Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

NEW$ & VIEW$ (25 AUGUST 2015): Sentiment Watch.

China Cuts Rates China cut its benchmark lending rate to 4.6% and reduced the cash levels banks are required to keep as China’s stock-market tumble has sent its main stock index down 22% in the past four days.

China also did away with its ceiling on most bank deposits.

The People’s Bank of China said in a statement on its website that it also cut bank reserve requirements for rural banks by an additional half a percentage point.

  • CHINA PBOC CUTS INTEREST RATES
  • CHINA PBOC CUTS REQUIRED DEPOSIT RESERVE RATIO
  • CHINA PBOC CUTS 1Y DEPOSIT RATE BY 25 BPS
  • CHINA PBOC CUTS 1Y LENDING RATE BY 25 BPS
  • CHINA PBOC CUTS BANKS DEPOSIT RESERVE RATIO BY 50 BPS
China stocks plummet again as Beijing sits on sidelines
Beijing capitulates after spending $200bn to prop up equities

Beijing’s leaders appear to have belatedly decided it is too expensive and ultimately futile to fight gravity in the equity market, especially as the government is now intervening separately on a massive scale to stop its currency from devaluing further.

Since the People’s Bank of China devalued its currency and introduced a new “market-oriented” foreign exchange price-setting mechanism on August 11, it has had to spend as much as $200bn of the country’s foreign exchange reserves to prevent the renminbi from falling more than it wants, according to people familiar with the central bank and its market interventions.

That was more money than the PBoC had spent over the past two years to keep its currency in the desired range against the dollar, these people said.

The scale of the intervention in both equity and currency markets has led many to question whether the Chinese authorities are in control of the situation or whether they have made a series of policy blunders. (…)

CHINA’S HARD-LANDING TRIGGERS A REASSESSMENT OF THE PROSPECTS FOR GROWTH

(…) there are two groups of emerging market economies that look particularly vulnerable.

There are the commodity rich nations, such as Sierra Leone and Angola, which have met China’s insatiable demand for natural resources. And there are also the East Asian economies, such as South Korea, Malaysia and Vietnam, which export semi-manufactured and finished goods to China. Data suggest that China’s slowdown has already hit commodity producers hard, and they will continue to suffer — with crude oil prices hitting new six-year lows. (…) (Chart from BCA Research)image

Pointing up Abe Aide Hamada Says BOJ Should Ease If Economy Fails to Grow
Bear Grip Tightens on Emerging Stocks as Half of 30 Markets Wilt

Fifteen of the 30 largest equity markets among emerging economies extended losses yesterday from their peaks to 20 percent or more, fulfilling traders’ definition of a bear market. China and Russia have led the pack, tumbling more than 30 percent each. The remainder are either in a correction, or on the brink.

Investor Confidence Plunges Amid Emerging-Market Rout

Investors are even less confident about emerging-market equities than they were at height of the financial crisis in 2008, an index showed yesterday. That may be a signal that a market rebound is coming, argues Sentix, the data compiler.

The polling group’s gauge of sentiment in emerging-market equities fell about 20 points to minus 27.75 in August, the lowest since it began in early 2007.

The sharp decline in the index “is an enormous glimmer of hope as the appearance of fear is usually a precursor of a turn in price developments,” said Sebastian Wanke, senior analyst at Sentix. He said the sharp drop in the mood index in late 2008 preceded a rebound in emerging-market equities. (…)

Hmmm…

Chicago Fed: Economic Growth Picked Up in July

Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) rose to +0.34 in July from –0.07 in June. Two of the four broad categories of indicators that make up the index increased from June, and three of the four categories made positive contributions to the index in July.

The index’s three-month moving average, CFNAI-MA3, edged up to a neutral reading in July from –0.08 in June. July’s CFNAI-MA3 suggests that growth in national economic activity was at its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests limited inflationary pressure from economic activity over the coming year.

