- While the anticipated dead-cat bounce in the Shanghai Composite Index off the aforementioned lows has lasted longer (i.e. in duration) than we expected, we are encouraged as short-sellers of China to see that the index failed at its intermediate-term TREND line of resistance this week.
- That explicit quantitative signal is supportive of our fundamental research view that [largely] policy-induced banking sector headwinds will weigh on Chinese economic growth with respect to the intermediate-term TREND and the long-term TAIL (click HERE for the initial presentation of that thesis; click HERE for the latest update).
- Simply put, while Chinese economic growth has indeed stabilized at these historically-low rates [for now], we don’t see any degree of upside that would be supportive of any long-term bullish bias in Chinese stocks; nor do we expect Chinese fiscal and monetary policy to be supportive of meaningful speculation on the long side of Chinese equities from here.
- Lastly, in the section below titled, “WHERE TO FROM HERE”, we walk through precisely why Chinese growth data may not be as marginally healthy as it has [generally] appeared recently. In fact, our in-depth analysis of China’s financial sector lends credence to the view that China’s mini-growth rebound may be short-lived.
WHERE WE’VE BEEN
We’ve been on the right side of the wild cyclical swings that investors have become accustomed to in the Chinese equity market for well over a year now:
- Bearish from 6/7/12 to 12/10/12: -9.1%;
- Bullish from 12/10/12 to 4/19/13: +7.7%;
- Neutral from 4/19/13 to 6/7/13: -1.5%; and
- Bearish from 6/7/13 to present: -5.8%.
The caveat to that opening statement is that, as overt bears on China, we’ve been right squeezed by the +8% rally in the Shanghai Composite Index off of its late-JUN (6/27) lows to its 8/13 cycle peak. Hopefully you took our explicit advice to reduce your short exposure to China right around the index's YTD lows (when we openly proclaimed that our bearish thesis had been priced in on an immediate-term basis), but that’s neither here nor there.
What is both “here and there” is the fact that while the anticipated dead-cat bounce in the Shanghai Composite Index off the aforementioned lows has lasted longer (i.e. in duration) than we expected, we are encouraged as [rhetorical] short-sellers of China to see that the index failed at its intermediate-term TREND line of resistance this week.
That explicit quantitative signal is supportive of our fundamental research view that [largely] policy-induced banking sector headwinds will weigh on Chinese economic growth with respect to the intermediate-term TREND and the long-term TAIL (click HERE for the initial presentation of that thesis; click HERE for the latest update).
Simply put, while Chinese economic growth has indeed stabilized at these historically-low rates [for now], we don’t see any degree of upside that would be supportive of any long-term bullish bias in Chinese stocks; nor do we expect Chinese fiscal and monetary policy to be supportive of meaningful speculation on the long side of Chinese equities from here.
MERE STABILIZATION IS BULLISH WHEN BARRONS’ FLAGS CHINA’S “LOOMING CREDIT CRISIS”
On the same day when we were making the call that the bear case had been priced in on an immediate-term perspective, Barron’s (a publication we have a great deal of respect for) published this beauty:
Needless to say, the consensus attitude among investors had become that China was fast-approaching its much bandied about “hard landing” – a research view we’ve never bought into. Such hysteria prompted various officials to come out and affirm that Chinese growth would indeed stabilize at/around current levels:
- First, Chinese Finance Minister Lou Jiwei proclaimed at the JUL US/China Summit that 6.5% real GDP growth in 2013 “may be tolerable”;
- Then, the official state-run Xinhua News Agency subsequently proclaimed that what Jiwei really meant to say was that he has “no doubt” that +7.5% target would be achieved; and
- Finally, Chinese Premier Li Keqiang stated plainly that +7% real GDP growth is the “bottom line” for 2013.
