Here’s the dark view from Kyle Bass (via Zerohedge and Robert Huebscher, originally posted at Advisor Perspectives).
China’s economy isn’t just slowing down, according to Bass: It’ contracting. While China’s published rates for annual growth are still positive, Bass said the nation’s economic growth was negative from the fourth quarter of 2013 to the first quarter of 2014.
That is a result of excessive government spending on unproductive sectors of the economy. Bass said the People’s Bank of China (PBoC) has been more aggressive in its quantitative easing (QE) that the Federal Reserve has, but much of that money has gone into unproductive credit expansion.
China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.
China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector. The marginal return on those loans must be very small, he argued.
“A rolling loan gathers no loss,” Bass said, “and that’s what’s been going on in China for the last few years.” He said it is impossible to believe China could “manipulate” the inputs of its financial system without losing control of the outcomes.
Deflation is also threatening China. Bass said that its GDP deflator is now below zero. He expects the PBoC to engineer a devaluation of the renminbi as a way to stimulate exports and avert further deflation.
Bass said that if non-performing loans go from 1% to historical norms “somewhere in the teens” with loss severities of 100% for the worst loans, then China would delete its $4 trillion of foreign exchange reserves. Bass implied that China would need those reserves to stabilize its banking system, though he did not say so.
China’s leaders are fully aware of the dangers its economy faces, Bass said, and they hope to slow growth in a measured fashion, including through the restructuring of its banking system. “The jury’s out whether or not they can do it,” he said. “We actually believe they might be able to do that and that GDP [growth] is just going to slow down a lot more than people expect.”
“I’m not saying it is a calamity, a disaster or it’s going to end badly for the world,” Bass said. “All I’m saying is China is slowing down a lot faster than people think, and you need to think about how to position your portfolio for this.”
Bass advised against shorting Chinese equity as a way to capitalize on his forecast. Instead, he said, investors should look at China’s trading partners – Australia, New Zealand and Brazil. Those countries will be forced to loosen their monetary policy, raising rates and creating carry-trade opportunities.
With some supporting material:
(…) some high frequency indicators are once again flashing warning signals. According to the ISI Group research, exports to and sales in China by US corporations have turned materially lower after remaining stable since early 2013 – indicating weakening demand. Anecdotal evidence suggests that a similar slowdown has also occurred for Japanese and euro area firms selling to China.
The most worrying indicators however are the key industrial commodity prices. Futures on iron ore sold at China’s ports fell below $100 for the first time in years.
And steel rebar futures on the Shanghai exchange are also continuing to fall. Some of these declines are of course related to declining construction activity.
Once again, most economists do not expect a “hard landing” for PRC because the government has enormous resources to “backstop” the nation’s economy. Nevertheless, a number of indicators from China still point to persistent risks to growth.
Wait, wait, there is a rosier view:
Early Signs Point to Steady Growth, Stimulus in China
Tom Orlik, Bloomberg Economist:
Prices for steel, a key input for everything from skyscrapers to ships, were down 4.1 percent year on year Friday, an improvement from an 8.1 percent decline at the end of April. Prices for paraxylene — ubiquitous in fabrics and packaging — also continued to fall in May, though at a slower rate than in April.
That slight improvement aligns with evidence from business surveys. The flash reading from the HSBC Markit PMI came in at 49.7 in May, up from 48.3 in April and edging close to the 50 mark that separates improving from deteriorating conditions. Market News International’s index of business conditions also ticked up, rising to 55 in May from 54.6 in April.
Those signs of stabilization in the factory sector reflect better conditions for China’s exporters. Taiwan export orders, which tend to lead China’s overseas sales by several months, registered robust 8.9 percent growth in April, the highest since the end of 2012.
Market prices also provide insights on inflationary pressure. Prices for pork — a critical variable in the consumer price index — registered a pronounced increase in May, rising 8.3 percent year on year in the opening days of the month after falling in April. That should be enough to ensure a slight increase in the CPI from April’s 1.8 percent annual increase.
Despite signs of steadying growth, policy makers are still taking no chances. On a visit to Inner Mongolia last week, Premier Li Keqiang warned that the economy faced severe downward pressure and told local leaders to “remember that development is the first task”.
Monetary policy continues edging into supportive mode. An injection of 120 billion yuan by the People’s Bank of China last week saw the seven day repo rate fall to 3.1 percent Monday, down from 4 percent at the end of April. The slope of the government yield curve has flattened and the spread between AAA corporate and risk-free policy bank yields has fallen to its lowest level in three years.
Taken together, the early signs for May point to growth in industrial output stabilizing around the 8.7 percent annual rate seen in April, improvement in exports, and a moderate increase in consumer prices. Despite that, policy makers appear increasingly determined to draw a line under the economy’s deceleration.