The CFNAI Diffusion Index, which is also a three-month moving average, moved up to +0.06 in July from a neutral reading in June. Fifty of the 85 individual indicators made positive contributions to the CFNAI in July, while 35 made negative contributions. Forty-four indicators improved from June to July, while 40 indicators deteriorated and one was unchanged. Of the indicators that improved, 12 made negative contributions. [Download PDF News Release]

The next chart highlights the -0.7 level. The Chicago Fed explains:

When the CFNAI-MA3 value moves below -0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun. Conversely, when the CFNAI-MA3 value moves above -0.70 following a period of economic contraction, there is an increasing likelihood that a recession has ended.

The next chart highlights the -0.70 level and the value of the CFNAI-MA3 at the start of the seven recession that during the timeframe of this indicator. The 1973-75 event was an outlier because of the rapid rise of inflation following the 1973 Oil Embargo. As for the other six, we see that all but one started when the CFNAI-MA3 was above the -0.70 level.

CFNAI and Recessions

Financial Conditions Force Fed to Tiptoe to Rates Liftoff

(…) During the first two quarters of the year, real GDP increased 0.6 percent and 2.3 percent, respectively, for an average growth rate of 1.4 percent for the first half. With the economy on such thin ice, it isn’t clear how resilient households — or businesses — can be to a profound and prolonged market slump.

As of August 18, the Atlanta Fed’s GDPNow forecasting model estimates third-quarter GDP growth to be 1.3 percent. Keep in mind that the Atlanta Fed has the hottest hand in forecasting, having accurately predicted the first- and second-quarter GDP growth estimates. If the bank is correct again, third-quarter growth would be at essentially the same pace as during the first half.

Policy makers are cognizant that one 25 basis point increase will not derail the economy. However, they are sensitive to the fact that, if the market prices in a string of rate hikes, it would cause a significant tightening of financial conditions, and they do not want this given their hesitancy over the broader outlook. The key to the Fed successfully achieving liftoff will depend on it successfully telegraphing to the markets that the post-liftoff path of policy will be extremely shallow — more gradual than the roughly 100-125 basis points per year that it has previously signaled.

In short, the Fed can probably successfully pull off a September liftoff if it can convince the markets that it is a “one and done” approach for 2015. Policy makers can accomplish this through their forward guidance language, as well as through the dot plot.   

SENTIMENT WATCH

It is really amusing how everybody is able to explain the market rout after the fact…even though the facts were all there for everybody to see. Now, the guessing game on what is needed to turn things around:

  • David Rosenberg:

Gaining traction is going to take some sign of confidence returning to China since more than 80% of this year’s U.S. market selloff has occurred since the devaluation – since that time, more than $5 trillion paper wealth has been wiped off the value of global equities (…)

Quite clearly, the state-directed attempt to turn the Chinese equity market has unravelled and it may be this sense that the authorities have “lost control” that is the principal cause of this sudden dramatic loss of global investor confidence, and we are reminded by the domino effect to other regions just how interconnected the world is today (…)

The capitulation is definitely in.

Here’s what we need:

  • We need reassuring moves out of China. (…) Of all central banks, only the PBoC has anything left in its arsenal.
  • We need to see oil prices show signs of bottoming out
  • Technically, we need to see an outside positive reversal. (…) Credit spreads are usually a good leading indicator.
  • Break-even inflation rates bottom out
  • Less panic by global policymakers would be helpful too. (…) efforts to stimulate demand, not further manuipulate or distort asset prices.
  • ISI:

• The EM market plunge of almost -60% in 1997-1998 ended when the Fed cut the funds rate.
• The S&P decline of almost -20% in 2011 ended around the prospect of more QE.
• Last year’s S&P decline in Oct of -7% ended Oct 19 — “Monetary policies around the world edged toward easing, from BoE to China.” Oct 26 — “Policymakers are leaning toward easing, eg, Abe, China, Fischer, and Draghi.”

