Thursday, March 13, 2014

What's Going On In China? Recent Events and Their Significance Within Context of Key LT Trends

Is China slowing NOW?  Is the big collapse predicted for years by US hedge fund managers actually happening NOW?
"This is terrible," said Liu Li-Gang, a Hong Kong-based economist at ANZ Bank. "I wasn't expecting high figures, but this is worse than I thought."
Industrial output rose 8.6% year-over-year in the January-February period, down from a 9.7% increase in December, data from the National Bureau of Statistics showed Thursday. The rise in the two months—combined to adjust for distortions from the Chinese Lunar New Year holiday—is the slowest since 2009.
Growth in fixed-asset investment also eased to 17.9% year-over-year, the weakest pace since 2002, down from 19.6% last year as a whole. While activity continues to expand, the pace of growth is poor by Chinese standards. It now seems unlikely that economic growth in the first quarter of this year will match the 7.7% year-over-year rate logged in 2013.
Shortly before the data were released, Chinese Premier Li Keqiang expressed confidence that the nation would reach its economic targets for the year, brushing aside doubts from some foreign economists.
"Currently we see more difficulties (than last year)…but the Chinese economy has great potential and resilience," Mr. Li said, adding that he was confident Beijing could keep growth in a reasonable range.
Beijing has set an economic growth target of about 7.5% this year, unchanged from the 2013 target, though down from the actual growth recorded last year.
Despite the fact that data were combined for the two months, analysts say the economic figures so far this year may still include distortions from the period when many factories close down and migrant workers return to distant villages for the new year celebration. "Usually the March data would be slightly better than the first two months," said Ma Xiaoping, an economist at HSBC in Beijing.The median forecast of 13 economists surveyed by The Wall Street Journal was for industrial production to grow by 9.5%, much faster than the actual growth seen.
Markets turned southward after the unexpectedly weak figures, but the reaction was muted as traders weighed the possible holiday effect. Hong Kong's benchmark Hang Seng Index was down 0.4% within minutes of the release, and the Australian dollar fell less than 0.2%.
Other indicators, released together on Thursday, pointed to weakness elsewhere in the economy. Retail sales rose 11.8% year-over-year in the January-February period, down from 13.6% year-over-year growth in December. Construction starts, a key driver of growth in recent years, fell by 27% in area terms.
The key point is that growth must and will slow from here. Half of China's 7.5% growth today is coming from debt financed investment in property, infrastructure and factories - 3 sectors with huge excess capacity. If Chinese GDP is slowing sharply in 2014, that is positive for china longer term. If Bejing reacts to slower growth with fresh stimulus, the inevitable day of reckoning will be that much worse. Even if they continue to remove stimulus and follow through on critical reforms (interest rates, banks, SOEs, property taxes, just to name a few), the probability of an accident, a bank run, a systemic freeze-up of some kind, in this very large and complex country, is, IMHO, more than 50%. 

Two stories from the irreplaceable Caixin touching on the one area where china is undertaking dram if reform: the financial system. Specifically, the entry of Alibaba and Tencent, two tech giants that rank as among the best managed companies in china, into the business of accepting consumer d"deposits", on-line and earning interbank interest rates far above what the big ugly stupid SOE banks are permitted to pay (in rough terms 5% versus 1%). These two upstarts have raised in excess of $100 billion dollars in about half a year.  The Bejing authorities have said public ally they like what they see. But sucking out all the deposits from the traditional banks will expose their ginormous non-performing loans and force the government to once again bail out the banks. Is Beijing prepared for this? This all bears a vague resemblance to the end of Reg Q in the US in the mid-eighties.  Reg Q set a maximum savings account interest rate. The entry of aggressive S&Ls, willing and legally permitted to pay higher rates, sucked deposits from banks and forced the end of Reg Q. 

Rate liberalization driven by tech, approved by BJ
5 new private (I.e, not state-owned), one each for alibaba and tencent, are I final stages of winning approval. 

Buyer Beware!  China has a big risky macro story but investors cannot lose sight of the fact that there's still a morass of fraudulent companies (became clear to all in the 2011 reverse merger US listed china frauds), and that china still lacks rule of law with regard to corporate theft, and still lacks a transparent and rules based resolution process. Instead, politically well-connected PRC promoters are untouched whilst politically connected PRC creditors often get paid back partly with company assets - while US/offshore investors get nothing. Don't forgot this! China is a large stock market with a small % of investible companies. Most large cap stocks are low quality SOEs, and many small cap are either frauds or low quality bizs. Stocking picking in China remains a minefield, regardless of what happens on macro/reform. This piece from Caixin tells a tale of woe all too common for foreign investors into Chinese stocks. 

George Soros agrees with me. I've been saying this for a year but Soros' view probably carries more weight! Europe will survive and the periphery will stay in the Euro.  The US will continue to show mediocre, disappointing growth - but with de minimus risk of recession. The biggest risk to global risk assets is a step-wise drop in Chinese growth. 

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