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TROUBLE BREWING IN BEIJING?

Takeaway: Recent policy developments call attention to the systemic risks facing China’s banking system. Additionally, MAY growth data came in soft.

This note was originally published June 10, 2013 at 13:54 in Macro

TROUBLE BREWING IN BEIJING? - chinabank

SUMMARY BULLETS:

 

  • The pending introduction of a nationwide deposit insurance scheme and proactive regulations for dealing with commercial bank failures calls attention to the systemic risks facing China’s banking system. When taken in context with the outlook for interest rate liberalization and a bubbly property market, we are left continuing to hold a far-less-than-sanguine view of Chinese financials.
  • As a reminder, we’ll be hosting a flash conference call this Wednesday at 11AM EST to discuss Chinese financial system risks in greater detail, having added CHIX (Global X China Financials ETF) to our Best Ideas list on the short side. We look forward to your participation and questions then.
  • The sluggish MAY growth figures are in line with what we saw out of China’s recent PMI readings on both the manufacturing and non-manufacturing fronts and we continue to warn of A) incremental tightening (macroprudential or blunt instrument, if necessary) to stem rampant property price appreciation and B) a 2H13 slowdown in Chinese growth as conditions for credit growth deteriorate.
  • While certainly hard to know for sure, it is our view that much of the equity market upside stemming from positive sentiment surrounding the various avenues for reform (economic, financial, fiscal and social) was priced in during the recent rally.
  • For our latest thoughts on the Chinese economy and its banking system, please refer to the research notes hyperlinked at the bottom of this note.

 

PBOC, CBRC RAISING EYEBROWS (OURS AT LEAST)

This morning, we learned that the PBOC was out confirming that a deposit insurance system is ready to be launched after gathering much-needed political consensus. According to the central bank, the insurance system will help "increase the flexibility of commercial banks in terms of financial business innovation and risk control". Moreover, China’s regulation on the standardization of commercial bank bankruptcy – which has been deliberated on for five years – is expected to be submitted to the State Council in 2H13.

 

So let’s get this straight: Chinese authorities are A) implementing a deposit insurance scheme and B) finalizing regulations to facilitate commercial bank bankruptcies. Are we missing something or is Beijing preparing for some meaningful banking system headwinds over the intermediate-to-long-term?

 

In the context of the PBOC likely scrapping the deposit rate ceiling over the intermediate term, there have been concerns that smaller banks would be uncompetitive in a competing cost-of-funds environment. They would ultimately lose deposits and creditor faith as their ability to generate earnings growth declined amid slower or potentially negative financing growth.

 

The commensurate tightening of interbank liquidity is something we’ve been keeping an eye on; last week there was a rumor of a mid-sized bank failing to repay an interbank loan. Expect more to come on that front as we inch closer to the implementation of interest rate liberalization in China. Consensus has been celebrating/bidding up headlines on that front in the YTD, but we continue to hold a far less sanguine view:

 

  • On scrapping the lending rate floor (current minimum = 70% of the benchmark): Consensus expects this to increase the supply of credit to SMEs by lowering the cost of funds for SOEs and allowing risk-based credit allocation to flourish. We think there is risk that SOEs just demand cheaper financing from the banks and that SMEs continue to get crowded out in the absence of regulatory quotas.
  • On scrapping the deposit rate ceiling (current maximum = 110% of the benchmark): Consensus expects this to increase the return on household savings deposits (as do we), but fails to see the dangers of crowding out small-to-mid-sized lenders out of the market for deposits. Moreover, this would be an enormous blow to the systemic financial repression that underpins China’s investment economy (~46-47% of GDP) and higher real rates of return in safer, traditional savings deposits would slow the supply of yield-chasing funds to Trusts and WMPs – potentially exacerbating any liquidity constraints in those credit markets.
  • On doing both at the same time: We’re not sure what consensus thinks here, but it’s obvious to us that lowering lending rates and increasing deposit rates at the same time will inevitably result in NIM compression – something that can only be offset from an earnings perspective by accelerating credit growth. In the context of subdued GDP targets, the Party’s economic rebalancing agenda, a bubbly housing market and an inevitable and potentially dramatic rise in NPLs over the long-term, a meaningful, sustained increase in credit growth appears unlikely.

 

TROUBLE BREWING IN BEIJING? - dar1

 

 

RATTY MAY DATA

This weekend brought us some pretty ratty growth data out of China for the month of MAY. Perhaps the largest callout would be export growth slowing from +14.7% YoY in APR to +1% YoY in MAY, which is what we were calling for post the regulatory crackdown on fake invoicing. Back in line with reality, the MAY export growth figures may arouse global growth fears (exports to the US slowed to -1.6% YoY; exports to the EU slowed to -9.7% YoY).