“I’m not a buyer that this is 1998. Nor am I am a buyer that that’s 2008. And in 1998 you had a lot of fixed exchange rates. Now you have fewer of those. And 2008 was about the payments and settlement system. This is not about the payments and settlement system. This is an old-fashioned repricing of two things.”

He added: “I’m not a buyer that this is the crisis of all crises. Yes, this is a very unpleasant repricing, very unpleasant. And it’s going to go quite deep, but it’s not going to derail the economy in a major way.”

El-Erian said he believes a December rate hike is still possible: “I think December is still on the table, and for the following reason. The economy will benefit from lower commodity prices, particularly oi. And the economy will benefit from lower interest rates. And that’s going to fuel some underlying strength that the economy does have. The big question is how much damage are we doing to the wealth effect, and to what extent will external demand collapse? We cannot answer that question yet. So I would think December is still a possibility, but September is unlikely to happen.”

(…) Today the story is much different. Governments learned from the last crisis, and have more macroeconomic and policy tools at their disposal. Their currencies already float, and none are running current-account deficits with fixed exchange rates. Their foreign-exchange reserves are larger (though Malaysia’s have just fallen below $100 billion for the first time in five years), and their banking systems stronger, with larger domestic-deposit bases. Their currencies have not come under attack—low oil prices are dragging down the ringgit, while concerns over long-term competitiveness are hampering Indonesia—and their economies better able to handle foreign-investment inflows. Big emerging-market firms look slightly less healthy; many have taken on large and growing piles of dollar-denominated debt, which have become less affordable as the dollar has risen in value. But these debts do not yet look a plausible source of widespread systemic financial risk. 

The worry, though, is that governments have equipped themselves well to fight the last war. A panic-driven crisis may not loom, but emerging-market currencies the world over have taken hits from low commodity prices, China’s slowdown and an impending American interest-rate hike. Yet in fact, Asia’s currencies are faring relatively well: the Russian rouble, Colombian peso and Brazilian real have all fallen more than twice as much as the rupiah and ringgit. Low global demand has kept export growth low this year; a weakening yuan will make things worse. Last month Indonesian exports were down almost 30% year-on-year, a sluggishness mirrored across the region. Indeed, some now reckon that emerging markets will try to stimulate external demand through devaluation, as Vietnam did last week. That, in turn, suggests a different risk: that much of the world economy will try to cope with economic weakness by selling to the American consumer. Yet the sorts of global imbalances that result from competitive depreciation are dangerous, as the 2000s demonstrated. Americans might borrow too much as they attempt to play the role of engine of economic demand. Or they may simply tire, leaving the world without a source of economic locomotion.

(…) “U.S. economic trends are still very much driven by domestic phenomenon and data points continue to intimate growth as opposed to developments overseas that are creating turbulence and distressing investors,” he writes. “Specifically, American employment, plus consumer and capital spending (ex-energy) remain on track.”

The two key sectors to look at to gauge the health of the American consumer and economy—automotive and housing—still look healthy, according to Levkovich )…)

Levkovich points to three indicators that are at levels close to the previous market bottom in October and suggest that a rebound could be imminent:

  • The share of stocks listed on the New York Stock Exchange trading at or below their 200-day moving average is within shouting distance of the October 2014 level.
  • The ratio of 90-day to 30-day implied volatility is more than two standard deviations below its longer-term norm.
  • The put/call ratio exceeds the level it was at last October.

“In this context, investors should be sharpening some pencils to find the corn being thrown out with the chaff,” he concludes.

(…) But there is nevertheless reason to think any weakness will ultimately prove temporary.

It is worth reflecting on just how aggressive a 10-per-cent stock market repricing is. It is the equivalent of concluding that one 10th of every company’s future earnings stream has suddenly and forevermore vanished. Even a full-bore recession doesn’t usually have an effect that corrosive. Confused smile

To the contrary, global leading indicators continue to point to mediocre economic growth. The Chinese slowdown – while certainly consequential for the world – is unlikely to induce a recessionary nadir at the global level. Meanwhile, the latest bout of low interest rates and low commodity prices are both accretive to global growth.

