China grew 7% in 1Q, the slowest in 6 years ... the IMF says it'll slow more
Services account for over half of growth for the first time
Iron and coal industries are getting tax breaks and tariff protection ... copper could be next
Defense spending is in the double digits for the 27th year in a row ... still lagging globally as a share of GDP
Banks, insurance, and movie studios are joining the overseas M&A bandwagon
|MRP||McAlinden Research Partners | DIBS||
Daily Intelligence Briefing - April 16, 2015
Maybe we left too much on the table. Last November, MRP recommended taking a long position in China's stocks in light of renewed stimulus measures, including monetary easing, additional fiscal spending, and reforms that opened up the stock market to increased participation by domestic and international investors. By March 24, stocks were up sharply and we closed the recommendation. Since then, stocks have basically gone up nearly every day even as the outlook for economic growth continues to darken. While MRP retains a short recommendation on the yuan, we're staying on the sidelines for the stocks. Here's why.
Part of the rally stems from a quirk in the dual-listing by many Chinese firms. The recent boom began with the "A Shares" on the Shanghai Stock Market, where trading had been generally limited to domestic investors. The "H Shares," which trade in Hong Kong and are available to international investors, was late to the party but is now rapidly closing the gap. Reforms allowing greater cross-border access to the Shanghai market should eventually erase the gap altogether through arbitrage. However, many international investors continue to prefer to trade in Hong Kong on the expectation that the markets will converge by lifting the H Shares higher. The risk is that convergence comes instead from a decline in the A Shares.
Reindexed to 100 on 1 Jan 14. Source: Bloomberg, McAlinden Research
Whether priced in Shanghai or Hong Kong, the continued rally in stocks stands in contrast to how China's leadership has been managing down growth expectations. Policymakers say they are planning on slower growth as the economy shifts from the traditional investment-led smokestack industries to consumption-led growth that relies more on services and technology. To gauge the economy's transition, China's planners have devised a monthly Real Activity Index that tracks 10 representative sectors of the economy, which itself is split into two parts: the Old Activity Index (iron production, real estate investment, textiles, fossil energy, and state-owned enterprises) and the New Activity Index (pharma, auto exports, green energy, telecoms, and private enterprises).
Source: Bloomberg, McAlinden Research
The risk is that China's old economy slows faster than the new economy gains traction. Indeed, in past years, whenever the overall economy slumped too much, the planners simply reached into their back pocket and issued directives to banks, factories, and local politicians to boost growth. In 2009, 2011, and 2012, the Old Activity index duly turned up and helped support the overall economy.
However, beginning in 2014, the smokestack industries have continued to lag, bringing overall growth to the slowest pace in years despite a "mini-stimulus" that was launched in early 2014 and bolstered later in the year with further fiscal and monetary measures. More recently, China's leaders are cajoling the banks into boosting lending and local authorities into accelerating their spending outlays. But many of those same local authorities are weighed down by massive debt and are gun-shy from the central government's ongoing crackdown on discipline. In the current environment, fewer are willing to stick their necks out and take bold action at the local level.
The upshot is that the stock market is pricing in stronger growth but the data is pointing to a weaker economy ahead. China's leaders say they are content with growth of around 7%, which would be the slowest in 25 years. That's also been the consensus among economists as tracked by Bloomberg, with slower growth of 6.7% next year. They all might need to ratchet their expectations even lower: Citigroup's Economic Surprise Index has dropped sharply in the last few weeks.
Source: Bloomberg, McAlinden Research
The stock market's rally, at this point, has less to do with the economy's fundamentals than the stampede of domestic and international investors into equities. As long as the fund flows hold up, the rally could have a long way to go. However, while it is easy for the planners to issue directives telling banks to issue more loans and factories to make more ships – and currency managers to weaken the yuan – it is another thing to instruct stocks to keep going up. For now, MRP will remain on the sidelines as far as China's stock market is concerned and look for new investment themes elsewhere.
