Tag Archives: RRR

Don’t Say I Didn’t Warn You!

1 Dec

So we wake up this morning with the news that the official PMI data shows a contraction in Chinese manufacturing activity for the first time since February 2009. This follows the HSBC survey published a couple of weeks ago which similarly illustrated a contraction. In this context it’s easier to understand the reduction in RRR yesterday afternoon. That reduction added some $63bn of liquidity to the Chinese economy.

Clearly the Government sees that the economy is not in for an easy ride. I mean after steadily raising the RRR in 12 steps since January 2010 from 15.5% to 21% (a record), and then leaving them since June 2011, this is a watershed moment. While commentators yesterday lauded the move as the PBOC’s attempt to steer the economy to a soft landing I would prefer to describe the move as follows: A long running policy of loose monetary conditions led to an influx of speculative capital. The change in direction (i.e. to tightening in Jan 2010) combined with a huge acceleration in housing construction has killed the boom, created distress and the PBOC is now waking up.

Initial loosening is generally greeted with joy (note markets were buoyed somewhat way before the announcement of combined central bank activity yesterday to put a band aid on the Euro crisis). However, within time the market will see that the damage that precipitated the change in monetary policy is too big for a gentle loosening. As such I expect Chinese economic conditions to continue worsening (today’s PMI data is one example), and the PBOC to take more agressive moves to loosen credit conditions. This will heighten the impact on those assets that were tied to the prior boom. In this case I would expect damage to significant parts of the EM equities, fixed income, and commodity complex, in addition to pain in the domestic real estate market. Don’t say I didn’t warn you.

Also note – there’s a chance this could spill over to the banking system.

PS – some additional color on the PMI data. New orders 47.8. Export orders 45.6. Note that the export sector’s value added accounts for only 10% of GDP (yes – only 10%). As such, domestic weakness is most likely to be the driver of GDP deceleration in the coming months. Index of finished goods inventory rose to a record high. Tobacco, transport equipment and petrol were above 54. Below 43 were textiles, chemical fiber and plastics, and ferrous metal. The biggest losers were electrical machinery and special purpose equipment.




Things are getting messy

3 Oct

For someone who blogs on China, leaving 100 days between entries is inexcusable! What can I say? I’ve been working on increasing my coverage of the Turkish and MENA consumer space for a new product my fund plans to launch. It’s been a lot of effort. In fact, I was in Turkey last week meeting management teams, and am happy to share some of my thoughts with you in upcoming entries. Even though they are not China related, I hope someone will find them interesting! (More to come on that later this week).

Anyway, for a while now I’ve aspired to move to China and to work in the Chinese markets. With that in mind I was speaking to a friend who lived in HK for a number of years. My aim was to price the cost of living and to see at what stage of my career I could make such a move. He told me that in 2005 when he last lived there he rented an apartment for US$5,000 a month.  The details of the apartment are irrelevant. The interesting point is that today the same apartment costs $10,000 a month to rent… and it’s occupied!

A 100% increase in 5 years is surely indicative of a problem. Since hearing this, my attention has been increasingly drawn towards cracks in the China story…

Let’s start with another piece of anecdotal evidence – I love a good story! Last weekend Sotheby’s in HK failed to sell all of its wine on auction for the first time in 17 sales. Anyway…

Last Thursday Reuters carried a story about Chinese entrepreneurs going into hiding to avoid repaying loans. According to the report cash-strapped firms, unable to borrow from banks due to a credit clampdown directed from Beijing, have turned to underground lending markets.  These underground markets are known to have annual lending rates as high as 100% (15x higher than the official benchmark).

Local media reported last week that the bosses of 9 SMEs in Wenzhou had fled town, unable to pay corporate loans.  One such boss is the Chairman of glasses manufacturer Zhejiang Center Group.  In 2008 these guys were hoping for an IPO. According to their website they employ 3,000 people and enjoy annual revenues of ~550m yuan.

The total underground lending market is estimated at about RMB 5bn – that’s about 10% of total Chinese lending. About half of this figure comes from high net worth (HNW) individuals, anxious to put their money to ‘better use’ than make do with the rates received on official deposit accounts.  As the risks of default increase HNW are trying to withdraw their commitments.  Yet the market is getting concerned that HNW are going to take a hit, and stop buying sports cars and luxury goods (not to mention their trips to Macau).

The picture gets complicated when this lending (and the HNW purchases) is removed from the real estate pie. Not only is real estate hit (and my friend’s old rental might come down from US$10,000 a month), but there is US$1.7tr (yes trillion) of outstanding local government debt in China. So what’s the issue – about 40% of local government revenue  comes from land sales, and volumes are down about 30 this year!

In fact, for the first time in five years Chinese housing starts are on the decline as credit becomes increasingly harder to arrange. New developments are being postponed or slowed with banks less happy to lend for construction. In addition, the availability of mortgages has fallen while pricing has increased.

One final tidbit – the average days for accounts reveivable of the largest 300 Chinese stocks stood at 48 days in 1H11 – that compares with a decade average of 39 days. Apart from bein g a sign that SMEs are finding it harder to pay their suppliers, that’s going to impact the price of borrowing as well as cash flows. Yes this has happened before, but it was always in an environment in which RRRs were decreasing – today they are increasing.

So with the interconnected nature of financing, real estate, SMEs, HNW, employment, and Government revenues – things are about to get messy.