Second, Chinese concerns warrant a more careful parsing. Recent stock market problems in the Middle Kingdom hardly matter to the rest of the world – the market is small relative to its host economy. China’s stock indexes remain higher than they were in mid-2014 and mainland shares are largely domestically held. The currency story is also no great shakes given that the currency has stabilized at just 3 per cent lower against the U.S. dollar.

China’s debt problems are a legitimate concern and the main reason for China’s economic deceleration. Recent news of shadow-finance entities requesting government bailouts merely adds to the list of supplicants. Fortunately, the national government remains both inclined and equipped to rescue beleaguered parties. To be sure, China’s economy will continue slowing, but a “soft landing” is still more likely than a crash.

Third, it is surprisingly normal for stock markets to swoon by 10 per cent or more. This happens every few years, and markets normally then reclaim the lost ground in short order. When framed in the context of the U.S. presidential cycle – a classic technical indicator – the bellwether S&P 500 usually experiences a decline very similar to this one somewhere in the year before an election, before surging back to new highs later that year.

Fourth, stock market valuations were fine before the correction took place. There is always a searing debate on this subject, given the wide range of metrics that exist, but classic measures such as the price-earnings ratio and more advanced ones such as the risk premium between stocks and bonds argue that equities are a reasonable buy.

Fifth, policy-makers generally do what they can to restore tranquility to financial markets. Chinese policy-makers almost certainly have more up their sleeves. The European Central Bank may yet do more in light of the euro’s revival. Possibly most important, the Fed is now unlikely to tighten rates in September – eliminating one of the original catalysts for the stock market correction.

In the end, identifying financial market bottoms is highly imprecise, and some markets – including Canada’s – may experience an especially sluggish revival due to persistently undershooting commodity prices. But with these caveats firmly in place, this looks more like a temporary correction than a permanent new trend.

The usual cheerleaders are out reassuring everybody that all is fine. Not a word on profits. And valuations were fine before! Sarcastic smile

  • Bearnobull:

Nobody can really forecast what will happen next and how markets will react. We can, however, re-assess the risk/reward equation. The growth scares of 2010, 2011 and 2012 brought the Rule of 20 P/E to between 15x (1425 on the SPY) and 16.4x (1575), while the 2014 mid-October drop stopped at 18x (1750). The “Lower Risk” area for the Rule of 20 P/E is between 15 and 20 with the low end generally reached in cases of extreme pessimism (actual recession or perceived high recession risk), conditions which currently do not exist in the USA.

image

My sense is that 17x (1640) would be a solid floor making 18.0-18.5 (1750-1800) a reasonable mid-point where potential upside reward would begin to exceed downside risk. This leaves another 5-8% of downside before a better risk/reward ratio surfaces.

This assumes that EPS do not deteriorate (TTM $108) and that core inflation remains fairly stable around 1.8%. A meaningful decline in inflation would normally have a positive impact on P/Es if deflation fears remain muted. Shorter term, headwinds will remain strong, likely offsetting positives from lower energy and commodity prices on the OECD economies.

  • China is slow and slower with questionable leadership.
  • The Fed seems clueless with few visible ammo left. This is Jackson Hole week.
  • Earnings will continue soft for another 3-6 months.
  • Inflation not a problem. Deflation?
  • Currencies?
  • Emerging markets?

Based on today’s pre-opening indication (1940, +3%), the Rule of 20 P/E is 19.7, back in “lower risk” territory but not very comfy. BTW, the support has been redefined…

SPY Channel

Just kidding I have been writing about markets losing confidence in central bankers. Jared Dillian does not help with this:

(…) the current Board of Governors is composed of
Yellen
Fischer
Powell
Tarullo
Brainard
And maybe Landon
And now Kathryn Dominguez.