Today’s Issue Cluster: China
- China grew 7% in 1Q, the slowest in 6 years ... planners expect the same for the full year, the slowest in 25 years ... the IMF says it'll slow more
- Premier Li tells local officials to meet their targets... Vice Premier Wang tells exporters to boost trade
- Services account for over half of growth for the first time
- Iron and coal industries are getting tax breaks and tariff protection ... copper could be next
- Interior metro areas are growing far more briskly than the big coastal cities
- Defense spending is in the double digits for the 27th year in a row ... still lagging globally as a share of GDP
- Banks, insurance, and movie studios are joining the overseas M&A bandwagon
- As checkbook diplomacy falters, China is creating new multilateral initiatives in which it will have the largest sway
- Leaders have labor relations higher on the agenda as reports of strikes surge
- Russia: The Ruble Runs Ahead of Oil
- Aluminum Long vs Steel Short: Iron Price Wars
- Iran's Potential Investment Implications
- Reconfiguring the Abe Trade
- Closing Long China Stocks and Staying Short the Yuan
|MAJOR DATA POINTS||Top|
Stocks – HK: Becomes world’s largest exchanges operator
Gains in PetroChina Co., Industrial & Commercial Bank of China Ltd. and China Mobile Ltd. have made their shares the fourth-, seventh- and eighth-most valuable in the world, after each was absent a year ago, data compiled by Bloomberg show. Each has surged in the past 12 months amid an advance that pushed the Shanghai Composite Index up 94 percent. B
Stocks – HK: Buyers Shun Blue Chips
Stocks – China: Overshadowed Shenzhen Market Surges
Stocks – China: Disappointment inevitable for those buying into froth
Currencies – Momentum Builds to Label Yuan a Reserve Currency
To be awarded reserve-currency status by the IMF, the yuan must be “freely usable,” a term that leaves wide interpretation by the executive board that will rule on the issue later this year. China’s policy of carefully managing the yuan’s value doesn’t necessarily rule it out from consideration. WSJ
Currencies – HK in no rush to switch dollar peg
In the first three months of the year, China’s economy grew 7 percent compared with a year earlier, in line with economists’ forecasts... China’s Communist Party leadership has lowered its official growth target for this year to about 7 percent. That would be the nation’s slowest annual expansion in 25 years. NYT
The Chinese government had previously announced a growth target of “around 7 per cent” for 2015. “We have the ability to keep economic operation within the proper range,” Premier Li Keqiang told the Financial Times in an interview on March 31. “This is not going to be easy but we will do our best and we can do it,” Mr Li added in his first interview with a western media organisation since assuming office two years ago. FT
The IMF estimated that the world's second-largest economy will grow 6.8 percent in 2015 before slowing to 6.3 percent in 2016, maintaining its previous predictions from January... The IMF's estimate for this year matches the median forecast in an AFP poll of 15 economists ... The IMF also forecast that China's consumer inflation rate will fall to 1.2 percent this year after hitting 2.0 percent last year, before rebounding to 1.5 percent next year. AFP / FT
India is now the rock-star emerging market, tipped to grow 7.5 percent this year...
While China’s lousy industrial data -- worse than any of the 40 analysts surveyed by Bloomberg News anticipated -- received the most attention from Wednesday’s releases, buried in the numbers was an important milestone for China. The services sector for the first time accounted for more than half, at 51.6 percent, of GDP in the first quarter. B
The apparent discrepancy between China’s headline 7% growth figure and the much-weaker underlying data is raising new questions about the reliability of Chinese gross-domestic-product data and other statistics. In a report Wednesday titled “Growth Likely Overstated,” Citibank said actual growth could be as low as 6.3% year-on-year as judged by the industrial-production numbers, and it could even be below 6% if the tepid quarter-to-quarter growth figures, declining electricity production and other measures were factored in. WSJ
China – Faltering Growth Forces Reliance on Traditional Tools
Premier Li Keqiang.... told provincial officials they must meet their economic and social targets to safeguard people’s income and jobs... Vice Premier Wang Yang urged exporters to accelerate trade growth...