 

TROUBLE BREWING IN BEIJING? - 2

 

In the context of slower capital flows stemming from a reduction in “fexports” (i.e. fake exports) and tighter interbank liquidity, the MAY credit growth data was also pretty subdued: total social financing growth slowed to +CNY1.19 trillion MoM from +CNY1.75 trillion prior as new loans ticked down to +CNY667.4 billion MoM from +CNY792.9 billion prior. That is unsupportive for fixed assets investment and industrial production growth, the both of which ticked down marginally.

 

TROUBLE BREWING IN BEIJING? - 3

 

TROUBLE BREWING IN BEIJING? - 4

 

TROUBLE BREWING IN BEIJING? - 5

 

All told, the sluggish MAY growth figures are in line with what we saw out of China’s recent PMI readings on both the manufacturing and non-manufacturing fronts and we continue to warn of A) incremental tightening (macroprudential or blunt instrument, if necessary) to stem rampant property price appreciation and B) a 2H13 slowdown in Chinese growth as conditions for credit growth deteriorate.

 

While certainly hard to know for sure, it is our view that much of the equity market upside stemming from positive sentiment surrounding the various avenues for reform (economic, financial, fiscal and social) was priced in during the recent rally.

 

For our latest thoughts on the Chinese economy and its banking system, please refer to the research notes hyperlinked at the bottom of this note.

 

Darius Dale

Senior Analyst

 

  • IS THE RECENT RALLY IN CHINESE EQUITIES SUSTAINABLE? (5/17): We do not think the recent strength in the Chinese equity market is sustainable, as China’s 2H13 growth outlook appears dicey at best.
  • WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? (5/8): Chinese firms are goosing exports to drive incremental liquidity into the banking system – a phenomenon that appears set to slow from here.
  • TWO CHINAS? (5/1): Financial system headwinds continue to outweigh consumption tailwinds within the Chinese economy.
  • REPLAY: Will China Break? (4/30): The Party’s use of state owned banks to drive economic growth through fixed asset investment has left the financial system loaded with bad assets.  The bad assets mirror bad investments in the real economy.  They also can limit the ability of Chinese banks to make new loans.  Following the financial crisis, the Chinese government pushed too hard on the FAI growth lever, building infrastructure projects “for the next 10 years.” It has also left the banking sector choked with bad debts that may limit future lending.  Those factors should slow Chinese FAI growth and slower Chinese FAI growth should be negative for commodity prices and resource-related profits, all else equal.
  • CAN CHINA AVOID FINANCIAL CRISIS? (4/26): The risk of a Chinese financial crisis is heightened to the extent that financial sector reforms are not appropriately managed.
  • REPLAY: EMERGING MARKET CRISES (4/23): We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable. China is particularly vulnerable to experiencing a financial crisis.
  • IS CHINA CAREENING TOWARDS FINANCIAL CRISIS? (3/28): Systemic risks are present across China’s financial sector – as is the political will and fiscal firepower needed to avert a crisis.

GLOBAL MACRO GRIND

Client Talking Points

CHINA

We reiterated our short call earlier this week on emerging markets and China. (Ping us if you want a copy of this concise presentation.)  Our short call has played out positively and is backed by asset flows out of emerging markets funds. In the most recent week the exodus from emerging market funds was $9 billion - the third largest weekly outflow ever (after March 2007 and January 2008). Credit growth in China is slowing and the increasing likelihood that the PBOC tightens will provide an impediment to credit growth.

UNITED STATES

#GrowthAccelerating. The dreary global growth outlook we have continues to push us back to the one economy (and stock market) we remain positive on – the US. As it relates to macro data coming out today, the big one is of course Michigan Consumer Confidence. It will be a decent “tell” on how the US consumer is feeling on top of yesterday's nice retail sales number. As we look at today's setup for the S&P 500, the range is 48 points or 1.92% downside to 1605 and 1.02% upside to 1653.          

Asset Allocation

CASH 48% US EQUITIES 20%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 12%

Top Long Ideas

Company Ticker Sector Duration
NSM

Financials sector head Josh Steiner is the Street’s head bull on residential mortgage originator/servicer Nationstar, projecting $9 in earnings for the company in 2014.  This is well above the company’s own guidance range, which tops out at around $7.50. NSM had a successful start to the year as it won servicing bids on substantial mortgage portfolios.  They also reported significant increases in their profit margins on those portfolios, and double-digit increases in their own originations.  Housing prices are ramping significantly higher, as Steiner predicted, as demand continues to exceed supply in both new and existing homes.  Steiner says this quality mortgage company could ride the crest of a sustained wave of sector improvement.

