In Beijing we trust

Jun 23, 2014 22:13 UTC

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China’s credit woes are bubbling up into the news again (previously here and here).

The World Bank’s top economist, Kaushik Basu, is worried about China’s reliance on credit to fuel growth. He said last week that eventually credit will catch up with it: “We’ve seen that in the U.S. in 2008, and China may have to face up to that sometime in the coming year, or couple of years because of its bloated finances.” Back in April, the IMF’s Global Stability Report warned that China was risking a financial crisis if it didn’t rein in borrowing, and that the country should settle for lower growth in order to save itself from credit calamity (the WSJ has a good summary of the report). “Pockets of stress have already begun to emerge, particularly in the trust sector, with spillovers to other parts of the financial system,” the report says.

The Financial Times is in the middle of a series investigating the shadow banking sector, starting with Chinese trust products, which is often where companies turn when they can’t get a bank loan in China. The FT describes trust products as “lightly regulated trust companies … making high-interest loans to risky borrowers, repackaging them and selling them through banks.” Trust products are only supposed to be sold to investors who have 1 million RMB to spend, to make sure investors have money to lose, but the FT reports this rule is often ignored. The story also quotes research analyst Charlene Chu, who says within the Chinese shadow banking sector, “bad decisions and bad risk management are the norm.” Yet, many borrowers assume local governments will be there to bail them out if they can’t pay their debts.

David Keohane thinks there should be more worry about Chinese trusts. He quotes a recent Credit Suisse report that says, basically, a combination of government bailouts, bank rollovers, and acquisitions has saved the shadow banking sector in the short term, but things aren’t looking good for the future. “The basic point is that it’s improbable that local governments are going to be able to handle all of this on their own so, as CS suggest, it’s the central government which is going to need to step in. Or not,” says Keohane.

The Economist has a good overview of the state of Chinese trust products. It details the reasons why China, in the event of a mass of trust product defaults, would likely not see a huge financial crisis like 2008, even though China’s shadow banking system has many similarities to the West in the mid 2000s:

The main reason why a calamitous run on Chinese shadow banks is unlikely, however, is that the country has the capacity to absorb lots of non-performing loans. Its debts, both shadowy and well-lit, are much smaller relative to GDP than they were in most Western countries before the crisis struck. More important, China’s central government and the big state-owned banks are still in rude financial health and could intervene to buy up troubled assets, preventing the credit market from seizing up. Currency controls would stop panicked Chinese from spiriting their money out of the country.

— Shane Ferro

On to today’s links:

Regulations
San Francisco informs startup that you’re not actually allowed to rent out public parking spaces you do not own - SF Chronicle

Compelling
What if wages rise? - Josh Brown

Crisis Retro
“It is easy to see the similarities between the financial crisis and the climate challenge we now face” - Hank Paulson

Macro Problems
Greg Ip on secular stagnation - The Economist

Study Says
Sophisticated investors more sophisticated at investing - NBER

Housing
Housing on the rebound - Shane Ferro

MORNING BID – Losses continue, and other concerns

Mar 14, 2014 12:27 UTC

The ructions in China have had an interesting effect on commodities prices – good for gold, crappy for copper. And more developments in this area should be expected as the market deals with growing weakness and the threat of a deflating credit bubble coming from the massive lending to various sectors in the world’s second-largest economy. Copper has been rather weak of late, but the broader CRB commodities index is actually much higher on the year. This is the biggest divergence since the eurozone debt crisis in 2011, points out Ashraf Laidi, the chief global strategist at City Index in London.

Again, the recent selling has had to do with the Chinese companies using the metal (and iron ore, too) as collateral for cheap dollar financing. So we’ve hit a weird storm here – weak yuan that makes those loans more expensive, and copper falling too, and again, that also messes with those loans. Put that together and you have a few markets moving in directions that are not beneficial to a major counterparty in several of them, for one, and resulting in the kind of activity that tends to turn into a vicious cycle.

