“The tighter you squeeze, the less you have.”
China is tightening reserve requirements on its banks by another 0.5% this morning. This is not new. This is a longstanding reminder that the tighter you squeeze a banker’s lending terms, the less he has.
In sharp contrast to Western politicians, the Chinese government doesn’t seem too keen on bailing out bankers or juicing up the pre-market futures of its stock market. China’s strategy in dealing with lenders appears to be far less diplomatic.
After seeing that moon-shot Chinese loan growth number of 1.39 Trillion Yuan for the month of January (reported yesterday), Big Brother China appears to share the tactical view of one of America’s Three Stooges, Moe Howard, telling their local lenders that, “I’ll squeeze the cider out of your Adam’s apple.”
With that, we enter the waning hours of China’s Lunar Year – the Year of The Ox – and, oh, what a year it was. By the end of the Western world’s calendar year, the Shanghai Composite was up +80%, GDP was running double digits at +10.7%, and China was still reporting year-over-year deflation in its Consumer Price Index (CPI). Economic nirvana, in the rear-view. Then, after Goldman said “buy China” in early January, the music of free moneys stopped.
Alongside Buck Breakout and Rate Run-up, this has been one of our Top 3 Macro Investment Themes for Q1 of 2010. We called it Chinese Ox In a Box. We will be reviewing these 3 Macro Themes on a special intra-quarter conference call after this long weekend. If you’d like to participate in that call, please email . As usual, our subscribers will have some great questions and we won’t have Investment Banking Inc. auditing our answers.
We were bullish on China for most of last year, and our long term TAIL (3 years or less) call on China’s economy remains intact. However, our call for the Chinese Ox In a Box here in Q1 has us short China (CAF) for both immediate and intermediate term durations. We call these durations TRADE and TREND.
Conceptually, we do not like to think within the sell-side box. We pressure ourselves to consider multiple durations and multiple price outcomes across those durations. Some investors have one duration – long term - and are willing to remain long something like China’s stock market for 10-20 percent corrections. As Real-Time Risk Managers, that’s definitely not what we do.
Currently, because we are bearish on China doesn’t mean we are calling for a crash. We are simply calling for what the Chinese government has told us it is going to do – slow speculative growth. There are plenty of places to quantify Chinese speculation, but here are 3 factors we have been proactively anchoring on:
1. Money supply growth
2. Chinese Yuan-based loan growth
3. Chinese stock prices
Money supply growth (M2) is already slowing (from +29.7% y/y growth in November to +26% y/y just reported for January). Chinese Yuan based loan growth is accelerating (the January print of 1.39T Yuan implies y/y growth of 73%! versus last year’s record +52% annualized pace). And Chinese stock prices are some of the worst performing, globally, for 2010 to-date.
So, all in, 2 of 3 fixes are in motion and the last one to fix is most likely to correct most abruptly. To some extent, seeing a final rip higher in Chinese loans this past month makes sense. If you know Big Brother China is going to tighten, you probably clamor to borrow as much as you can before he actually does good by his promise.
You see, in China, they mean what they say, and they do what they mean. While the Chinese have yet to raise interest rates on their benchmark lending rate or allow the Chinese Yuan to appreciate, those two things are coming to a CNBC pre-market open theater near you as well. So, again, that’s a foreseeable global macro risk that you shouldn’t wake up surprised to like people are, evidently, here in the US this morning.
From a risk manager’s perspective, I can simplify all 3 of the aforementioned research factors by correlating them with the lines of support and resistance in my 3 factor duration model (TRADE, TREND, and TAIL). For the Shanghai Composite, here are those lines:
1. TRADE line resistance = 3098
2. TREND line resistance = 3176
3. TAIL line support = 2881
Put another way, I will cover my short position in China (CAF) as the real-time market price approaches my long term TAIL of support at 2881. Last night, the Shanghai Composite closed at 3018 (down -7.9% YTD), so that gives me another -4.5% of downside from here.
Again, I am currently not calling for a crash, nor am I saying I may not start to call for a crash. What I always say is 1. that as the game changes, I will, and 2. that as people start to freak-out about China, I have a proactive plan to cover my short position and consider the long side again. Everything has a time and a price.
A drop to 2881 would equate to a -13.7% correction in Chinese equities versus the recent cycle-peak made of 3338 on November 23, 2009. As the crowd rolls in here worrying about Chinese tightening, you want to roll out. Understand that this situation is A) not new and B) likely to continue, to a point.
Chinese property stocks peaked in July of 2009. The healthy correction in those stocks obviously isn’t new either. Yes, “the tighter you squeeze, the less you have,” but markets move on expectations, not yesterday’s news.
Expectations for Chinese bankers and levered long only stock market speculators alike are well entrenched. They expect to have the “cider squeezed out of their Adam’s apple” if they don’t tone it down. Just remember that as CNBC scurries away from focusing you on Greece.
Best of luck out there today and have a great long weekend,
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).
EWG - iShares Germany — We added to our position in Germany on 2/4/10 on 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.
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.
GLD – SPDR Gold — We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.
CAF – Morgan Stanley China — The Chinese Ox Remains In A Box. We shorted CAF on 2/10/10 ahead of another inflationary report that registered China’s CPI at +1.5% in January Y/Y, and PPI at +4.3% Y/Y.
RSX – Market Vectors Russia — We shorted Russia on 2/9/10 and maintain our intermediate term TREND bearish view on the price of oil.
XLP – SPDR Consumer Staples — The Consumer Staples sector finally broke both our TRADE and TREND lines on 2/8/10. Given how many investors own these stocks because it was a "way to play the weak US Dollar" last year, we have ourselves another way to profit from a Buck Breakout with this short position.
EWW – iShares Mexico —Mexico short is a solid compliment to our concerns about sovereign debt risks and our bearish intermediate term view on oil.
EWJ – iShares Japan — We re-shorted Japan on 2/2/10 after the Nikkei’s up move of +1.6%. Japan's sovereign debt problems make Greece's look benign.
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.