Easier monetary conditions as a result of the central bank’s fine tuning should help bolster lending and growth in the months ahead. (BloombergBriefs)
In case you missed it, here’s what Premier Li said last week:
China’s economy still faces “relatively big” downward pressures and timely policy fine-tuning is needed, Premier Li Keqiang was quoted by state radio as saying on Friday.
“Currently, the economy is generally stable and we see positive structural changes, but downward pressures are still large and we cannot be complacent,” Li said during a visit to the northern region of Inner Mongolia.
“We should use appropriate policy tools and pre-emptive fine-tuning in a timely and appropriate manner to help resolve financing strains for the real economy, especially small firms’ difficulties in financing and high borrowing costs,” he said.
Such policy fine-tuning should help maintain “reasonable growth” in money supply and bank credit, he said.
Everything is there:
- The economy is not getting worse short-term, being stable at a low level.
- Risks are mounting and downward pressures are large.
- Wait-and-see is over. China must move pre-emptively in a timely and appropriate manner.
Stay tune. Action is coming.
(…) Last year’s slide in the South African rand – along with currency weakness in Australia, Colombia, Peru and elsewhere – cost SABMiller some $400m in the year to end March, the group reported on Thursday. Mothercare meanwhile said depreciation in the rouble and other currencies would eat into the royalties they earn on international sales that now represent more than 60 per cent of group network sales.
They have joined a procession of companies warning that adverse movements in exchange rates will hit this year’s earnings. These range from consumer groups, such as Unilever and Procter & Gamble, which are sensitive to currency swings because of their slim margins but can rapidly adjust prices, to manufacturers such as Rolls-Royce, which hedges against currency risks several years out, because of its lengthy contracts.
A year of turbulence in emerging markets currencies has proved punishing for multinationals that bet heavily on growth in the developing world to compensate for the prolonged post-crisis malaise in their home markets. The problem is especially acute for European companies, since the recent strength of sterling and the euro has exposed them to swings of some 20 per cent against some of the worst hit currencies. (…)
Yet while corporate treasurers are accustomed to hedging in major currencies, until now most have found it too expensive and impractical to protect against fluctuations in volatile and relatively illiquid emerging markets currencies that may lack developed derivatives markets. (…)
Currency Chaos in Venezuela Portends Write-Downs The highest inflation rate in the Americas and at least five currency devaluations in the past decade have turned Venezuela into a guessing game for multinational companies, which may have to take write-downs.
(…) The country’s foreign-exchange system puts companies on an uneven playing field, depending on their business. At the government’s official rate for companies that import essential goods, such as food and medicine, a U.S. dollar costs 6.3 bolivars. Companies invited by the government to participate in a middle-tier rate system can effectively buy a dollar for 10 bolivars. For companies in the next and newest tier, 50 bolivars fetch a dollar, leaving them to ponder the true value of their Venezuelan factories and inventories.
(…) companies face the quandary of which exchange rate to use when they close their books at the end of the quarter. So, investors should brace for more write-downs.
Avon Products Inc. switched to the newest government-sanctioned rate in the first quarter and took a $42 million charge, while Estée Lauder Cos. absorbed a $38 million hit. The majority of companies still are calculating asset values using more-favorable exchange rates.
Since the beginning of April, more than 100 international companies have mentioned Venezuela’s currency exchanges in their financial filings as a drag, or potential drag, on earnings, up from eight in the year-earlier period, according to data provider Morningstar.
Goodyear Tire & Rubber Co., Herbalife Ltd. and Energizer Holdings Inc., have said they would need to take write-downs of $235 million, $103 million and $62 million, respectively, if they revalued at the new rate. (…)
Auto makers have been especially hard hit because they lack the dollars to pay their suppliers. Fuel Systems Solutions Inc., a New York-based producer of natural-gas fuel systems for cars, didn’t sell a single part in Venezuela between October and April because car makers have been strapped for dollars, said Pietro Bersani, the company’s chief financial officer.
Ford Motor Co., which temporarily stopped local production of its Fiesta and other vehicles, moved to the mid-tier exchange rate in this year’s first quarter and booked a $310 million charge. Ford said it concluded it would need this exchange to access dollars in the future. The company declined to say if it would adopt the most recent exchange rate.
“We have received a commitment from the Venezuela government to help resolve the issues and to get our production up and running by the start of next month,” Ford said in a statement.
General Motors Co. wrote off $400 million in the first quarter, and said every 10% devaluation of the bolivar from the mid-tier rate would force another $100 million write-down. Chrysler Group LLC wrote off $129 million in the quarter, and warned “there may be significant changes to the exchange rate in future quarters.” (…)
Canada’s annual inflation rate rose to the central bank’s 2 per cent target in April for the first time in two years, Statistics Canada said on Friday, further dampening talk of a cut in interest rates.