More copper weakness, more yuan weakness, wash, rinse, repeat. Add a slowing macro economy and it’s a recipe for some more problems down the line. It’s also not good for other risk assets, even U.S. stocks, and part of the reason bonds rallied on Thursday. The growing problems there may be a reason why the Fed’s custody holdings data on Thursday afternoon showed foreign central banks dumped more Treasuries this past week than at any time – $104 billion, almost triple the previous record – as banks prepare for liquidity problems.

And it’s why things look like they’re going to be a bit ugly on Friday following more losses in Russia (down 5 percent) and in Asian markets. That’s not all, though. More defaults on trust products in China are expected. These started earlier in the year, where these big trusts that were sold to investors guaranteeing big returns backed by loans to coal producers didn’t repay investors on time. “The number of defaults are likely to accelerate in coming weeks as more Trust funds are expected to mature starting in April,” wrote Robbert van Batenburg, strategist at Newedge. He points out how intertwined these companies are in differing industries, with the common link being that they’ve all promised big returns for investors that now seem like they’re not going to come to fruition. Sound familiar? “If these problems in China escalate, a flight in gold and Treasuries is likely to ensue,” van Batenburg wrote. Well, that’s what we’re seeing again on Friday; the safe havens get the benefit while other markets suffer.

A bit of the reverse is happening in gold, which is predictably benefiting from the safe-haven allure of the yellow metal at a time when tensions are also rising between Russia and Ukraine and as a possible response from the West looms if Russia annexes the Crimean region of Ukraine (even if they want to go).

MORNING BID – Copper, China and currencies

Mar 12, 2014 12:58 UTC

Markets start on the back foot this morning, with weakness overseas – and particularly in emerging markets – feeding through to a bit of strain on U.S. futures and a bit of flight to quality to the U.S. bond market.

The outlook for China once again comes into play, with the most recent fears being more corporate defaults in the world’s second-largest economy and the way in which copper imports are used in China as collateral to raise funds. So it’s all nicely intertwined here and has had a detrimental effect on both China’s stocks, stocks in various exchanges around the world, and of course the price of copper, which was down 5 percent in Shanghai.

What that’s done is hit the currencies more sensitive to the commodity complex – the Aussie dollar in particular – and the outlook has both worsened for that and commodity prices, while we see improvement in the dollar, Swiss franc and the yen. “Yesterday’s price action warns investors with broad commodity exposure of increased risks of a downside, and a possibly sharp correction is likely,” wrote strategists at Brown Brothers Harriman this morning.

This would also seem to undercut demand from commodity-sensitive economies of which China, to some extent, is one, but U.S. strategists still see a favorable outlook for the capital spending trend among big companies. Indeed, both Bank of America and Citigroup have noted, of late, how capex has been stronger than expected and spending plans are looking favorable right now.

MORNING BID-All the metal in China

Feb 26, 2014 13:59 UTC

Without a lot of fanfare, the U.S. equity market has worked its way back to a few points of all-time highs, as concerns over emerging markets (largely related to Ukraine) have magnified, as have worries over China’s struggling growth.

That’s once again produced the “best house in a bad neighborhood” effect for the U.S. stock market; bond yields remain range-bound in the 2.70 to 2.75 percent area, the 10-year still reflects a value that doesn’t suggest economic acceleration or worries over massive slowing either.

One of the better indicators of the effect of China’s slowdown comes out of Brazil, where Vale SA, the world’s largest iron ore producer and exporter, will issue its fourth-quarter results.

The company was expected to exceed expectations due to cost cutting and higher iron ore prices, but sluggish demand in China is a long-run effect that cannot be shunted aside. Starmine sees the stock as heavily undervalued, as it has been in a persistent downward trend since early 2011, when it peaked at about $35 a share (US); it now marks time around $13 to $14. The company did surprise the last time, so it’s got that going for it.

It comes at a confusing time for those following China. Authorities there have been allowing or guiding the yuan lower, weakening it at a time when exporters have been less competitive due to China’s real effective exchange rate (measured by the IMF and BIS) hitting all-time highs, according to a Brown Brothers Harriman note on Tuesday. “We believe that officials would like to contain further appreciation by moving the nominal exchange rate weaker,” they wrote.

