present and future – is far outpacing the growth in demand in the YTD.
As it relates to the slope of future demand in the Chinese property market, we continue to take our cues from Chinese policymakers and the unilateral nature of China’s command economy generally means what they say goes with regards to the ebb and flow of economic activity. While front running any changes on the margin in their policy stance can be helpful from a speculative perspective, we wouldn’t recommend doing so at the expense of ignoring their repeated attempts to temper market sentiment:
Net-net, it’s pretty easy to see where Chinese policymakers stand with regards to the future demand in China’s property market. Moreover, we think their resolve to continue combating “overly high prices” and speculative demand warrants further caution with regards to any expectations for both prices and transactions in the Chinese property market over the intermediate term. Additionally, QE3-inspired commodity price inflation has caused monetary easing expectations to be priced completely out of the Chinese interest rate market from a NTM perspective.
As an aside, we were keen to point out the undeniable negative impact of QE3 on global GROWTH (via accelerating INFLATION and decelerating POLICY easing) in the following two notes (hyperlinked for your reviewing ease):
The diminishing outlook for “stimulus” in China – particularly on the monetary easing and property market regulation fronts – led to a proactively-predictable selloff across property developer stocks in recent months. Notably, this chart does not rhyme with the pollyannaish expectations for the impact of QE3 in the US equity market:
With Chinese real GDP growth trending so weak in the YTD (+7.6% YoY in 2Q was the lowest since 1Q09) and expectations for future growth making lower-highs in the YTD (Bloomberg Consensus 2013 estimate at +8.1% YoY currently, down from a peak of +8.6% in MAR), it’s natural to ponder why Chinese policymakers appear so content to let their economy slow to a relative crawl.
The most logical answer that comes to mind is official fear of social unrest. As such, keeping a lid on inflation and maintaining economic stability are two of the primary goals of the Communist Party agenda. In on the inflation front, it’s easy to see why they would be concerned with prices in China’s residential market (~80% of total supply; ~90% of sales) that 74.3% of polled Chinese households find “too high to accept” (per the PBOC’s latest quarterly monetary policy report). Furthermore, the intense government focus on increasing the supply of affordable housing also lends credence to this view.
On the economic stability front, we think Chinese policymakers have been keen to recognize the lessons learned from the US housing bubble and its subsequent bust, which led to the 2008-09 Global Financial Crisis. US employment remains structurally impaired as a result and we think Chinese policymakers are carefully seeking to avoid this fate.
While we certainly aren’t calling for a Chinese banking crisis (nor do we think their property market is a bubble in the traditional sense), we do find it worth noting that the total amount of loans on Chinese bank balance sheets have more than doubled since end of 2008, creating ample room for adverse selection as well as a future upswing in non-performing loans, which are at historic lows as a percentage of total loans. Additionally, the memories of shelling out a total of $650 billion (44.7% of 2002 GDP) to bail out the country’s fragile banking system during the years of the late ‘90s/early ‘00s may still be potent in the minds of Chinese policymakers (the top brass has been in power for a decade).
Broadly speaking, bank credit is just shy of historic peaks as a ratio of the Chinese economy and the 2,000-plus basis point upswing from 2008 to 2009 lends credence to the view that the Chinese policymakers (via state-directed lending at policy banks) may have levered the economy too quickly in an attempt to reflate growth in the wake of the GFC – an event which led to an acceleration of inflation as well as rising risk of an NPL cycle over the long term. It is our understanding that this is a view increasingly shared by Chinese policymakers atop the central planning hierarchy (and perhaps one of the primary reasons they have been reluctant to implement a commensurate stimulus package in the YTD):
[The] 4-trillion yuan package of state spending and tax cuts announced in 2008 stoked inflation and sparked concern local governments took on more debt than they can afford.”
– Xu Lin speaking to reporters at Peking University on SEP 17, 2012
Again, we’re not currently in the camp that China is careening towards a banking crisis; we are, however, flagging the risk that a potential broad-based deterioration of credit quality across the Chinese financial system is likely to keep Chinese policymakers focused on quashing any signs of a property price bubble in a proactive, not Western-style reactive, manner. Furthermore, the credit risk embedded in a [potential] severe property price bust is not well diversified across the Chinese financial system – meaning the Chinese government would ultimately be on the hook for any damages (net corporate bond issuance was a mere 15.4% of the aggregate net bank loan and trust financing extended in 1H12 – a similar ratio to full-year 2011).
With fixed capital formation at 46.2% of Chinese GDP, we would be remiss to single out property developers as the only industry at risk; there are a handful of other industries such as steelmaking (Baoshan Iron & Steel Co.?) and construction equipment manufacturing (Sany Heavy Industry?) that may also experience a structural erosion in credit quality. A chart of Chinese steel products prices agrees with this view:
Perhaps that’s why Chinese policymakers were keen to focus their 12th Five-Year Plan on rebalancing the country’s economic growth model, calling for a structurally-slower pace in the process. Rather than reflate now and risk an epic economic and financial market collapse at some point in not-too-distant future, Chinese policymakers are likely attempting to engineer a soft landing/smooth transition to a more sustainable growth model (i.e. the Politburo ≠ the Fed). Even though they explicitly told us that’s precisely what they were going to do, it’s just now all starting to make sense in the context of the “missing stimulus bazooka”.
