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Unveiled in early January, our Chinese Ox in a Box 1Q10 theme called for an economic slowdown in China. We seen just that in the equity markets, reflected by the Shanghai Composite and Hang Seng posting YTD declines of -22% and -11%, respectively. Much of the negative equity performance has been the result of government tightening to dampen inflation pressures and cool an overheating property market, which, for the most part, have been priced in. Still, concerns regarding the Eurozone’s fiscal and debt crisis, a domestic property bubble on the verge of rapid collapse, domestic wage issues, and international pressure are negatively impacting growth outlooks even beyond what we’ve seen in the numbers thus far. If yesterday’s PMI release was any indication (alongside copper breaching its long term TAIL line of support $3.03/lb), the Chinese Ox could very well be boxed in for quite some time going forward.

Below is a quick summary of recent developments from the last week which are additive to the current bear case for China. While we certainly aren’t recommending you join the “short everything China” trade now, we do think the latest developments out of China suggest further downside risk.

5/25 – More tightening in the property market:

  • Shanghai to introduce property tax trial next month
    • Estimates of an annual tax of 1.5%
    • Prices for new homes dropped 16% in Shanghai for the week ended May 23rd
  • Ronnie Chan, chairman of Hang Lung Properties said residential real estate prices in the mainland could fall by 20% - 30%  from current levels
    • Real estate investment is 12% of Chinese GDP at most recent readings

5/27 – Liquidity drying up:

  • China’s benchmark money-market rate rose 24bps to 2.4% - the highest levels since Feb. 12th
    • Prompted China to offer higher yields on short term bills @ auction (up 4bps to 1.49%)

5/28 – Domestic investors seeking returns forced to chase IPOs, which are now in a bubble:

  • Chinese IPOs beating Chinese benchmark indices by an average of 33 points in their first month of trading – best in the world YTD
    • Chinese IPOs raised $25B YTD due to many Chinese individuals being restricted from Int’l markets
    • P/E of Chinese IPOs: 46x vs. Shanghai Composite (16x) vs. Shenzhen-listed securities (23x)
    • Chinese IPOs gained an average of 32% in the first month of trading

6/1 – PMI slowing sequentially; property development and transactions eroding sequentially; domestic consumption slowing sequentially; battle over wages continue; China continues to get called out for “cheating”; and China increases its efforts to add liquidity to a financial system that has been drying on the heels of tightening in the property market and news out of the Eurozone:

  • PMI 53.9 in May vs. 55.7 in April vs. 54.5 consensus
  • HSBC PMI 52.7 in May – the lowest in a year
    • HSBC Index more weighted toward smaller, privately-owned businesses (400 manufacturing companies)
  • PMI components            
    • Output 58.2 in May vs. 59.1 in April
    • New Orders 54.8 in May vs. 59.3 in April
    • Export Orders 53.8 in May vs. 72.6 in April
    • Input Price Index 58.9 in May vs. 72.6 in April
  • Official PMI typically declines sequentially in May (3 of last  4 years) – seasonal adjustment factor off?
  • Property sales falling sequentially in May (M/M)
    • Beijing down roughly 70%
    • Shanghai around 70%
    • Shenzhen near 62%
  • Developers are postponing project launch dates and are waiting to see market developments and government policies before launching new projects
    • Shanghai – only 46 of a scheduled 96 developments were put on sale in May
  • Transactions for new homes in Shanghai fell 56% for the month through May 16 (M/M)
  • Secondhand home transactions in Beijing down 70% M/M in May
  • Hong Kong retail sales down sequentially to up 16.8% Y/Y in April vs. up 19% Y/Y in March
    • Retail sales volume down sequentially to up 12.4% in April vs. up 17.3% in March
    • Visitation up 18% Y/Y in April (1.7M)
  • Passenger car sales down sequentially - up 25% Y/Y in May vs.  Up 34% Y/Y in April
    • Has risen each month since Feb 2009 after gov’t lowered the tax on small vehicles to 5% from 10% in Jan. of ‘09
      • The tax was increased by 250bps this year to 7.5%
    • May 2010 is the most sluggish pace of growth since March 2009
    • Stockpile of vehicles up sequentially by 64,900 units in May
  • Honda Motor Co. production in China will remain halted at least through June 3rd as striking workers rejected a 24% pay increase to 1,910 yuan per month (looking for 2,000-2,500 per month)
    • Production of up to 3,000 cars per day has been lost since its auto assembly factories shut down last week
      • May 17 – plant in Foshan, Guangdong closed
      • May 24 – 2 plants closed in Guangzhou, Guangdong
      • May 26 – 2 plants in Guangzhou and Wuhau, Hubei
    • First time a strike has stopped Honda’s local auto production
    • Scuffles broke out between workers and staff from the government-backed trade union yesterday
      • Some workers sent to the hospital for treatment
  • Trade unions and employers appear to be reporting a growing number of work stoppages in China, although there are no official numbers, according to the International Labor Organization in Beijing
    • Hon Hai Group (assembler of iPhones) said last week it may raise wages 20% amidst a probe into the companies working conditions after the deaths of 10 people this year at their Shenzhen factory
      • Police treating as suicides
  • John Clarke, Head of EU delegation to WTO said today that “China uses a weak currency, export incentives, and subsidies to bolster its economy”… “the EU has seen some worrisome signals of stagnation in China’s efforts to revamp its economy”… “[EU] companies have reported a worsening of the [Chinese] business climate”
    • China March trade to EU up 25% Y/Y ($21.45B) – setting up for reported figures to slow sequentially in April and May
    • EU is largest recipient of Chinese exports in March (19.1%) vs. US (17.2%)
  • WTO judges are probing complaints by the EU, US, and Mexico against Chinese restrictions on exports of raw materials
    • Duties on coke, zinc, bauxite, magnesium, manganese, silicon carbide, yellow phosphorus
      • Used in steel, aluminum, automotive, and chemicals production
    • China claims taxes aimed at easing overproduction and pollution
    • WTO remarked that “export restraints tend to reduce export volumes of the targeted products and direct supplies to the domestic market, leading to downward pressure on the domestic prices of these products”
  • China’s Central Bank sold 1Y bills at 2.0096% vs. 1.9264% last week
    • Sold 15B yuan of 1Y bills
  • China’s Central Bank also raised rates on 3-month bills for second straight auction on May 27
  • China has added a net 145B yuan of cash into the financial system last week – the 2nd weekly injection of the last month after draining cash each week in April and March

6/2: Employers giving in to wage demands; liquidity drying up further; China may finally address restrictive residential system that has been marginally inhibiting to growth – a sign that the government may begin to pull out all the stops to avoid a full economic collapse:

  • Honda reopened a parts plant in China
    • Most of the parts factory’s 1,900 workers accepted an offer this week for a pay raise to 1,910 yuan ($280) a month (24%)
  • Hon Hai Group will raise worker salaries at least 30% after series of suicides
    • Workers with a monthly wage of 900 yuan per month will be paid 1,200 yuan effective immediately
  • 7-day repurchase rate rose 8bps to 3.28% - the highest since Oct. 2008 (19 month high) vs. 1.56% (12/31/09) vs. 0.96% (6/1/09)
  • Bank of China Ltd. (third largest lender by market value) started selling convertible bonds today
    • Plans to raise 40B yuan ($5.9B) according to a May 30 statement
  • China may gradually implement a residence permit system in 10 cities that may relax the Hukou rules, according to the South China Morning Post, which cited a State Council document

Chinese Ox Still Boxed In - SSEC