Part of Chinese officials’ motivation seems to be to inject a bit of two-way volatility into the currency market, lest it become a constant one-way bet, but making the environment more competitive for their exporters is also a necessity.

As Bank of America/Merrill Lynch pointed out this week, the U.S. only exports about 0.6 percent of GDP to China (one reason the slowing there isn’t as big a deal for the USA) but China’s exports to the US and Europe are about 7 percent of its GDP – and that’s an issue.

MORNING BID – Turkey, the Fed, and we all float down here

Jan 29, 2014 14:46 UTC

The messy sell-off in emerging markets was stemmed overnight after Turkey surprised everyone by raising rates to 12 percent – but it didn’t last. Major averages in Britain and Germany opened at their highs of the day but have since faded, and even though the big rate increases in Turkey, South Africa and India are meant to stem capital flight, so far the market’s shooting first and asking questions later. S&P futures were up about 20 points after the Turkey rate hike – an odd move for such a localized event – and we’re seeing the reaction now, which, to quote Tom the cat about the ‘white mouse no longer being dangerous,’ “DON’T…YOU…BELIEVE…IT.” So we’re lower, and continue to head lower, and for those of you new to the markets, this is what’s called a selloff.

The big question: Will the Federal Reserve defer its tapering campaign in recognition of emerging-markets difficulty? One could say the Fed cannot be expected to act as the underwriter for global risk-taking, but you’d be laughed out of the room, given the performance of assets around the world in the last several years as the Fed went into full-QE mode.

On the other hand, there’s a difference between providing broad support to the markets (via helicopter or not) and an actual admission that you’re changing policy to respond to specific issues worldwide, and such a move strikes us as the latter, not the former. With that in mind, it would be remiss to think the Fed does not continue at its measured pace, dipping down to $65 billion in bond purchases per month this time, as Janet Yellen takes the reins and we find out what kind of situation the new Fed head has gotten herself into while Ben Bernanke eases into what one hopes is a steady and muted retirement (think Johnny Carson, not Alan Greenspan).

For one, eventually reducing the monthly stimulus to zero at least gives the Fed room to ratchet up that stimulus again if they really need to.
Furthermore, the emerging markets, in a sense, are already gone. No, it’s not a disaster yet – but the implosion of China’s shadow banking system, the resignation of every Turkish official in Ankara, and the, well, uh, never mind, Argentina is Argentina, and isn’t going to be solved by the Fed put. The Fed might give it lip service in its statement but any more than that really ratchets up the moral hazard.

Furthermore, when one takes a look at the relative strength of emerging markets stocks with the U.S. market, it’s clear EM has been struggling for a while anyway. A comparison of relative performance between the MSCI EM index (.MSCIEF, or EEM.P if you’re into the ETF thing) is at 0.7 or so, and U.S. markets have been the steady outperformer since the beginning of 2013, and that outperformance accelerated throughout the year but particularly in the second quarter when the Fed started talking about reducing stimulus in the first place.

That doesn’t mean they can or will reverse course – it makes no sense. But less liquidity washing ashore means a bad investment can no longer be covered by smoke and mirrors. The MSCIEF’s relative performance index is still looking terrible, having fallen below the 30 level that indicates an oversold condition. It’s not quite at the nadir of the June 2013 or May 2012 selloffs, but it’s close, so if there’s a place one might expect some buying, it’s now. But it’s not happening yet – and that does raise questions about whether we’ll see more soothing words from central banks.

WE ALL FLOAT DOWN HERE
Back in the USA, the Treasury is readying its first-ever auction of two-year floating-rate securities, likely to see demand from various types of investors.
There are currently more than $200 billion in agency and “supra-sovereign” floating rate notes outstanding, mostly from Federal Farm Credit and Federal Home Loan Bank, per Morgan Stanley data. So, Treasuries should add nicely to the mix here, and it’ll quickly become a very big dog in a very small pond (dogs can jump in ponds, go with the analogy). So the $15 billion will add to the week’s mix of other supply.