Vassar Undergrad (82), Yale PhD (87), taught at Harvard, got tenure at Harvard (which is damn near impossible for an assistant professor to do, so quite an
achievement), and then went to UMich.

I have never said that Fed people are dumb. They are unquestionably brilliant. They just have no real world experience! If the two nominations go through, this
is what the board will look like:
Professor
Professor
Professor
Professor
Lawyer
Lawyer
Banker (buddies with Obama)

NEW$ & VIEW$ (28 AUGUST 2015): GDP Up or Not? Fed Up or Not?

Surprised smile GDP Numbers Reveal Momentum Underlying U.S. Economy

The Commerce Department said Thursday the nation’s gross domestic product—the government’s broadest measure of economic output—expanded at a 3.7% seasonally adjusted annual rate in the spring, faster than the initial estimate of a 2.3% growth rate. Other recent reports have shown gains in consumer confidence, retail sales and home building.

The latest GDP numbers show that consumer spending, which represents more than two-thirds of economic output, grew at a 3.1% rate in the second quarter, up from the initially reported 2.9% pace. That is a marked improvement from the first quarter’s 1.8% rate, and July’s encouraging retail sales figures suggest the consumer outlook is improving amid steady hiring and lower gasoline prices.

Spending on home building and improvements advanced at a 7.8% pace, compared with a previous reading of 6.6% and a first-quarter gain of 10.1%. Solid readings may carry into the third quarter, underpinning growth. July single-family housing starts and existing home sales both have touched postrecession highs. (…)

Inventories, which add to GDP when they are rising, are one factor likely to weigh on growth in the second half of the year. Companies have added heavily to stockpiles—rising at a $121.1 billion pace in the second quarter—an accumulation of goods that is unlikely to continue into the current quarter. (…)

High five By Another Measure, U.S. Economic Growth Has Nearly Stalled This Year

An alternative measure of economic output, gross domestic income, advanced at a much slower 0.6% pace last quarter. By that gauge, economic growth barely inched ahead in the first half of the year. (GDI advanced at 0.4% pace in the first quarter versus a 0.6% increase for GDP.)

GDI and GDP measure the same thing: the size of the economy. GDP measures production based on what is spent by consumers, businesses and governments, while GDI measures the income generated from production. So, things like wages, corporate profits and taxes.

In theory, the two measures of output should be identical. But since they come from different source data, they can differ widely from quarter to quarter. For example, in the first quarter of 2012, GDI advanced 7.7%, while GDP increased at a 2.7% pace. In the third quarter of 2007, GDI fell at a 2.2% pace but GDP advanced 2.7%. Both measures are adjusted for inflation. (…)

The president’s Council of Economic Advisers advocates for considering a blend of two measures. A report published last month noted an average of GDI and GDP “is a better predictor of future revisions to the data” than considering the initial read of GDP alone.

That could indicate Thursday’s GDP figure could be downgraded when government number crunchers incorporate more comprehensive data.

The Commerce Department acknowledged those views, to a degree, in Thursday’s report by publishing the average of GDI and GDP for the first time. It showed 2.1% growth last quarter.

Sound familiar? By either measure, the economy has been growing only a little better than 2% annually since the recession ended—though the average annual gain in GDI from 2010 through 2014 was slightly larger than the increase in GDP.

The weaker GDI increase the last two quarters has helped pull the overall output figures closer into alignment.

Fed Urged to Press Ahead With Rate Rise After months of forewarning by the Federal Reserve that it is preparing to raise short-term interest rates, some international officials have a message: Get on with it already.

(…) “If you delay something that you were planning to do, then you leave the impression that your compass is different than what you led markets to believe,” Jacob Frenkel, chairman of J.P. Morgan Chase International and former head of the Bank of Israel, said in an interview Thursday. Market drama is increased by delay, he added. (…)

“It’s better for the U.S. to make a decision,” Bambang Brodjonegoro, Indonesia’s finance minister, said Wednesday in an interview in Jakarta. “What makes the financial markets volatile is the uncertainty.”

