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BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE

Takeaway: A deteriorating GIP outlook and an increasingly clear status-quo policy outlook leave us negative on China w/ respect to the TREND duration.

We’re probably a bit late with this research note, largely because the last few months of mixed policy signals amid rapidly souring economic data left us in “do nothing” mode with respect to our preferred China exposures. Recall that we’ve been advocating a long “New China”/short “Old China” investment strategy since early December:

 

 

That investment strategy has performed modestly well (+577bps on an equal-weighted basis using the CQQQ, CHIQ, CHIX, and CHXX etfs as proxies), though it has certainly given up a lot of performance juice in recent weeks. This narrowing of performance between “New China” plays and “Old China” plays was a key leading indicator of the fundamental outlook we are now modeling in from a GIP perspective – with policy guidance being the other.

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - EM Divergence Monitor

 

Our GIP outlook for China isn’t all that negative from an absolute perspective (I mean, does anyone actually care if Chinese growth is +7.2 or +7.4 percent?), but we now see Chinese #GrowthStabilizing in 2Q (vs. an initial projection of #GrowthAccelerating) amid a likely acceleration in reported inflation (i.e. the GDP deflator – assuming China’s real GDP calculus is, in fact, “real” calculus).

 

The back half of the year should see the Chinese economy mired in Quad #3 (i.e. growth slowing as inflation accelerates) – largely because the Chinese economy lacks sufficient sequential momentum for us to justify China “comping” increasingly difficult comps as we progress through the year.

 

Moreover, both credit growth and headline GDP growth tend to be weighted towards the first half of the calendar year, so seasonality is in favor of this research view.

 

Lastly, now-consistent policy guidance out of key members of the Politburo, State Council and PBoC have severely quashed our expectations of any major fiscal or monetary stimulus over the intermediate term.

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - CHINA

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - GROWTH

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - GDP COMPS 

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - INFLATION

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - CPI COMPS

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - FX

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - Median CPI   US  Eurozone and China

 

Going back to China’s lack of sufficient sequential momentum, the balance of Chinese economic growth data shows a general trend of rather muted MoM improvement – if any – across a number of key indicators. On a trending basis, Chinese growth data remains more-or-less flat – with the exception of Chinese trade data, which has shown marked improvement in recent months.

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - China High Frequency GIP Data Monitor

 

Looking to China’s property market tells a sharply divergent tale – particularly one of sharp deterioration on a trending basis. Specifically, headline measures of financing, supply, demand and price are all crashing with respect to their trailing 3M, 6M and/or 12M trends. It’s worth noting that the recent collapse in land areas purchased is a headwind for both prospective real estate development and local government finances – the latter of which could limit the scope of any additional targeted fiscal stimulus efforts.

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - China Property Market Monitor

 

Given that property investment accounts for ~20% of Chinese GDP according to some estimates, this is not good. So much so that the PBoC had to embark on qualitative easing today, urging banks to accelerate residential mortgage lending in order to help curb the sharp deceleration in demand that has spilled over into China’s Tier 1 cities in recent months (residential sales values dropped -31% YoY in APR and are trending -27% YoY in the YTD).

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - China Months Supply

 

One thing Chinese banks can do is lower mortgage rates; while they are allowed to lend down to 70% of the PBoC’s benchmark 5+ year mortgage rate (currently at 4.5%), they’ve actually kept the cost of capital fairly high in the YTD. The PBoC’s latest Quarterly Monetary Policy Report showed mortgage rates averaging 6.7% in 1Q14, up +17bps QoQ.

 

The aforementioned maneuver out of the PBoC follows a plethora of piecemeal easing measures in recent months, including but not limited to:

 

  • Rhetorically extending the implementation of the nationwide property tax trial;
  • Allowing developers to tap equity markets for fuding;
  • Allowing property developers to markedly accelerate off-shore bond issuance ($8.8B in the YTD vs. $17B for all of 2013); and
  • Allowing insurers to boost quotas for real estate investment (up to 30% - inclusive of infrastructure assets – from 10% previously).

 

In summary, our call on China is simple: with real GDP growth upside seemingly capped at/near +7.5% for the foreseeable future and asymmetric downside heading into 2015 (e.g. principle due on listed Chinese property developer debt more than doubles to 69.7B CNY next year as funding slows sharply currently; deposit rate deregulation threatens both marginal lenders and borrowers as the cost of capital remains artificially low throughout the Chinese financial system; and capital account deregulation without broad expectations for structural CNY appreciation could be disastrous), we see no reason for investors to get involved in China here other than “valuation”.

 

Valuation is not a catalyst…

 

What are catalysts, however, are GIP fundamentals and tail risk. While we continue to believe that both the political resolve and fiscal & monetary firepower will continue to mitigate the latter, neither are currently skewed in favor of being long anything China at the current juncture. At best, investors should remain on the sidelines.

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - PILLAR III

 

BOOKING RESEARCH ALPHA IN CHINA; TURNING NEGATIVE - EXPLANATION TABLE

 

Don’t ever forget that China’s economic reform agenda, while likely structurally positive for the Chinese economy, may not be all that fun for investors in the short term – which is actually something we concluded roughly 2.5 years ago! Dozens of research notes and several conference calls later, what have we really learned?...

 

Enjoy your respective evenings; feel free to ping us with follow-up questions.