For one thing, this gives the Treasury the chance to manage its issuance a bit more by reducing the number of short-dated auctions of bills, instead issuing this note that resets based on market rates for floating-rate notes. It will helpfully cut back on the weird dislocations that the market has seen of late in bills that are maturing just as the United States is set to run afoul of the debt limit (again) or face some kind of annoying only-in-Washington-type spectacle.

(Of course, if it was all two-year floaters, then in the month it had more floaters coming just as a budget crisis hit, those yields would go through the roof. So you can’t entirely solve the Washington problem this way, and floating-rate notes as far as we know cannot hold Congressional office).

The other advantage for the Treasury is the lack of what’s called “term premium,” which Morgan Stanley says will lead to interest-rate payment savings.
Term premium refers to how much additional interest you have to offer someone who is taking the risk of buying longer-dated securities (and therefore risking wide swings in interest rates or other unforeseen events over a five-year period vs. say, six months). But floating rate notes have no such provision (they float, after all), so that *should* save Treasury some money.

Reuters’ bond correspondent Richard Leong points out they’re expected to sell with a yield of 0.10 percentage point, almost a quarter less in the two-year fixed-rate note supply sold on Tuesday. So, that’s savings for Uncle Sam until the FRN yield rises above the fixed-rate two-year notes. Overall, the interest rate should be greater than what’s embedded in notes, though, which is good for money market funds (they hold about $276 billion of floating rate notes already).

FRNs are great in an environment where interest rates are on the rise, which has been the case for several months now (until this month that is), and therein, of course, lies the danger. If rates fall, well, not so great, as the interest rate on the notes would be chipped away.

MORNING BID – Emerging Markets, Apple, Ma Bell, and whatever else one can think of

Jan 28, 2014 13:56 UTC

In the words of Inigo Montoya, let me explain. No, there is too much. Let me sum up.

The market’s most immediate issues remain tied specifically to what’s going on overseas, particularly in Turkey. There, monetary authorities are meeting on a potential interest rate hike as a way of getting on top of the inflation problem (inflation’s at 7.5 percent, and the central bank’s lending rate is, uh, 7.75 percent).

So that’s a problem: Inflation is running real hot, the lira is in free-fall, and as Reuters’ Mike Peacock in London points out, the consensus view for a rate hike puts it at about 10 percent for when the bank announces its decision at midnight Istanbul time, 5:00 p.m. Eastern time (1000 GMT). Will that be enough to put a floor under the lira? Perhaps.

Now, U.S. companies don’t exactly have a lot of exposure to Turkey, and in this emerging markets rout we’re in the midst of right now, there’s a real question as to whether we’ve reached that “contagion” level. Sure, everything is selling off, but that’s not quite the definition, and it will take a little bit more time and effort – that is, more wholesale selling, liquidation of positions across various countries – to really call this a contagious effort. There are worrisome signs on that front, though. An analysis by Reuters’ Sujata Rao-Coverley, Dan Bases and Vidya Ranganathan points out that the increased funding through publicly traded fixed-income markets rather than bank lending means these markets are more intertwined, leading to the possibility of more selloffs that feed on each other.

Emerging markets with big current account deficits.

Back in 1998, bank loans were the funding mechanism for lots of emerging countries. Furthermore, the sheer dollar volume now dwarfs what was out there in the 1998 Asian contagion that later saw the collapse of the ruble. EM bonds are now in the range of $10 trillion, versus $422 billion in 1993, per JP Morgan; funds benchmarked to EM have assets of $603 billion, more than double what existed in 1997. EM ETFs? About $300 billion now – compared with nothing in 2004. And let’s remember the main ETF for emerging markets – EEM is the symbol – which is routinely the second-most active ETF in the United States. Long-term investing this ain’t, and the flight exacerbates the worries.

After three days of selling, emerging markets have stabilized a bit on Tuesday, so that’s something. Again, these selloffs often combine magnitude and time, with the swiftness only one part of it – the sheer ongoing nature of it is the other part. But that doesn’t mean preparations aren’t in order: David Kotok of Cumberland Advisors said his firm is raising cash levels, noting volatility tends to spike in forex markets when central banks have held interest rates near zero for a long time (which they have).