While Beijing has become more selective in the projects it approves—wary of past bridges-to-nowhere spending—economists say the basic playbook is frayed. Local governments, responsible for implementing many projects, face mounting debt, sinking land prices and tighter budget rules—all of which are constraining their willingness to spend... The two-year-old anticorruption campaign has also discouraged officials from approving projects and working closely with private businesspeople for fear they will be accused of malfeasance. WSJ
China – One silver lining was strength in services
One explanation for how the economy grew as quickly as it did is that the mix of growth is shifting away from the ailing manufacturing and construction sectors, toward services. For the first time on a quarterly, nominal basis, services contributed more than 50% of economic output.... To China bulls, the shift to an economy driven by services and consumer spending represents a bridge over the debt-filled chasm that is the industrial and property sectors. WSJ
China – Soft or hard landing?
China has several advantages. The vast majority of its debts are held at home. In many cases both debtors and creditors answer to the same master, the government. A state-owned bank is not about to call in a loan from a state-owned shipbuilder. ... Credit growth has fallen below 15% year-on-year, down by more than a quarter from the average of the past decade. But since nominal growth is even slower, China’s debt-to-GDP level continues to rise. Lending will thus have to slow yet further...
A much-needed shift towards consumption-led growth is just getting under way. Investment accounts for 50% of economic output, well beyond what even Japan and South Korea registered in their most intensive growth phases.... the government ... is trying three kinds of reform. The first is financial liberalisation. ... The second area for reform is fiscal, a push that has just begun. .... Bureaucratic reforms are the third focus. Here, progress has been uneven. E
* * *
China – Trade Plunge Won’t Reach Great Depths
All things being equal, most of the drop in imports in the first quarter can be attributed to lower prices for just two line items: oil and iron ore. By value, China’s first-quarter imports of these two were down $63 billion from a year earlier. But in volume terms, China imported more of both WSJ
China – Interior cities still growing
China – Banks on a glut-busting “Silk Road”
The Manila-based Asian Development Bank estimates that Asian infrastructure demand will total some $8 trillion between 2010 and 2020. According to some estimates, that translates to about 500 million tons of cement demand per year, or 20% of China's current annual production. N
China – Has lent billions to spread influence but defaults loom
Ukraine is heavily in arrears in its Chinese lending, while Zimbabwe has failed to repay a much smaller amount. Other recipients of Chinese policy-driven finance — such as Venezuela, Ecuador and Argentina — are suffering varying degrees of economic distress, casting doubt on their ability to repay. ... There are signs that Beijing is growing less tolerant of the more egregious risks, a trend that could deprive some of the world’s most fragile economies of crucial lines of credit. Beijing also appears intent on spreading its risk, embracing a more institutional and multilateral approach FT
China – ‘Explains collapse in global inflation rates’
|POLITICS & FISCAL POLICY||Top|
China – Beijing influence over AIIB a concern ahead of founders’ meeting
"Looking at GDP-based contributions, if the No. 1 and No. 3 (the United States and Japan) aren't in, then China will have an overwhelmingly large quota and voice," said one Japanese official. "No country would be able to challenge China. If Japan were in, it would have considerable influence." R
Forty-six countries had joined or applied to become founding members of the China-led Asian Infrastructure Investment Bank when the deadline closed CD
China – AIIB to Focus on Big-Ticket Projects, Indonesia Says
China – Projections of power
Beijing’s rapid spending increases and stubborn defence of its maritime claims, including an area of ocean sticking out into the South China Sea called the “nine dash line” and over islands in the East China Sea disputed with Japan, threaten to ignite an arms race across Asia.... Beijing has been taking on international commitments, starting with a mission in 2008 to deploy its navy off the east coast of Africa to combat piracy, the first time the navy has deployed that far in 600 years.... military expenditures are small by international standards if measured as a percentage of GDP. FT
China – Collectors get aggressive as governments seek revenue
Provincial officials are desperate to make up the difference. The quickest way to fill empty coffers is to go after multinational corporations.... In February, national tax officials told foreign fund managers they would impose a 10% tax on their capital gains for the 2009-2014 period under two programs that allowed foreign investors to buy stocks and other financial assets. Aside from multinationals, officials are also looking to the offshore income of Chinese companies and citizens to improve collections. N
PBOC – Reserves Decline by Record on Intervention, Euro’s Slide
China – Are Foreign Exchange Reserves Really Falling?
