“We have two classes of forecasters: those who don’t know – and those who don’t know what they don’t know.”
-John Kenneth Galbraith
This morning you are going to see a host of perpetually bullish market forecasters start to get worried about China. It’s about time. As we have been saying for the last few months, the Chinese Ox is in a Box in Q1 of 2010.
The way that this works is that China reports a better than “expected” GDP number for Q4 of 2009, CNBC cheers, but the local market reaction in both China and Hong Kong is lower stock prices. Then, all of the revisionist forecasters start asking why? And, finally, they end up knowing what they didn’t know.
In the aggregate, China’s Q4 GDP is the equivalent of the bark on the tree. Whereas the December and January growth numbers, combined with an explicit change in Chinese monetary policy, is the forest. China is tightening monetary policy as inflation accelerates. Slowing sequential growth and accelerating sequential inflation is what is putting Chinese stocks in an intermediate term box.
Slowing growth and accelerating inflation? Yes, that’s been our forecast, and here is the data:
1. Industrial production growth slowed in December to +18.5% year-over-year (missing expectations)
2. Consumer Price Inflation (CPI) accelerated, big time, in December to +1.9% year-over-year (up from +0.6% last month)
3. Money Supply growth (M2) slowed 200 basis points in December to +27.7% versus a record high of +29.7% (y/y) in November
What’s most interesting about this call for China to tone down what we have called speculative loan and money supply growth, is that the Chinese government absolutely agrees with us. They will not pander to the politics of inflating asset prices. They have learned what not to do from us.
Within China’s Q4 economic growth report, the government removed the language of “moderately loose monetary policy.” For all of the US Federal Reserve watchers out there, that would be the equivalent of Bernanke removing the “extended and exceptional” language in his currently conflicted and compromised stance.
It’s one thing to be in the political penalty box for doing something like starving your citizenry of fixed income on their savings accounts. It entirely a different thing to put yourself in the box with an explicit attempt to slow speculative borrowing. The latter is China’s strategy. The former is America’s. And for those like Goldman who came out saying “buy China” on January 1st who didn’t know that… well, now they know.
We hosted our Macro Themes conference call for our subscribers last week, and we will be presenting the case for the Chinese Ox In a Box later on today on Yale’s campus at an investor lunch. If you’d like a replay of our call and the slides, please email sales@ hedgeye.com.
Now that I have issued you a shameless sales plug, here are the top 3 conclusions from our Chinese Ox In a Box presentation:
(1) Money supply growth slowing. Right now the central bank has not stated a 2010 target for growth in M2, but had a 17% goal last year. The actual growth rate was more than 25% for 2009, peaking at 29.7% growth YOY in November. We think that money supply growth could be cut by 1/3 of its current pace.
(2) Loan growth slowing in 2010. Chinese banks extended 9.59 trillion Yuan of loans in 2009, compared with 4.15 trillion Yuan in 2008 (+131% y/y growth). We think loan growth could drop by at least 1/3 of its current pace.
(3) Bullish on the Chinese currency. The Chinese Yuan appreciated +18.7% between 2005 and 2008, but has been basically flat for the past 18 months. This will change, when the Chinese government decides to raise both lending and currency rates again in 2010. We think that currency appreciation will be at least +3-6% in the coming 6-12 months.
Additionally, here are the key lines of resistance that have now built themselves into real-time Chinese stock market prices:
1. China’s Shanghai Composite Exchange = 3204
2. Hong Kong’s Hang Seng Index = 21,829
We remain bullish on China’s long term TAIL, but that’s an investment view that has 3 years in duration. When one is bullish on something for the long term, that doesn’t mean they have to be bullish on it at every price.
Our call for Q1 on China is simply that, an intermediate term call of caution. It’s what our Hedgeyes are forecasting so that you can proactively manage the risk associated with stock market prices that have stopped going up.
Best of luck out there today,
KM
LONG ETFS
EWC – iShares Canada — We remain bullish on the intermediate term TREND for Canada. With a pullback in the ETF on 1/15/10 we bought Canada.
XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.
UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).
VXX - iPath S&P500 Volatility — The VIX broke down to our immediate term oversold line on 1/6/10, prompting us to add to our position on VXX.
EWG - iShares Germany —Buying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.
EWZ - iShares Brazil — As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero. On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.
CYB - WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.
TIP - iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.
SHORT ETFS
IEF – iShares 7-10 Year Treasury — One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.
RSX – Market Vectors Russia — We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.
EWJ - iShares Japan — While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.
SHY - iShares 1-3 Year Treasury Bonds — If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.