Raising rates would signal that the Fed is confident about the U.S. economy, Bank of Japan Governor Haruhiko Kuroda said Wednesday in New York, before the Fed gathering. “That is not only good for the U.S. economy, but also for the world economy, including the Japanese economy,” he said. (…)

New Zealand central-bank Governor Graeme Wheeler, who has expressed a desire to see his country’s currency depreciate, said in a speech in July that “we are likely to see the Federal Reserve and the Bank of England begin the process of normalizing their interest rates, and this may assist the [New Zealand] currency lower.” (…)

(…) Thursday’s revision to second-quarter gross domestic product—the Commerce Department now says that it grew at a 3.7% annual rate, rather than 2.3%—shows the economy is on good footing. And with the rebound in the stock market, nerves are a little less frayed. A good August jobs report next week, reasonably calm markets and September would be very much in play.

Moreover, a September liftoff would give the Fed an opportunity to show markets a little tough love with little consequences. It is, after all, looking to raise its range on rates from the current zero to 0.25% this year. Doing so sooner rather than later would be a signal the Fed wasn’t going to let markets dictate what it should do, and that it wouldn’t predicate policy on waiting for the absolute perfect time to move.

At the same time, with inflation well below its 2% target rate, it is also clear any rate increase this year won’t likely be followed quickly by further ones. So a September move wouldn’t spook investors into thinking policy was about to get a whole lot tighter. (…)

(…) “I want to take the time I have between now and the September meeting to evaluate all the economic information that’s come in, including recent volatility in markets and the reasons behind that,” Ms. Mester said. “But it hasn’t so far changed my basic outlook that the U.S. economy is solid and it could support an increase in interest rates.” (…)

Ms. Mester said there is now more downside risk in her forecast for economic growth because of market volatility and uncertainties about the growth outlook in China. Moreover, falling oil prices and a rising U.S. dollar mean it will take longer for inflation to rise toward the Fed’s 2% inflation objective, she said. She had seen a return to 2% inflation by late 2016, but now says it will take longer to get there.

But she added that recent economic data—including reports on economic output, durable-goods orders, household spending and consumer confidence—suggested the economy has “pretty solid momentum.”

“There is probably more downside risk to my forecast now given the volatility, but my baseline forecast probably hasn’t moved enough to change my view on policy,” she said. (…)

U.S. Pending Home Sales Post Limited Gains

The National Association of Realtors (NAR) reported that pending sales of single-family homes rose 0.5% during July (7.2% y/y) following a little-revised 1.7% June decline. Expectations were for a 1.0% increase according to Bloomberg.

Last month’s sales gain was due mostly to a 4.0% rise in the Northeast (12.3% y/y). Sales in the South improved 0.6% (5.3% y/y) but in the Midwest sales were unchanged (5.4% y/y). In the West, sales declined 1.3% (+9.2% y/y).

image

Last 3 months: Northeast: +9.1%; Midwest: –3.8%; South: –3.6%; West: +0.8%. Total: –0.6%.

Go figure!

Lending to Eurozone Firms, Households Advances

The data published Thursday showed that loans to firms grew by 0.9% in July in annual terms, higher than the 0.2% seen in June. Lending to households rose by 1.9% on the year versus 1.7% in June.

China Will Respond Too Late to Avoid Recession, Citigroup Says

China is sliding into recession and the leadership will not act quickly enough to avoid a major slowdown by implementing large-scale fiscal policies to stimulate demand, Citigroup Inc.’s top economist Willem Buiter said.

The only thing to stop a Chinese recession, which the former external member of theBank of England defines as 4 percent growth on “the mendacious official data” for a year, is a consumption-oriented fiscal stimulus program funded by the central government and monetized by the People’s Bank of China, Buiter said.