THE HEDGEYE 20-CITY NOMINAL PROPERTY PRICE INDEX
As you probably are aware, the National Bureau of Statistics pulled the plug on its monthly nominal property price data back at the end of 2010, leaving analysts and investors alike searching for clues to the severity of China’s policy-induced property market downturn. Until now, we had been content with analyzing the monthly 70-city MoM data, but the need to contextualize those sequential changes became too great to ignore. As such, we’ve combined price per sq.m² data from China Real Estate Information Corp. (one of China’s top real estate data providers) to formulate an average market price of 20 of China’s busiest property markets.
The caveat here is that their data series start in JAN ’11, making historic context hard to come by. To solve for this constraint, we indexed our new series to China Economic Information Network price indices going back to 1998 (though 2010). Our methods aren’t perfect, as both data sets aren’t necessarily apples-to-apples, but it’s as good a long-term read on the nominal price level of the Chinese property market as any we have access to at the current juncture.
Our chart below showcases the performance of the EUR/USD currency pair over the past year. You can easily spot some of the big events that occurred in 2012: the turmoil of Spain and Italy over the summer, the late July "whatever it takes" comments by Mario Draghi and of course, the "unlimited' buying remark made on September 6 that really kicked the Euro into high gear.
It reminds us of charts we've displayed in the past showing Bernanke's effects on various markets. This is just the European version.
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Takeaway: Fundamentals and the challenges inherent in the Union of uneven states suggest our $1.31 EUR/USD resistance level will hold.
Positions in Europe: Short EUR/USD (FXE); Long German Bonds (BUNL)
Keith added FXE to our Real-Time Positions at $129.13. FXE’s TRADE range is $127 – 129 with a TAIL resistance of $131.
With regard to the trade Keith said: “Europe didn't cut rates today. But they will, again, eventually. This is the Currency War. Immediate-term TRADE overbought within a bearish long-term TAIL.”
We’ve written a number of notes on Europe this week. Certainly at any moment the EUR/USD can be influenced by numerous factors, however below are the larger forces we think are acting on the cross:
There is great political uncertainty in Europe right now, which lends support that the EUR/USD will not cross our quantitative long term TAIL line of resistance at $1.31. The market consternation centers around:
On a banking union we’ve already seen push back from stronger nations like Germany to “blindly” accept this risk (ie without conditions to benefit itself and/or limit reduction in its credit rating) and coordination to set up the logistics of a fiscal union inducing a protracted drag in this decision.
To the point on timing, ECB Executive Board member Joerg Asmussen said on Monday that the ECB will not rush through “half-baked” plans for a new pan-European supervisor.
Also, remember that German Chancellor Merkel and Bundesbank President Jens Weidmann continue to butt heads on many fiscal issues. Eurobonds is one topic that Weidmann remains vehemently against while Merkel has not ruled out their use. However, if the Eurozone is to move to a fiscal union, Eurobonds are simply a natural extension of a fiscally united union. This is one hot topic to monitor as we move through the calendar year.
NO CHINESE SAVIOR
Interestingly, this week, Jin Liqun, chairman of the supervisory board of the China Investment Corporation (China’s $480B sovereign wealth fund), said that CIC will not buy bonds issued by debt-ridden Eurozone countries until their fundamental problems are solved. This point is of note because some over the last 12 months have suggested there’s a reduction in “risk” across Europe given the willingness of the Chinese to step in and support the region. Further, Jin said:
“The mass demonstrations in Greece and in Spain against fiscal tightening do not bode well for attracting investment into their debt… It's not realistic to expect any Chinese investor, CIC included, to buy the bonds, which are not safe…If the euro zone would issue a Eurobond backed by all of the countries - it is more attractive to international investors. Backed by all of the countries means backed by the core members."
European Manufacturing and Services PMIs for September (released on Monday and Wednesday, respectively) have shown little to no improvement over the last 7-8 straight months, stuck below the 50 line indicating contraction (see chart below).
The next immediate political catalyst for the cross is the Eurogroup being held next week in Luxembourg on October 8-9, however we do not expect any definitive action to be agreed upon. Taken together, we are fully aware of the powers of Central Bankers to drive the EUR/USD. That said, the fundamental data from Europe keeps us grounded in our opinion that despite best efforts from Eurocrats to craft rescue programs, we think slowing growth, rising inflation, and the structural flaws inherent in creating a Eurozone will continue to present challenges that should prevent appreciation of the EUR/USD above our TAIL line of resistance at $1.31.
POSITIONS: 9 LONGS, 5 SHORTS
I leaned longer again on the open, covering CAT and buying some of our favorite long ideas. The signal is the signal. I think I’ve been as flexible adhering to leaning long or short in the last 3 weeks as I have all year.
Across risk management durations, here are the lines that matter to me most:
1. Immediate-term TRADE resistance = 1463
2. Immediate-term TRADE support = 1448
3. Intermediate-term TREND support = 1419
In other words, what was resistance yesterday (1448) is now support. That changed, so I did. And there are no rules against selling some at 1463 ahead of tomorrow’s employment report either. That’s the market we are in. Romney just changed the probabilities of Obama winning too.
#EarningsSlowing is bearish. Potential for political change (was with Obama in 2009 too) is bullish.
Keep managing the risk of this 1419-1474 (Bernanke Top) range.
Takeaway: Despite the beat, lodging demand is softening.
In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance.
INCENTIVE FEE GROWTH
COURTYARD SALE IMPACT
NORTH AMERICA SPECIFIC
GROUP BOOKINGS OUTLOOK
ME REVPAR GROWTH
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.