MPEL

Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.  

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road

TWEET OF THE DAY

Today the High Freaks will know before everyone else how confident Americans are in the stock market (Reuters/UMich invoice in the mail) @zerohedge

QUOTE OF THE DAY

"One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute."

- William Feather

STAT OF THE DAY

340,000,000: The # of tweets that are sent every day on Twitter.


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – June 14, 2013


As we look at today's setup for the S&P 500, the range is 48 points or 1.92% downside to 1605 and 1.02% upside to 1653.          

                                                                                                                     

SECTOR PERFORMANCE


THE HEDGEYE DAILY OUTLOOK - 1A

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:


THE HEDGEYE DAILY OUTLOOK - 10A


CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 1.85 from 1.87
  • VIX  closed at 16.41 1 day percent change of -11.73%

MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Producer Price Index, May, est. 0.1% (prior -0.7%)
  • 8:30am: Current Acct Bal., 1Q, est. -$110.8b (pr  -$110.4b)
  • 9:15am: Industrial Production, May, est. 0.2% (prior -0.5%)
  • 9:15am: Capacity Utilization, May, est. 77.8% (prior 77.8%)
  • 9:15am: Manuf (SIC) Production, May, est. 0.1% (prior -0.4%)
  • 9:55am: UMich. cons. sentiment index, June prelim, est. 84.5
  • 11am: Fed to buy $1.25b-$1.75b notes in 2036-2043 sector
  • 1pm: Baker Hughes rig count

GOVERNMENT:

    • Iranian presidential election will be the first since 2009, which sparked street protests amid allegations that MahmoudAhmadinejad’s re-election was the result of ballot fraud
    • 8:30am: Sen. Max Baucus, Rep. Dave Camp discuss tax overhaul efforts at CSM breakfast
    • IMF Managing Director Christine Lagarde holds press conference on U.S. economy

WHAT TO WATCH

  • Exchanges preparing pilot programs for changing tick sizes
  • FX rates said to face global regulation after Libor review
  • U.S. agencies said to swap intelligence w/thousands of firms
  • Johnson & Johnson sells last of 25.4m shares of Elan
  • SoftBank, Sprint dismiss Dish claim to FCC of broken pledge
  • Visa sues Wal-Mart to stop co. from filing swipe fee claims
  • Marchionne said close on Fiat-Chrysler refinancing agreement
  • Airbus A350 becomes airborne as test pilots start first flight
  • Boeing seen reaping $6b/yr on 787 output rising again
  • Senate committee approves $625b defense spending measure
  • Wal-Mart says approved Ranbaxy products “safe and effective”
  • Gene patent ruling triggers race to mkt cancer risk scans
  • Bernanke, G-8 Summit, Paris Air Show, NBA: Wk Ahead June 15-22

EARNINGS

    • Smithfield Foods (SFD) 6am, $0.43
    • NGL Energy Partners (NGL) Bef-Mkt, $1.03

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Corn Set for Weekly Drop as Demand Slows and U.S. Crop Rebounds
  • Gold Bears Return as ETP Rout Extends to 17th Week: Commodities
  • Copper Climbs on Indications of Rebounding Economy in the U.S.
  • WTI Rises to 10-Week High Amid U.S. Growth, Middle East Tensions
  • Aluminum Fees Immune to Abenomics as Japan Buyers Don’t Budge
  • Gold Declines as Investors Cut ETP Holdings on Stimulus Outlook
  • Thailand Sets Record Sugar Production Target of 13 Million Tons
  • Rebar Trades Near Lowest Level in Nine Months on China Concerns
  • Lower Crop Prices Seen Erasing Savings in U.S. House Farm Plan
  • Nickel Glut Fuels Price Slump for LME Laggard: Chart of the Day
  • U.K. Power Price to Double German on Wind, Solar: Energy Markets
  • U.S.-Europe Diesel Flow Seen Rising Amid Output at 23-Year High
  • Oil Hunted in Mozambique After World’s Largest Gas Discoveries
  • Crop Price Decline Top Commodity Opportunity at Goldman Sachs

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4A

 

EUROPEAN MARKETS


THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS


THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 


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Tape(r) Worms

“Shy and proud men are more liable to fall into the hands of parasites and creatures of low character.  For in the intimacies which are formed by shy men, they do not choose, they are chosen.”

-Henry Taylor

 

Tapeworm infestation is not something we would wish on our worst enemies.  According to Wikipedia, tapeworm infestation is the infection of the digestive tract by adult parasitic flatworms called cestodes or tapeworms.  Typically, consuming uncooked food is the way in which tapeworm larva find their way into humans.  Once inside the digestive tract, a larva can grow into a very large tapeworm.