“Despite the economy crying out for it, the Chinese leadership is not ready for this,” Buiter, chief economist at Citigroup, said in a media call hosted Thursday by the Council on Foreign Relations in New York. “It’s an economy that’s sliding into recession.” (…)

“They will respond but they will respond too late to avoid a recession, which is likely to drag the global economy with it down to a global growth rate below 2 percent — which is in my definition a global recession,” said Buiter.

The global economy will expand by 3 percent this year, while China’s is forecast to grow 6.9 percent, the slowest pace in a quarter century, according to economists surveyed by Bloomberg. (…)

China’s Banks Face Worst Year in More Than a Decade China’s biggest lenders are scrambling to clear rising bad loans from their books, as a faltering economy weighs on loan repayments and sets banks on pace for their worst year since they began listing shares 13 years ago.

(…) Industrial & Commercial Bank of China Ltd., the nation’s largest lender by assets, said Thursday that its net profit in the first half rose 0.6% to 149.02 billion yuan ($23.27 billion), far below the 7% growth in the same period last year and half the rate of 1.4% in the first quarter.

Agricultural Bank of China Ltd., the country’s third-biggest bank, posted net profit growth of 0.3% to 104.32 billion yuan, compared with 13% a year ago and 1.3% in the first quarter. Profit at Bank of Communications Co. rose 1.5% to 37.32 billion yuan, compared with a 6% gain a year ago.

Bank of China Ltd. said Friday its first-half net profit rose 1.1% to 90.75 billion yuan, slowing from 11% growth a year earlier. (…)

Chinese banks maintain a squeaky-clean level of toxic debt on their books. ICBC said its bad-loan ratio, which measures nonperforming loans as a percentage of total loans, reached 1.4%, compared with 1.29% at the end of March. Bank of Communications posted 1.35%, a rise from 1.3% three months earlier. Agricultural Bank reported 1.83%, up from 1.65% in the first quarter.

These levels are low by global standards, but few analysts believe the rate accurately reflects asset quality among lenders. Valuations of Chinese banks provide a better clue to worsening bad-loan levels, analysts said.

“The banks’ share prices acknowledge there is way more uncollectable debt on their books than they now acknowledge,” said Anne Stevenson-Yang, director of J Capital Research in Beijing.

ICBC’s Hong Kong-listed stock is trading at 0.8 times its book value, a measure of net worth, from 2.9 times book value in 2009. Bank of China Ltd.’s price-to-book ratio has fallen to 0.68 from around 1.8 in 2009. Investors use the indicator to gauge potential problems in the company.

The first-half reports show banks have been scrambling to throw out bad debt. ICBC wrote off 31.3 billion yuan of bad loans, more than double 12.7 billion yuan of a year earlier. AgBank’s write-offs reached 15.4 billion yuan in the period, from 11.8 billion a year ago.

Though banks’ data suggest nonperforming loans are inching up only slowly, another measure suggests troubled loans are mounting. Special-mention loans, a category that banks deem overdue but not yet impaired, are rising. Analysts say these loans are often just soured loans that lenders haven’t acknowledged yet.

At the end of June, ICBC reported 420.4 billion yuan of special-mention loans, nearly three times more than its nonperforming loans and accounting for 3.6% of total loans. A year ago, the bank reported just 231 billion yuan of special mentions, or 2.1% of loans.

“The market believes that there is a lot more bad loans under the hood,” said Oliver Barron, head of research at investment bank North Square Blue Oak.

As worries loom, lenders have been increasing provisions, but these buffers can’t keep pace with the proliferation of bad loans. ICBC set aside provisions that were 1.63 times as large as their bad-debt levels in the first six months, down from 2.4 times in the same period last year—a sign that it is struggling to insulate itself, analysts say. Provisions at Agricultural Bank reached 2.39 times the level of bad debt in the January-June period, slipping from 3.46 times a year earlier.

How Brazil’s China-Driven Commodities Boom Went Bust Brazil’s big bet on China is turning sour as the Asian country’s once voracious appetite for Brazilian exports dims.

