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IS CHINA THE NEXT CYPRUS OR IS CYPRUS JUST A SMALLER VERSION OF CHINA?

Takeaway: Contrary to consensus perception, the real headwinds facing China’s banking system are structural (i.e. NOT cyclical) in nature.

SUMMARY BULLETS:

 

  • As outlined in a research note published early yesterday afternoon, we do think China’s cyclical banking system woes are: A) near fully priced in on an immediate-term basis and B) near fully understood by market participants – inclusive of today’s front-page WSJ callout. As such, we would expect to see a relief rally of sorts at some point over the immediate-term, as speculators follow through thanks to additional clarity out of the PBoC and what may morph into USD-debauching, anti-tapering headlines out of the Federal Reserve.
  • We are however, inclined to fade any relief rally as the SHCOMP approaches its immediate-term TRADE line of resistance up at 2,123. That’s approximately +5.2% higher from today’s closing price – which actually took out the near 4Y lows established in DEC ’12. It remains our view that the real headwinds facing China’s banking system are structural (i.e. NOT cyclical) in nature.
  • For those of you seeking a greater understanding of those risks, please review our recent short-China presentation, as well as the compendium of hyperlinked research notes and slide decks found at the conclusion of this note. As always, if you or anyone on your team has questions on China, please feel free to reach out to us via email at any time. We always look forward to engaging in thoughtful dialogue with clients.

 

CHARTS OF THE DAY

A 5Y chart of China’s Shanghai Composite Index tells a pretty rough tale of a country in economic transition (click HERE & HERE for historical context):

 

IS CHINA THE NEXT CYPRUS OR IS CYPRUS JUST A SMALLER VERSION OF CHINA? - 1

 

A 6Y chart of China’s Shanghai Composite Index tells an even rougher tale of an economy with a formerly world-beating, internationally-attractive growth model that is now squarely in the rear-view mirror (click HERE & HERE for historical context):

 

IS CHINA THE NEXT CYPRUS OR IS CYPRUS JUST A SMALLER VERSION OF CHINA? - 2

 

A 10Y chart of China’s Shanghai Composite Index overlaid with Cyprus’ FSTE Stock Exchange 20 Index tells a rather damning tale of two countries that once lived large on financial excesses and are now facing up to the harsh realities of rapid credit expansion and adverse selection – not the least of which is structural liquidity constraints across the financial system (click HERE, HERE & HERE for more details):

 

IS CHINA THE NEXT CYPRUS OR IS CYPRUS JUST A SMALLER VERSION OF CHINA? - 3

 

THE PBoC [FINALLY] COMES TO THE RESCUE… WELL, SORT OF

Down another -5.8% on its overnight lows, the SHCOMP rallied sharply intraday to close essentially flat on a rumor that the PBoC CSRC, CBRC and CIRC were going to hold a joint press conference to discuss recent market developments and banking liquidity. For now, that mega joint press conference remains a Hilsenrath-style rumor – and somewhat unlikely given the generally silo’ed nature of China’s regulatory branches.

 

Also supportive of the intraday rally in Chinese equities and the pacifying of money market rates was commentary out of Ling Tao, deputy head of the PBoC’s Shanghai branch, which was affirmed by a broader PBoC statement (bold emphasis our own):

 

  • “The People’s Bank of China has provided liquidity to some financial institutions to stabilize money-market rates and will use short-term liquidity operations and standing lending-facility tools to ensure steady markets.”
  • “With the elimination of seasonal and emotional factors, interest-rate fluctuations and the tight liquidity situation will gradually ease.”
  • “Financial institutions’ cash reserves stood at about 1.5 trillion yuan ($244 billion) as of June 21, compared with the 600 billion yuan or 700 billion yuan sufficient under normal circumstances to cover payment and clearing needs. The present liquidity is not insufficient.”
  • “We’ll closely monitor the change of liquidity within the banking system going forward, flexibly adjusting liquidity management based on international payments and the liquidity demand-and-supply situation.”
  • “The PBOC will strengthen communications with market institutions, stabilize expectations and guide market interest rates within reasonable ranges.”
  • “Banks should handle fluctuations in liquidity calmly and avoid irrational behavior.”
  • “The PBOC will provide liquidity support to those banks with temporary needs if they are lending to help the economy. For banks with liquidity-management problems, the PBOC will take corresponding measures according to circumstances to ensure broader market stability.”

 

IS CHINA THE NEXT CYPRUS OR IS CYPRUS JUST A SMALLER VERSION OF CHINA? - 5

 

It’s worth noting that the final point should be taken in the context of Chinese authorities seemingly preparing the country to handle a large-scale, domestic banking crisis – which we still view as improbable over the intermediate-to-long-term.