 

DD

 

Darius Dale

Associate: Macro Team



Poll of the Day Recap: With Slight Edge, 51% Say Next Stop for $SPX is 1,800

Takeaway: 51% said 1,800; 49% said 2,000.

The S&P 500 closed at a record high yesterday and is currently sitting at 1,900. But, as CEO Keith McCullough pointed out this morning, “Calling total US Equity Volume a cricket yesterday wouldn’t be giving it its due credit! On the “all-time-high” CNBC Dow cheers (RUT and QQQ are down -5% to -6% from their year-to-date highs) volume was down -10% and -31% versus one-month and three-month averages, respectively.”

 

We wanted to know what you thought, so we asked in today’s poll: What’s the next stop for the S&P 500?

 

Poll of the Day Recap: With Slight Edge, 51% Say Next Stop for $SPX is 1,800  - bull3


At the time of this post, in a very close, neck-and-neck race, 51% said the next stop would be 1,800; 49% said it would be 2,000.


Those who believe it will drop to 1,800 say it’s due to “money flow and volume.” Additionally these voters said:

  • “As the FED continues its taper the market will eventually crack and fall below 1800, the FED will have no choice but to un-taper, that is when it will get really fun!”
     
  • “This tape is up on air as the market's new leaders are hiding places. No real mo mo leaders. Great divergences, sentiment sucks, Fed out of gas, economy has yet to prove it is catching on despite Fed, Fed is buying futures and shorting $VIX, etc, etc.”
     
  • “We tested two leading and separate indicators (R-squared in the 90s) for S&P 500 earnings and the multiple.  We're getting 1,500 on the S&P 500 if trends for either or both slow even modestly.”
     
  • “I'm guessing that margin debt would begin to decrease as the risk/reward heading to $2000 isn't as favorable and margin debt gets expensive if we chop sideways.  I'm showing overbought today on my system.”
     
  • “The market may creep slightly higher but no strength to get to 2000. The new highs are by less and less each time.”
     

However, those who said it will go to 2,000 simply believe it’s a bull market:

  • “This market just doesn't want to go down. Bad news, good news, it does not seem to matter.”
     
  • “The world is addicted to stimulus, and all the weak global economic data is demanding of MOAR stimuli ...”
     
  • “As much as I expect and want the S&P to correct, the market just doesn't want to break it lower. Honestly I don't even know what will cause the market to drop anymore. The path of least resistance just seems to be higher.”
     
  • “The lower rates go the MORE bullish I get on stocks - the historical regression of rates to P/E ratios is inversely correlated so multiples can stay where they are currently - stocks will drop once ‘bubble’ talk is over - bubble talk has already moved investors to the side lines.”
     
  • “There is no reality to this market.  The Fed has and will continue to manipulate all markets.  I believe they have also been buying the index funds.  Don't say they can't.  Just look at them buying indirectly the debt!  There is always a way.” 

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CHIN MUSIC: APRIL RETAIL SALES

Headline Retail sales grew +0.1% sequentially while the Control Group measure (GDP input) declined -0.1% sequentially with electronics spending and the e-sales and dining-out proxies each decelerating on a MoM, YoY and 2Y basis. 

 

CHIN MUSIC:  APRIL RETAIL SALES - RS Control Group 

 

The positive revision to the march data will help drag 1Q GDP back to positive territory but the early read through for reported 2Q growth is less sanguine – particularly in the context of consensus estimates  which have increased ~20% over the last month to +3.3%.  

 

CHIN MUSIC:  APRIL RETAIL SALES - COD 

 

 

Meanwhile, sales-to-Inventory ratio’s continue to peak despite the spread between nominal spending and nominal earnings growth re-expanding in recent months. 

 

With wage growth running sub-2% and savings rates at a cycle low (& the very low end of the historical range) the upside to consumption growth over the immediate/intermediate term remains very much constrained, in our view. 

 

CHIN MUSIC:  APRIL RETAIL SALES - Nominal PCE vs Nominal Earnings April 051314

 

CHIN MUSIC:  APRIL RETAIL SALES - Savings Rate

 

CHIN MUSIC:  APRIL RETAIL SALES - IS ratio 

 

In short, with the ~24% of the domestic economy that is retail sales off to an inauspicious start, consumption has some significant hay to bale in order to best rising consensus growth expectations and re-capture last year’s slope of growth.

 

With the dollar and 10Y broken and food/energy/housing inflation taking down a greater share of wallet, we're not convinced that consumption acceleration materializes.  

 

CHIN MUSIC:  APRIL RETAIL SALES - Retails Sales Then vs Now

 

CHIN MUSIC:  APRIL RETAIL SALES - Retail Sales table

 

 

Christian B. Drake

@HedgeyeUSA


Daily Trading Ranges, Refreshed

Takeaway: Last chance to buy what’s been working all year? Slow-growth-yield-chasing is where the performance is at.

Editor's note: This unlocked edition of Daily Trading Ranges was originally provided to subscribers on May 13, 2014 at 7:22 a.m EST. For more information on how you can receive these levels every morning in your inbox click here.

 

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BULLISH TRENDS

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Daily Trading Ranges, Refreshed - Slide6

BEARISH TRENDS

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Daily Trading Ranges, Refreshed - Slide11

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