At the time, we weren’t really sure what to do with all that except to expect anything from a sequential flattening of the then-negative slopes to a modest improvement in Chinese growth data in JUL, which, for the most part (other than some noteworthy exceptions), is precisely what happened:
- JUL Manufacturing PMI: 50.3 from 50.1 prior
- The New Orders index ticked up to 50.6 from 50.4 prior
- The New Export Orders index ticked up to 49 from 47.7 prior
- The Employment Index ticked up to 49.1 from 48.7 prior
- JUL HSBC Manufacturing PMI: 47.7 from 48.2 prior
- The New Orders index fell to 46.6, which was the lowest since AUG ’12
- The New Export Orders index contracted for a fourth-consecutive month
- The Employment index slowed to the lowest level since MAR ’09
- JUL Non-Manufacturing PMI: 54.1 from 53.9 prior
- JUL HSBC Services PMI: flat at 51.3
- JUL Industrial Production: +9.7% YoY from +8.9% prior
- JUL Retail Sales: +13.2% YoY from +13.3% prior
- JUL YTD Fixed Assets Investment: flat at +20.1% YoY
- JUL M2 Money Supply: +14.5% YoY from +14% prior
- JUL Total Social Financing: +CNY808.8B MoM from +CNY1.04T prior
- New Loans: +CNY699.9B MoM from +CNY860.5B prior
- JUL Electricity Consumption: +8.8% YoY from +6.3% prior
- JUL Exports: +5.1% YoY from -3.1% prior
- JUL Imports: +10.9% YoY from -0.7% prior
- JUL Trade Balance: $17.8B from $27.1B prior; -$7.5B YoY from -$4.8B YoY prior
- JUL Real Estate Climate Index: 97.4 from 97.3 prior
WHERE TO FROM HERE?
In looking at the data, we can reasonably conclude that Chinese growth has indeed stabilized, though the sharp slowdown in credit growth (i.e. the lifeblood of the Chinese fixed-assets investment-driven economy) is cause for concern with respect to Chinese growth in 2H13. Additionally, property prices continue to accelerate and, while combating property prices is no longer a top priority for the PBoC, we are curious to see if further macroprudential tightening measures are coming down the pike – as recently hinted by Zhu Zhongyi, vice president of the China Real Estate Industry Association.
On the positive side of the ledger, our favorite concurrent-to-slightly-leading (only because we get the data on a daily basis) indicators for Chinese growth auger positively for China’s AUG monthly growth data as well (they front-ran the positive inflection in JUL).
Additionally, money market rates on the short end of the curve continue to ease on a MoM and QoQ basis as the PBoC has become a consistent net provider of liquidity into the Chinese financial system via the issuance of reverse repos and allowing previously-issued central bank bills to expire on a net basis.
But… we continue to see signs of deterioration underneath the hood. Across the maturity curve, interest rate swaps continue to trade well above the current cost of capital in China. In the past, we’ve interpreted this market signal as a sign that monetary policy tightening was increasingly probable over the intermediate term. We don’t view that scenario as likely at the current juncture; rather, we believe the market sees what we see: a prolonged erosion of financial liquidity, at the margins, will continue to apply upward pressure to money market rates over the intermediate-to-long term.
That erosion of financial liquidity can be further identified in today’s failed bond auction by the Export-Import Bank of China – which couldn’t price 2Y or 7Y paper – and in China’s sovereign yield curve. China’s 10Y-2Y sovereign yield spread has widened modestly off its JUN mini-crisis spread lows, but it has yet to buck the trend of tightening that has been in place for just over one year now. Moreover, recent compression from the early-JUL highs is being driven by a dramatic backup in both the short end of the yield curve that is in excess of the also-noteworthy backup in the long end of the yield curve.
The mere fact that both ends of China’s sovereign debt market is selling off should be interpreted as supportive of our view that the Chinese economy will be increasingly liquidity constrained, at the margins, as NPLs – both of the reported and unreported (i.e. debt rollovers/evergreening) genres – accelerate sustainably. A dour secular outlook for “capital” flows via the trade surplus is also supportive of our liquidity constraint thesis.
All told, there’s simply not enough liquidity present in the Chinese financial system currently and on a go-forward basis to consistently justify pricing bonds at yields well below what the future cost of capital will likely be for Chinese banks when the PBoC decides to liberalize deposit rates as it recently did with lending rates.
The aforementioned dynamic should remain a structural headwind to the overall growth rate(s) of the Chinese economy, at the margins, given the country’s overreliance on fixed assets investment as the primary engine of growth.
Unless, of course, the Politburo plans to thread the needle with respect to their structural economic rebalancing agenda, which calls for slower overall GDP growth amid an elevation in the respective roles of the Chinese consumer and services sectors. Good luck “massaging” the data enough to get anyone to believe that!