 

It’s also worth noting that the “if they are lending to help the economy” clause should be taken as a direct shot across the bow to lenders that have been contributing to widespread speculation in China’s fixed assets investment bubble (i.e. all of them). We reiterate our view that Chinese policymakers no longer consider FAI as a sustainable or desired engine for economic expansion and employment/labor income growth.

 

Moreover, that policy shift is extremely negative for industrial commodity prices and anything tangentially linked to the mining CapEx bubble (email us if you’d like to connect with our Industrials Sector Head, Jay Van Sciver, regarding his list of short ideas within this theme).

 

WHERE TO FROM HERE?

As outlined in a research note published early yesterday afternoon, we do think China’s cyclical banking system woes are: A) near fully priced in on an immediate-term basis and B) near fully understood by market participants – inclusive of today’s front-page WSJ callout. As such, we would expect to see a relief rally of sorts at some point over the immediate-term, as speculators follow through thanks to additional clarity out of the PBoC and what may morph into USD-debauching, anti-tapering headlines out of the Federal Reserve.

 

IS CHINA THE NEXT CYPRUS OR IS CYPRUS JUST A SMALLER VERSION OF CHINA? - 4

 

We are however, inclined to fade any relief rally as the SHCOMP approaches its immediate-term TRADE line of resistance up at 2,123. That’s approximately +5.2% higher from today’s closing price – which actually took out the near 4Y lows established in DEC ’12. It remains our view that the real headwinds facing China’s banking system are structural (i.e. NOT cyclical) in nature.

 

For those of you seeking a greater understanding of those risks, please review our recent short-China presentation, as well as the compendium of hyperlinked research notes and slide decks found at the conclusion of this note. As always, if you or anyone on your team has questions on China, please feel free to reach out to us via email at any time. We always look forward to engaging in thoughtful dialogue with clients.

 

Darius Dale

Senior Analyst

 

  • IS OUR BEARISH THESIS ON THE CHINESE FINANCIAL SYSTEM PRICED IN YET? (6/24): On an immediate-term basis, yes. On an intermediate-to-long-term basis, no. A crisis appears unlikely, but structural headwinds will remain.
  • THE CHINESE FINANCIAL SYSTEM IS FREAKISHLY STRESSED (6/19): There appears to be no end in sight for desert-like liquidity conditions across the Chinese financial system.
  • REPLAY PODCAST AND SLIDES: ARE YOU SHORT CHINA [AND OTHER EMERGING MARKETS] YET? (6/12): We think the outlook for Chinese credit growth is structurally impaired. Moreover, we anticipate that growth in non-performing loans will accelerate sustainably over the long term. Lastly, we believe that net interest margins across the Chinese banking industry face immense regulatory headwinds that may ultimately have dire consequences for China’s fixed assets investment bubble. At a bare minimum, investors should steer clear of these obvious value traps over the intermediate-to-long term. Moreover, we continue to believe assets linked to Chinese industrial demand will remain under pressure for the foreseeable future.
  • IS CHINA PREPARING FOR SYSTEMIC FINANCIAL RISK? (6/10): Recent policy developments call attention to the systemic risks facing China’s banking system. Additionally, MAY growth data came in soft.
  • IS A RATE HIKE(S) COMING DOWN THE PIKE IN CHINA? (6/4): No change to our dour view of China’s TREND-duration growth outlook or the pending bifurcation of FAI and consumption growth.
  • 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.
  • BEST IDEAS UPDATE LONG CHINA (NOT); SHORT YEN (4/19): We anticipate the impact of recent and pending regulatory measures to continue weighing on both economic growth and investor sentiment across the Chinese economy.
  • 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.

CCL F2Q 2013 CONF CALL NOTES

We didn't expect much to come out of this call but as always, management is optimistic on yield outlook, particularly in Europe. We just wish it was reflected in the yield guidance. 