Core inflation, which helps guide the Bank of Canada since it excludes natural gas, gasoline, fruit and vegetables and other volatile items, edged up to 1.4 per cent in April from 1.3 per cent in March, with prices rising 0.2 per cent on the month. Both figures again matched the median forecasts in a Reuters survey.
Mexico on Friday cut its economic growth estimate for this year, after tepid growth in the U.S. and new taxes in Mexico led to a weaker-than-expected first quarter.
Gross domestic product is now seen expanding 2.7% in 2014, the Finance Ministry said, better than the meager 1.1% growth of last year but far from the 3.9% initially expected.
The government cut its estimate after the national statistics agency reported that the economy grew 0.28% in the January-March period from the previous quarter, below expectations. That translates into an annualized rate of 1.1% and means a modest improvement compared with the 0.13% growth in the fourth quarter.
On top of the weak external backdrop, across-the-board tax increases that came into force at the beginning of the year weighed on private consumption and business confidence. Also, the construction sector has been in recession for more than a year, with several home builders struggling under heavy debt.
EUROZONE RETAIL SALES TREND UP, FINALLY:
Source: FactSet, Eurostat. As of May 20, 2014 via Charles Schwab & Co., Inc.
London and New York look to extend bull run Upbeat tone follows hints of eurozone monetary easing
(…) Stock-market bulls have stayed the course amid continued evidence of slow but steady improvement in corporate profits and the U.S. economic backdrop. Meanwhile, some say stocks look attractive in comparison to bonds paying historically low interest rates.
Skeptics point to the fact a long-awaited acceleration in economic activity has yet to emerge, and last year’s rally has left stocks less attractively valued. (…)
It’s not quite blood-red seas and locusts, but the bears are starting to get downright apocalyptic as they trot out their warnings of an imminent breakdown in the financial markets: tumbling Treasury yields; staggering small-company stocks; incinerated Internet shares; and blown-up biotechs. There’s just one problem: Transportation stocks should be crashing if the end were truly nigh. Instead, they’ve sailed through the carnage virtually unscathed. (…)
Instead, the Dow Jones Transportation Average has gained 9.3% over the past three months, on its way to an all-time high of 7986.58 on Friday — its 14th record close this year. There’s plenty to worry about given the weakness in some parts of the market, but the strength in transports sends “a very bullish message,” says Stephen Suttmeier, technical research strategist at Bank of America Merrill Lynch.
Transports have been so strong, it’s almost worrisome. Since March 2000, the S&P 500 Transport Index has gained 11% annually, more than doubling the Standard & Poor’s 500 index’s 4.1% return over that period. Because of the rally, the price of the S&P 500 transports relative to the S&P 500 has now topped the last peak reached in 1994 — 20 years ago. Transports went on to underperform the full index by 16 percentage points annually during the next six years. (…)
It has been an ugly year for the Financial sector. In all three market cap ranges, stocks in the sector are underperforming their peer indices, and for all three, relative strength is at or near a 52-week low. While stocks of all size are underperforming, large caps have been holding up the best, and as we have noted numerous times in the past, that is due in large part to the regulatory environment for the sector which tends to put the largest companies in the sector at an advantage relative to smaller rivals. (Bespoke Investment)
From Liberty Blitzkrieg blog via Zerohedge:
The retail investor is getting back into the stock market and is seemingly focused on the riskiest types of shares; unlisted penny stocks. They aren’t just dipping their toes in either, the pace exceeds that of the tech boom of the late 1990?s and has just hit the highest amount on record.
(…) The investors are buying up so-called penny stocks—shares of mostly tiny companies that aren’t listed on major U.S. exchanges—at a pace that far eclipses the tech boom of the late 1990s. Those include firms that focus on areas from medical marijuana and biotechnology to fuel-cell development and precious-metals mining—industries that are perceived by some investors as carrying strong growth potential.
Average monthly trading volume at OTC Markets Group Inc., which handles trading in shares that aren’t listed on the New York Stock Exchange or Nasdaq Stock Market, has risen 40% this year in dollar terms from a year ago, to a record $23.5 billion. (…)
The rebound also comes as individual investors are showing signs of increased interest in stock trading in general.Discount brokers TD Ameritrade Holding Corp. and E*Trade Financial Corp. last month reported jumps in daily trading volume in the first quarter from the same period a year ago. (WSJ)
Chinese Ship Sinks Vietnamese Fishing Boat Territorial tensions in Asia continue to rise…
APPARENTLY, THIS LEFTY IS NOT RIGHT
Thomas Piketty, author of a best- selling book on the widening gap between rich and poor, relied on faulty data that skewed his conclusions, the Financial Times reported on its web site.