A Guru in China (part II)

1 Dec

Anthony Bolton updated investors via webcast today on his thoughts about investing in China. There were some interesting insights regarding the composition of his China fund at Fidelity.  I’ve previously written about Anthony’s bold move to move to China (https://ravendragon.wordpress.com/2010/11/18/an-investment-guru-in-china/ ). In that previous blog entry you will find a link to Bolton’s previous webcast, with more general China investment themes/insights. I will update this blog entry with a link to today’s webcast once Fidelity add it to their website.

What did we learn today?

  • 37.5% of the fund is in companies below US$1bn market cap. 35% of the fund is invested in companies with a market cap between US$1-5bn. This plays into Anthony’s themes of looking for growth companies, and companies that are less likely to be covered by the sell-side. The idea is that low coverage can equate with hidden value.
  • The presentation outlined all sector weightings. What interested me was that the fund is massively overweight consumer stocks (21.7% vs. an average of 5.5%). This plays into a macro theme that I’ve written about a number of times: the growing power of the Chinese consumer. Anthony talks of a 2-tier world when it comes to growth, with China outpacing the West (albeit slightly slower than the past decade). This 21.7% weighting clearly plays to that theme.
  • Top holdings include:

o   Bank of China in HK – If I understood correctly, this company has an effective monopoly in clearing!

o   China Unicom HK and China Mobile – Convinced that the data revolution will have a positive impact on Chinese telephony.

o   Ping An – Insurance. The State is slowly migrating its responsibility to the private sector.

o   Brilliance China – 50% JV with BMW. Expects them to sell 300k cars in a few years (up from 50k). This is part of a replacement cycle (including replacement of BMWs built in Germany). A highly recognized brand that’s underrepresented in the domestic market.

o   United Labs – working on insulin. Set to take on the dominant global players.

  • 2 of my questions were answered in the webcast:

o   With blue-chip US companies at historical lows, and the recent flows into EM/Chinese markets, do you think there’s likely to be pressure on Chinese markets next year?

Anthony answered with his investment thesis on the 2-tier growth world. He said that he is not concerned as he expects US growth not to return to its regular place for a while, and expects the delta to remain compared with Chinese growth. He added, however, that flows will indeed reverse if he is wrong.

This answer concerns me slightly. Why? There are key differences between US GDP and the S&P500. The former is characterized by domestic spending (mainly consumer), net imports, net borrowing, prefers a strong USD, and is captive to US taxation. The S&P500 on the other hand is global, driven by business spending (and note that global Capex spend is becoming less dependent on the US), is characterized by net savings, prefers a weak USD, and contains companies exposed to attractive tax rates compared with the US.

Granted the strength (or lack thereof) of the S&P is not the only driver of Chinese/EM markets. The risk is even lower for a fund that does not track an index. Nonetheless, I do envisage flows to the US pressuring EM markets in 2011.

o  My second question was whether Anthony sees a risk of rising interest rates in China impacting the market. He said that he feels that at some level rate increases can impact a bull market, but he felt that China is less sensitive than Western markets, mainly due to the fact that there is less consumer debt. As a side point, he said that’s why the authorities rely more on direct controls to lending and increased RRRs when as tools to control real estate and liquidity.

My question does not come out of thin air.  The Dow Jones Industrial Average was 875 on both the 31 Dec 1964 and 31 Dec 1981. Over that 17 year period US GNP grew 373%. By 31 Dec 1998 the Dow was up 10.5x to 9181.43. Over that 17 year period US GNP increased 177%. It’s no coincidence that at the end of 1964 long bonds in the US were 4.2%. At the end of 1981 they were 13.65%, and at the end of 1998 they were back down to 5.09%. There’s a lot more to say about this subject, and many other drivers of the markets (including psychology, and expectations). But interest rates do have a major impact in the value of all assets, and not just bonds!

Today with quantitative easing, economic stimulus, commodity increases, and flows into EM the risks are tilted towards an increase in interest rates from their historically low levels.

What else? He said he likes Gold, but is not bullish on other commodities.

Don’t expect a rate hike

3 May

Over the weekend the PBoC raised the bank’s reserve requirement ratio (RRR) by 50bp.  This is likely to remove about RMB250b from the banks.  The question is, why make such a move?

A priori it makes no sense as the government controls the loan supply by setting targets – a target of RMB 7.5tn was set for 2010 for example.  In fact over the past few weeks both short-term rates and long-term yields have been heading south, the result of adequate supply and limited demand for credit.  In other words this RRR increase is not a tightening measure, but simply the equivalent of issuing in central bank bonds at a lower rate (i.e. the deposit rate for required reserves is 1.62%, while the 1 year bills are about 1.93%).  But we still haven’t directly answered the question as to why the RRR was raised.

Well, it looks like the PBoC’s move was intended to manage market expectations of an imminent rate rise.  In recent weeks hot money has flowed into China, and foreign currency in the country has been exchanged to RMB on the assumption that the currency would appreciate.  Such FX flows in combination with tightened demand for credit reduced rates at the near end of the curve.  By raising the RRR the PBoC is trying to support short-term rates, which means that the banks itself does not intend an imminent rate rise.

A number of my readers have commented that they would like a beginner’s explanation of some of the topics I cover in my blog.  There is a wonderful website called http://investopedia.com – a financial dictionary with tutorials and comprehensive articles.  This blog entry touches on topics including money supply, the impact of interest rates, foreign exchange.  Clicking on the link below will take you to a definition of the term “money supply”.  There are links on the page to related terms and related articles.