 

 

CONFERENCE NOTES

  • Arnold will be CEO in early July
  • Micky will remain Chairman for the foreseeable future
  • Timing of SG&A 
  • 2Q:
    • Capacity increased 1%
    • EAA yield : +4.6%, driven by AIDA, COSTA
    • NA yield: -1%, more dry docks days YoY
    • Net ticket yields: -2.7%
      • EAA brands down 3.8%, declines in Northern Europe offset by increases in Costa and P&O Australia 
    • NA brands down 1.8% driven by promotional discounting at Carnival brand
    • Net onboard and yields: +0.5%
    • Lower fuel prices saved the company 8 cents
  • zero collar fuel hedges: 40% consumption hedged ; 25% in 2017
  • 25 cent dividend to continue
  • CFO guidance of $2.7 bn
  • Net capital investment: $2.1 bn
  • 2H 2013: certain brands expect to increase promotional spending
  • Ex Carnival bookings last 11 wks:
    • NA & EAA: higher YoY at higher prices
  • NA brand
    • Carnival bookings/pricing last 11 wks: lower in the high single digits and low double digits YoY, respectively
      • Over last 6 wks, gradual improvement in volumes and prices
    • Caribbean volumes last 11 wks (ex Carnival): slightly lower YOY at slightly higher prices
    • Alaska bookings (ex Carnival):  signifcantly higher at lower prices
    • European bookings slighlty lower at nicely higher prices
  • EAA brand last 11 wks
    • Caribbean bookings running behind last year but at nicely higher prices
  • 3Q (ex Carnival)
    • Fleetwide bookings: slightly behind at slightly lower prices
    • NA bookings: slightly behind at flat prices
      • Alaska pricing behind
      • European pricing higher
    • EAA bookings: occu slightly behind at lower prices
      • Asia/Australia: bookings nicely higher at slightly higher prices
        • Costa in China particularly strong
    • Ex Carnival, 3Q revenue yields -1.5-2.5%
  • 4Q (ex Carnival)
    • NA bookings: occu slightly lower at slightly lower prices
    • Carnival brand: occu lower at slightly higher prices
    • EAA bookings: occu flat at lower prices
    • Costa occu nicely higher; expect Costa to deliver nice yields in 4Q
  • 1Q (incl Carnival)
    • occu lower at higher prices
    • NA occu lower at nicely higher prices
    • EAA occu lower at slightly higher prices
  • Expect nice yield at Costa in 4Q
  • 1Q 2014 EAA brands bookings lower at slightly higher prices
  • Carnival brand
    • 2013 Forecast YoY profit decline is estimated have a 50% per share on the company's YoY results. Of this, approximately $.27 is primarily due to rent lower revenue euros, $.16 results from our failings and repair costs related to the Carnival triumph Triumph refurbishments, increase in Carnival's and higher plan marketing spend in the second half of the year for Carnival Cruise Lines amounted to seven cents a share, and that builds to the $.50 to cleaning declining year-over-year results.
    • Recovery will be gradual - will take 2-3 years
  • Costa will return to profitability in 2013
    • Italian market (largest market) has significantly improved
    • Recent bookings volume strong
    • Expect higher yields in 3Q and 4Q
  • Believes worst is over  
  • Full rollout of scrubber technology in 2014
  • New ships will be far more fuel efficient

 

Q&A

  • CCL consultants say it will take 3 years to regain its brand perception
  • Some of the repair cost will be in 3Q
  • Vessel enhancement costs in 2013: 6-7 cents
    • Some vessel enhancement costs in 2014
  • Will begin putting scrubbers on tomorrow's ships later in 2013
  • Believe they can mitigate a substantial portion of the worst-case $265MM additional costs from the change in sulfur requirements
  • Expects Carnival brand yield improvement in 2H 2014
  • 4Q will be a little better than 3Q as they continue to see improvement in Europe
  • 3Q and 4Q yield will be mostly driven by pricing
  • Higher promotional spend 2H 2013: A lot of it is going to be focused on travel agents and travel agent swap marketing, more trade advertising. A lot of it is social media and web-based marketing and TV-based. 
  • A little puzzled by Europe strengthening recently
  • When CCL went through the guidance in December, they had indicated that they expected northern European brands to be down, and expect Costa to get back about half the yield previously lost. As the months and weeks passed, Europe was worse than expected and CCL brought down yield guidance in both northern Europe and for Costa. Costa is only expected get back a quarter of what it previously lost. Even though northern European brands, the yield is still going lower, the yields at P&O cruises and AIDA are doing incredibly well. So it's a directional change in reduction.
  • Vessel enhancements: 2H 2013, 2014 and 2015
  • Carnival brand:  they haven't done anything to reduce prices since prices been reintroduced.
  • FY 2013 yield guidance: NA will be slightly more than the -2-3%; Europe slightly less; premium/luxury brands in NA is flat
    • Ex Carnival, rest of NA brand pricing would have to be flat to reach upper end of guidance
  • Europe, essentially what they've seen in the last 11 weeks is an uptick in European bookings and pricing across substantially all brands but since the last guidance color (5-6 wks ago), nothing has changed

Hedgeye Morning Call Q&A

Hedgeye CEO Keith McCullough offers his latest thoughts on the liquidity brouhaha in Beijing. Specifically, just how bad is the situation in China and do people fully appreciate it?