The real watcher is likely China’s shadow banking system and the possibility of problems there. Banks have been selling massive amounts of exposure to investment trusts to individuals for some time with promises of big returns and using that money invested for lots of lending; one of those trusts distributed by ICBC had to be bailed out this week. If there’s more of that to come, it’s a real question of what’s going on with the banking system’s health there – and that again leads to some uncomfortable conclusions about growth in China, which is far worse a problem than any crisis in Turkey, given its sheer size and influence.

OPEN-APPLE-RESET
Meanwhile, on a domestic front, Apple’s earnings weren’t what was expected. Sure, the company exceeded revenue forecasts and earnings forecasts, but it fell short of expectations on iPhone sales by a lot, and nobody’s happy about this. The stock was hit hard in after-hours action, and was, of late, down about 6 percent. Of course, selling 51 million phones over a three-month period isn’t exactly shabby, and the company is still making money hand-over-fist.

The disappointment comes, in part, from the realization that Apple’s growth rates just aren’t what they used to be, and that Samsung is widening its global lead in the smartphone market, with one report putting its sales at 86 million phones in the quarter. Samsung, of course, is selling more low-end phones, so it’s not like Apple is getting its head handed to it here, but its market share is down to about 17.6 percent from 22 percent, according to Strategy Analytics.

Carl Icahn’s recent calls for the company to get more aggressive in giving money back to shareholders through a big buyback are going to probably only get louder. This raises the chances that the company doubles down on the financial engineering strategy of growing earnings that admittedly has helped the shareholders of names like IBM, AT&T and Exxon Mobil, but doesn’t speak well from the innovation front for a lot of these names.

The company – the most valuable in the United States – had been banking on a big deal in China to sell even more phones, but the market is starting to look saturated on that front, Pacific Crest analyst Andy Hargreaves told Reuters’ Bill Rigby. And Apple doesn’t have a game-changing product on the horizon either right now, so that means the investment thesis comes down to volume. It’ll keep making scores of money, but reduced market share and pretty new colors and bells and whistles won’t be enough when “hardware can only go in one direction, and that’s flat or down,” said Alex Gauna of JMP.

If Apple is headed in the direction of AT&T, it’s going to eventually turn into one of those companies where investors get excited about special factors pumping up earnings results, and AT&T’s going to have that today when it reports results. What’s going on here? Pension related stuff – the market’s gains mean companies with lots of pension assets can mark those positions to market (read: make them bigger). And where previous years of losses can hurt those positions for the likes of Verizon, Ma Bell and UPS, this year it’s a help.

Verizon’s adjustment boosted S&P 500 earnings per share by 42 cents this quarter, and AT&T could make just as big a splash this time around. So AT&T is expected to record a gain of about $7.6 billion in the fourth quarter as a result of this, which is massive. Now, David Randall wrote a story a few days ago noting that few fund managers buy a stock based on this sort of thing – AT&T’s primary business is, uh, selling telephones, no, wait, ah yes, telecommunications – so if the business stinks, never mind the pension stuff.

But it’s nice that the pension funds are fully funded or better now, just in time for a big market correction.

from Data Dive:

China’s one-child policy in charts

Ben Walsh
Nov 18, 2013 17:11 UTC

On Friday, China announced its intention to relax its one-child policy, after more than 30 years. Reuters' Sui-Lee Wee and Li Hui report that the shift has been under consideration for the last five years. The complex set of family planning policies, they write, are "now regarded by many experts as outdated and harmful to the economy", due in part to an aging population.

Here's a Reuters chart showing China's dependency ratio, which compares the number of China's young and old citizens (its dependents) to the size of its working age population. A higher number means fewer working-age adults to support the young and the old.

 

You can also see above how big a social and economic trend urbanization has been over the last 40 years. Labor shortages have recently become a concern for Chinese leaders. It's important to note that the one-child policy change will be gradual, and that any increase in birthrates in the next few years won't lead to an increase in working age adults for at least a decade and a half.