 

No doubt waking up to read about tapeworms is the last thing you need.  Alas, we couldn’t think of a more appropriate analogy given the market’s recent fascination with the potential tapering of QE by the Federal Reserve.  Yesterday, the market actually rallied on this tapering rumor based on a blog by Jon Hilsenrath in the Wall Street Journal that tapering, if it is to occur, would be a more manageable version, perhaps something akin to Taper-lite.

 

We haven’t been stock market operators as long as many of you, but we certainly don’t remember a period in which there has been such a fascination with, and focus on, the next move of the Federal Reserve.  But until the market host rids itself of the QE parasite, this fascination and volatility associated with the next move of the Fed is likely to continue.

 

Back to the global macro grind . . .

 

Earlier this week, we reiterated our short call on emerging markets and China with a concise presentation by our Senior Asia Analyst Darius Dale. (Email to get a copy of the presentation.)  This short call has played out positively for us and has been backed by asset flows out of emerging markets funds.  In fact, in the most recent week the exodus from emerging market funds was $9 billion, which was the third largest weekly outflow ever (after March 2007 and January 2008).

 

The key new research we provided in the presentation was related to short Chinese financials.  We view this thesis as three fold:

  • Credit growth is slowing – The increasing likelihood that the People’s Bank of China tightens will provide an impediment to credit growth;
  • NIM compression is occurring – Based on the current NIM spread, we think this ratio can only tighten from current levels, which will pressure bank margins; and
  • Non-performing loans are rising – Even though the data is very opaque, NPLs of 20% are a reasonable estimate given by many experts.

In the Chart of the Day, we’ve highlighted one of the more insightful charts in the presentation, which is the Chinese 7-day repo rate monthly average, which highlights how tight money is in China currently.  This rate has gone from about 3.5% in May to 5.7% in June, which is the second highest monthly rate in the last five years and a staggering shift month-over-month.  If money sustainably tightens in China, economic growth will most certainly take a hit.

 

Our Senior Analyst covering Europe Matt Hedrick also gave a very lengthy and thoughtful update on Europe this week (once again email if you want to see this presentation).  While we don’t see the financial sector risks in Europe that we do in China, the economic outlook does remain largely bleak in Europe. Some of the key points that we highlighted in the presentation included:

  • Fundamentals in Europe remain challenged and we should expect long-term below mean growth;
  • We see limited risk to any country leaving the Eurozone or the Euro being disbanded, so another Cyprus flare-up is unlikely;
  • The bifurcation in Europe will continue and we are fundamentally bullish of Germany and the U.K. and fundamentally bearish of France, Italy and Spain; and
  • ECB is unlikely to shift policy anytime soon, which should continue to support our strong dollar call.

A structural issue that makes it inherently difficult for Europe to recover quickly is the inflexibility of the labor force.  In the United States, labor can flow freely from state to state based on employment opportunities.   So, in theory, the U.S. would be very unlikely to have states where the unemployment rate was north of 26%, such as in Spain and Greece, and other states where the unemployment rate is below 7%, such as Germany and Denmark.

 

Given the inability of labor to flow easily through European borders, due to differing qualification levels, work quotas and cultural barriers, it is no surprise then that a recession in Europe should be more protracted.  The bigger issue, of course, is that it creates unemployment hot spots, such as Greece, Cyprus, and Spain, that will have an inability to re-balance their economies, except over very lengthy time periods.

 

This dreary global growth outlook we have continues to push us back to the one economy and stock market we remain positive on – the U.S. of A.  On that front, as it relates to macro data coming out today, the big one is Michigan Consumer Confidence which is released at 9:55am to the masses, and five minutes early for those that pay up for the early look!  Regardless of who gets it ahead of you, it will still be a decent “tell” on how the consumer is feeling.

 

Our immediate-term Risk Ranges for Gold, Oil, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $100.21-105.43, $80.26-80.24, 93.54-95.85, 2.07-2.27%, 15.21-1857, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Tape(r) Worms - Chart of the Day

 

Tape(r) Worms - Virtual Portfolio


June 14, 2013

June 14, 2013 - dtr

 

BULLISH TRENDS

June 14, 2013 - 10yr

June 14, 2013 - spx

June 14, 2013 - dax

June 14, 2013 - euro

June 14, 2013 - yen

 

BEARISH TRENDS

June 14, 2013 - VIX

June 14, 2013 - dxy

June 14, 2013 - oil

June 14, 2013 - natgas

June 14, 2013 - gold

June 14, 2013 - copper 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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