once we strip out currency fluctuation effects – that is, the steep recent rise in the dollar – Chinese FX reserves actually increased mildly, rather than decreased, between last June and December. cfr
China – Finally Gets Cheaper Credit
China – Banks: a national service
China – Commercial lenders expand investment banking operations
China, which has traditionally maintained a strict Glass-Steagall-style separation between commercial and investment banking, bans commercial banks from underwriting initial public offerings or acting as broker-dealers in the stock market, the two biggest revenue sources for securities companies. But bond underwriting, wealth management, M&A advisory and custodial services have all emerged as areas of competition between banks and brokerages. FT
China – Small Businesses Lose Out on Cheaper Loans
Chinese banks have become less willing to lower lending rates since 2012, when Beijing eased restrictions preventing them from offering higher deposit rates. ... Banks are sticking to lending primarily to state-owned enterprises, even at low rates, to secure them as long-term clients and because those companies have implicit or explicit government backing for debt repayment. Sometimes there is political pressure from local or central governments too. WSJ
China – Smartphones replacing wallets
China – Boston Project Draws Insurance Firms’ First US Investments
HK – Builder shortage hits prices and delays key projects
|LABOR & EDUCATION||Top|
China – Aims to Soothe Labor Unrest
Strike occurrences more than doubled last year to 1,378, according to China Labour Bulletin, a Hong Kong-based watchdog, although it said that the increase is partly due to the growing use of social media among migrant workers, which gives labor protests more visibility. The trend extended into the first three months of this year, when the labor group logged 650 incidents, up from 569 in the previous quarter, as disputes over unpaid wages and work benefits swelled in the construction and manufacturing sectors. WSJ
China – May Have the Most Factory Robots in the World by 2017
The International Federation of Robotics estimates about 225,000 industrial robots were sold throughout the world last year—27% more than the year before and a new record. Of those, about 56,000 were sold in China.... it has relatively low “robot density.” China has about 30 robots for every 10,000 factory workers. In Germany, the density is 10 times higher. In Japan, it’s 11 times higher. wsj
China – Escalates Hollywood Partnerships, Aiming to Compete One Day
coproduction deals provide greater access to China’s tightly regulated market, which in a few years is expected to surpass the United States as the world’s biggest film market. ... With China adding an average of 15 cinema screens every day, the country’s box office brought in $4.8 billion last year, tripling in size since 2010, according to the Motion Picture Association of America. And Chinese piracy is no longer such a significant threat to American studios NYT
China – Asia’s box office for movies is now bigger than America’s
Metals – China regulation is key to copper pricing
In coal, oversupply has meant that about 70 per cent of Chinese coal miners are operating at a loss..... instead of closing mines, the Chinese government introduced import taxes on coking coal and thermal coal and reduced export taxes. It also placed limits on the quality of coal that was allowed to be imported, essentially putting a halt to coal from overseas lower cost miners....
If current copper price levels are sustained for a few more months, the pace of mine closures should pick up, according to a Reuters GFMS copper survey released in Santiago this week. The deepest cut to output should be in China, the world’s second-largest producer last year, the report said. FT
Goldman Sachs Group Inc. analyst Max Layton said that with Chinese steel demand tailing off in the past six months, copper will be “the next shoe to drop. “It’s just a matter of time,” he said, projecting that copper is likely to fall to $5,200 a ton by year-end, with risks “heavily skewed” to the downside. WSJ
Metals – Chinese hedge funds boost influence
94% of Chinese live east of the Heihe-Tengchong line
Warren Hatch, PhD, CFA
Portfolio Management and Global Investment Strategy
McAlinden Research Partners
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