(…) Brazil’s pain from China’s slowdown isn’t largely confined to the financial markets, as in some countries, but goes to the heart of its real economy. (…)

As inflation nears double-digits and as unemployment and interest rates rise, middle-class households are starting to miss car payments and the poor are eating less meat. (…)

Rich in iron ore, soybeans and beef, not to mention oil, Brazil was positioned as a supplier of many things China needed. Its annual trade with China, only around $2 billion in 2000, soared to $83 billion in 2013. China supplanted the U.S. as Brazil’s largest trading partner. (…)

Pointing up “Unfortunately, the history is that commodity-dependent economies do not catch up with the U.S.,” said Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management. “Not just oil producers. More countries end up being poorer, compared with the U.S., after they find a commodity than catch up.” Using data going back to 1800, he said commodity-dependent economies typically grow for a decade, then spend as long as two decades wallowing or slipping back.

Some reasons are structural. The influx of hard currency from commodity exports strengthens a country’s own currency, which can toughen conditions for non-commodity industries such as manufacturing by hampering exports and making imports cheaper. At the height of Brazil’s boom, Goldman Sachs declared Brazil’s currency, the real, the world’s most overvalued. Movies and taxis in downtown São Paulo were more expensive in dollar terms than in New York. Brazil’s manufacturers began contracting. (…)

Brazil’s exports to China tumbled by 19% in the first seven months of this year. (…)

SENTIMENT WATCH
Fed Up Investors Yank Cash From Almost Everything Just Like 2008

Since July, American households — which account for almost all mutual fund investors — have pulled money both from mutual funds that invest in stocks and those that invest in bonds. It’s the first time since 2008 that both asset classes have recorded back-to-back monthly withdrawals, according to a report by Credit Suisse.

Credit Suisse estimates $6.5 billion left equity funds in July as $8.4 billion was pulled from bond funds, citing weekly data from the Investment Company Institute as of Aug. 19. Those outflows were followed up in the first three weeks of August, when investors withdrew $1.6 billion from stocks and $8.1 billion from bonds, said economist Dana Saporta. (…)

Withdrawals from equity funds are usually accompanied by an influx of money to bonds, and an exit from both at the same time suggests investors aren’t willing to take on risk in any form. (…)

Stock Market Investors Should Watch the Credit Canary

(…) Yields on U.S. junk bonds recently hit their highest since 2012 before edging lower to stand at 7.33%, according to Barclays indexes. They have risen by 1.4 percentage point since the start of June, and by 2.5 percentage points from their 2014 low. (…)

Yields have been driven higher mainly by borrowers exposed to energy and commodity prices. Energy bonds are down 8.4% year-to-date; bonds issued by metals and mining companies are down 12.5%. Energy and basic industries are hefty sectors, accounting for 25% of the U.S. high-yield index. The energy sector’s woes will almost certainly cause defaults to rise. That, however, will be from low levels: the global default rate in July was 2.4%, according to Moody’s Investors Service Inc., well below the 25-year average of 4.6%. (…)

In the investment-grade market, the gap between the yield on corporate bonds and U.S. Treasurys has widened, a potential cause for added concern. But the move has been relatively modest. Spreads have widened by 0.25 percentage point to 1.7 percentage point since the start of June, according to Bank of America Merrill Lynch indexes. Bond supply has been extremely heavy; in July alone, issuance hit $145 billion versus an average over the previous three years of $78 billion, according to Société Générale. (…)

Chinese Stocks To Plunge Another 35%, BofA Says

The rebound in China’s stocks will be short-lived because state intervention is too costly to continue and valuations aren’t justified given the slowing economy, says Bank of America Corp.

“As soon as people sense the government is withdrawing from direct intervention, there will be lots of investors starting to dump stocks again,” said David Cui, China equity strategist at Bank of America in Singapore. The Shanghai Composite Index needs to fall another 35 percent before shares become attractive, he said.

Hmmm…Look at these GD charts (full report available here)

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