 


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Morning Reads on Our Radar Screen

Takeaway: A quick look at top stories on Hedge's radar screen.

Keith McCullough – CEO

Blackhawks' late goals stun Bruins to win Stanley Cup (via NHL.com)

Two Fed Presidents Emphasize Stimulus to Persist After QE Taper (via Bloomberg … KM note: Get out of our lives already)

 

Morning Reads on Our Radar Screen - earth

 

Josh Steiner – Financials

Bankrate US Home Mortgage 30 Year Fixed National Avg pops up to 4.51% (up another 15 bps overnight) (via Bloomberg)

Corzine facing civil charges on MF Global collapse (via Marketwatch JS note: Corzine finally facing (a little) justice. #ItsAboutTime)

Wall Street’s $8 Billion CMBS in Limbo as Bulls Retreat (via Bloomberg)

 

Daryl Jones – Macro

Credit Warnings Offer World a Peek Into China’s Secretive Banks (via New York Times)

 

Brian McGough – Retail

Neiman Marcus Files for IPO (via WWD)

 

Kevin Kaiser – Energy

Apollo's EP Energy looking at IPO – sources (via Reuters)

 

Howard Penney – Restaurants

Restaurant Franchises Are Hiring. Are They Dodging Obamacare? (via Businessweek)

McDonald's To Stop Serving Halal Food At 2 Michigan Restaurants (via HuffPost)

 

Jonathan Casteleyn – Financials

U.S. FTC Said to Open Probe of Oil Price-Fixing After EU (via Bloomberg)


DB MAKES THE MACAU CALL

It was inevitable so what do we do now?

 

 

As we speculated in our Macau note yesterday, a sell side firm would likely make a negative call based on the China credit situation.  Indeed, the Deutsche Bank analyst pulled the plug on a number of Macau stocks today.  We don’t disagree with the call from a Trend (intermediate) perspective, but we think the downgrade could push the stocks into buy territory over the Trade duration.

 

Our call yesterday was to wait for the inevitable downgrade and look to buy on that weakness.  The fact that the downgrade came from an influential analyst creates an even better opportunity. 

 

We like the short-term Trade here and are still bullish on the long-term Tail.  We share DB’s concerns over the Trend intermediate term.  As we wrote about in our 05/22/11 note “A VIP SLOWDOWN IN THE CARDS?”, we’ve found that China central bank moves impact the Macau junket market on a 2-3 quarter lag.  VIP is likely to be under pressure later this year.

 

However, over the near-term, we think the setup is positive as July could be a 20%+ growth month in Macau to go along with June’s high teens growth.  We like MPEL and MGM on today’s likely weakness.  MPEL looks to post another beat for Q2.  MGM Macau’s performance has been surprisingly strong and MGM could also benefit from terrific May Strip revenues which we expect to be reported in two weeks (see our note yesterday “MONSTER MAY”).   


Talk Is Cheap

Client Talking Points

CHINA

Down hard, then rumor, then bounce ... It looks like a "Bernanke/Draghi" type playbook in Beijing as the entire world attempts to watch what we cannot see. The Shanghai Composite closes down -0.2% overnight. #Oversold, but still crashing. Looks like hell down -19.5% since Feb 5. Bouncing on rhetoric doesn’t solve the long-term issue.

FTSE

Doing the dead cat bounce thing within a developing bearish TREND across all of European Equities. I learn the most during the bounces. This bounce in European Equities hasn’t seen one - not one-  major index recapture any of my intermediate-term TREND lines. The FTSE gained +0.8% to 6075, but it's still well below 6398 TREND resistance. DAX TREND line = 8014.

GOLD

A bear market "bounce" in gold of just +0.14%. Guess what? That is not going to get anyone excited about Gold. Nor will a 10-yr UST Yield of 2.5%. Nor will a US Dollar recapturing $81.21 TREND support. Gold is turning into a good proxy for deflation – deflating Bernanke Bubbles, that is...

Asset Allocation

CASH 63% US EQUITIES 13%
INTL EQUITIES 6% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 18%

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

We've had a 0% asset allocation to Fixed Income recommended to clients for almost 6 months

@KeithMcCullough

QUOTE OF THE DAY

"I am a man of fixed and unbending principles, the first of which is to be flexible at all times."

- Everett Dirksen

STAT OF THE DAY

Looking for a mortgage? Bankrate US Home Mortgage 30-Year Fixed National Average pops up to 4.51%. That's up another 15 basis points overnight. (Bloomberg)


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