Pew's Gretchen Livingston notes that "across Asia, even countries without a one-child policy have experienced a rapid decline in fertility rates in recent decades." Here's China's fertility rate since 1960, showing a dramatic decline before the one-child policy was implemented:

The Washington Post has an excellent rundown of the policy changes and some nifty charts on its unintended consequences. Business Insider has a chart from Nomura showing just how far outside the global norm China's male-female birth ratio is:

 

China’s growing problem

Jul 15, 2013 22:36 UTC

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Chinese growth slipped to 7.5% in the second quarter — making it now 9 out of the last 10 quarters that the growth of the world’s second-largest economy slowed. Although 7.5% wasn’t quite as low as was expected, it’s low enough that analysts at both Goldman Sachs and JP Morgan are predicting 7.4% annual growth for 2013, which would be the lowest the country has seen since 1990.

Tim Orlik points out that one worry when it comes to China is its reliance on exports. “The government wants consumption to play a bigger part in driving growth, taking over from overdone investment and exhausted exports. But so far in 2013, the reverse is happening”, he writes. Dexter Roberts reports that household consumption in China is only 35.7% of GDP (it’s over 70% in the US), as many people in China feel that they have to save up to avert financial disaster because of poor public benefit and pension systems.

China has posted some of the strongest GDP growth in the world over the last two decades, but that hasn’t translated into profits for foreign investors (even as the American government pushes China to further liberalize its markets). “Foreigners earned less than 1 percent a year investing in Chinese stocks, a sixth of what they would have made owning U.S. Treasury bills” in the last 20 years, Bloomberg reports. Meanwhile, tech and energy giants with big exposure in the Chinese economy — Advanced Micro Devices, Altera and Intel, to name a few — have also been hit in recent quarters, writes David Gaffen.

China has recently flirted with a credit crunch, may be facing a real estate bubble, and, as Gwynn Guilford writes, “businesses and local governments are increasingly taking out new loans to pay off old ones”. Over the weekend, Chinese state media reported that one government advisor warned “arguments about whether China will grow at 7% or 7.5% are ‘pointless’ because the economy is already in a financial crisis which may only worsen if the government doesn’t address the country’s crippling debt problem”.

William Pesek has consistently argued against obsessing over Chinese GDP data. A month ago, he wrote that slowing GDP growth is actually a good thing for China, because “a humming export engine deadened the urgency for change” in Chinese politics, and necessary, successful economic reforms have come in China only after periods of crisis. Today, he argues that the best thing to do with the growth data is to ignore it: “Obsessing about every little 0.2 percentage point GDP difference in output distracts us from the real problem: a Chinese hard landing that may impossible to see until it’s too late”. – Shane Ferro

On to today’s links:

Long Reads
The cartel of doctors that control Medicare – Washington Monthly

Alpha
The strange, amazing story of the downfall of the hedge fund king of Akron, Ohio – Roddy Boyd

Big Brother Inc.
Stores are now tracking your cell phone to learn about your buying habits – NYT

Cephalopods
Ex-Goldman trader Fabrice Tourre was called “Breezy” during his time volunteering in Rwanda – DealBook
Forget Fab, go after Cayne and O’Neal – William Cohen
How the Fabulous Fab trial could test the SEC – Reuters

Ugh
McDonalds tries to prove you can live on low wages, proves the opposite – Think Progress

Surprising
Why there are so many female entrepreneurs in the Middle East – Economist

The Fed
The Fed helped fund the DC metro system – Neil Irwin
“It is a dangerous thing for the Fed to be a one-man show, dominated by a single, dazzling intellect” – Matt Phillips

Regulations
Why has it taken so long to reform ratings agencies? – Mike Konczal
“You could think of the 21st Century Glass-Steagall Act as a measure to unwind the structure that Citigroup would become” – Simon Johnson

New Normal
In 2013, US employers have added far more part-time positions than full-time jobs (a reverse of 2012) - WSJ

Awesome
What it took 20 years on Wall Street to learn – Chris Arnade

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