Tuesday, June 30, 2015

Not Everyone is Buying the Renminbi Hype.

Earlier this month, the People's Bank of China released The Renminbi Internationalization Report 2015.  The Economic Observer ran a discussion piece (in Chinese) on this issue.  Not everyone is buying the hype.
[Translation:  "At what stage are we at in the process of renminbi internationalization? The People's Bank of China's report does not elaborate. However, we can reference the Renminbi Internationalization Report issued by the International Currency Institute of Renmin University in July 2014. According to that report, the Renminbi Internationalization Index (RII) in 2013 was 1.69. What does that mean? Even though the RII increased 84% in 2013, the U.S. Dollar International Index at 52.96 was 31 times higher than the RII. The similar rating for the euro, Japanese yen, and British pound were 18, 2.52, and 2.54 times higher than the RII. The answer is self-evident: Renminbi internationalization has a very long road ahead."]
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Monday, June 29, 2015

Supply and Demand in the Chinese Stock Market.

In June, which as of this posting has not ended, yet, the China Securities Regulatory Commission published 135 prospectuses on its website, more than double the average for the last three months, and close to twice as high as the previous high point, shown above as blue columns.  That was also the same month the stock market experienced its worst two weeks since 2008, shown above as a red line.  Perhaps the stock market's appetite has finally been satisfied?

There are only two days left in June, so it is likely that June will close lower than May, the first time the stock market has lost value month-over-month in years.  However, the People's Bank of China's announcement on Saturday has not been priced in.  Has anyone written a book called Shenzhen 10,000, yet?

Sunday, June 28, 2015

2015-05 Interest Rate Trends

Both the short-term state sector and long-term private sector interest rates fell significantly in May.

The Shanghai Interbank Offer Rate (Shibor) ended May at 1.04%, down 65 basis points from April. The trailing average for May is 2.20%, meaning Shibor is currently less than half the trailing average. The lowest rate ever reached was 0.80% in March, 2009, but 1.04% is still the lowest rate since June, 2009.

The Wenzhou Comprehensive Index ended May at 18.73%, down 114 basis points from April. It is also 97 basis points below the trailing average for May, and the lowest point for the data available. On May 10th, the People's Bank of China announced that it would adjust interest rates down. The interest rate charged for loans less than one year was reduced by 25 basis points down to 5.10%. The interest rate on one-year time deposits was also decreased 25 basis points to 2.25%. Reuters quoted the central bank's justification as being:
"At the same time, the overall level of domestic prices remains low, and real interest rates are still higher than the historical average."
The "domestic prices" they are referring to must not include equities. The Wenzhou Comprehensive Index is published by the Wenzhou City Local Finance Management Bureau. Occasionally, they publish reports on trends they see in the data. In the beginning of June, reports for January through May were updated. One observation they made was that "Examining lending periods show that short-term interest rates are higher than long-term interest rates.  Market transactions are primarily focused on short- and medium-term lending."

In May, the interest rate on a one-month loan was 18.81%, but a six-month loan was only 16.21%. April showed a similar trend. Shibor is the second-most market-oriented indicator for interest rates, but it is not showing an inverted yield curve. An inverted yield curve has generally been followed by a recession in developed countries. Perhaps the Wenzhou Comprehensive Index is telling us that China is experiencing, or will experience, a recession?

Friday, June 26, 2015

Shanshui's Technical Default.

Last week, China Shanshui Cement Group Ltd. announced that it could be the next Chinese company to default on its debt obligations. In this case, the cause of the default is corporate governance, not operating health. As Bloomberg explained:
China Tianrui Group Cement Co., which holds a 28.2 percent stake in Shanshui, has proposed to install four people -- including its chairman Li Liufa and Chief Executive Li Heping -- to the cement maker’s board, according to an exchange filing Monday. Tianrui has called for a vote to oust Shanshui chairman Zhang Bin and founder Zhang Caikui, an official said last week. The removal of board members including its chairman would constitute a “change of control” event that requires the company to repurchase its outstanding bonds, Shanshui said in a filing late Friday. It won’t have enough cash to redeem $921 million of its notes, leading to a default, it said.
In this specific case, the chairmanship may not transition, or Tianrui Group could step it to cover the debt if it does. If the company is forced to pay the debt back immediately, the inability to repay the total amount would not be caused by deteriorating cash flows.

Last September, Shanshui Cement was among a group of capital goods industry companies that were downgraded by global ratings agencies. The New York Times reported:
On [September 15, 2014], S&P cut the ratings of China Shanshui Cement and Guangzhou R&F Properties by a notch, plunging them deeper into junk status. Last week, fellow rating agency Moody's downgraded steelmaker China Oriental, already wallowing in non-investment territory, also by a notch.
All of these companies “that had binged on the easy credit springing from a round of government stimulus in 2008-2009.” Considering that Shanshui and Tianrui are both in the same industry, the dynamics that are affecting Shanshui should eventually come around to negatively impact Tianrui, as well. If one company is having difficulty paying off its debt in the long term, then another company in the same industry will most likely have similar difficulties down the road.

Thursday, June 25, 2015

Flashback: "Amid Financial Excess, a Revival of Austrian Economics"

Introduction:  The article re-posted below was written by Greg Ip and published in the Wall Street Journal on June 25, 2007.  Although it was written eight years ago, many of the trends have repeated themselves.  Specific mention was made of China's economic woes at the time.  We can only speculate what would have happened if China had faced its problems eight years ago, instead of piling up a huge mountain of debt to avoid the problems until today.
The Wall Street Journal - June 25, 2007 - Greg Ip - "Amid Financial Excess, a Revival of Austrian Economics"

Does the U.S. risk repeating the mistakes that led to the Great Depression? The Bank for International Settlements‘ annual report, released Sunday, suggests that it does, and offers a remedy steeped in the doctrine of Austrian economics.

In the 1930s adherents of the “Austrian school,” named for its Austrian-born proponents Ludwig von Mises, Joseph Schumpeter and Friedrich Hayek, argued the Great Depression represented the unavoidable remediation of misallocated credit and overinvestment in the 1920s. The Austrian school largely failed to become orthodoxy as first Keynesian demand management appeared to end the Depression and later monetarism blamed the Depression on inadequate attention to the money supply.

Austrian economics, however, has enjoyed a minor revival in the last decade, most prominently at the Basel, Switzerland-based BIS, which has few formal banking duties but is an important talking shop (it is sometimes called the “central bankers’ central bank.”) The BIS’s leading “Austrian” is a Canadian, William White, the head of the bank’s monetary and economic department and sometimes-rumored successor to retiring Bank of Canada governor David Dodge. In a 2006 paper Mr. White wrote that under Austrian theory, “credit creation need not lead to overt inflation. Rather…. the financial system … create[s] credit which encourages investments that, in the end, fail to prove profitable.” This leads to an “an eventual crisis whose magnitude would reflect the size of the real imbalances that preceded it [because] the capital goods produced in the upswing are not fungible, but they are durable. Mistakes then take a long time to work off.” He argued that in recent decades, “financial liberalisation has increased the likelihood of boom-bust cycles of the Austrian sort.”

Although the concluding chapter of the BIS’s latest annual report, released Sunday, never mentions the Austrian school, it is suffused with its influence. “Virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s, respectively,” it begins. “In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived.”

It notes that “the prices of virtually all assets have been trending upwards, almost without interruption, since the middle of 2003.” While fundamental economic improvements are at the root, “the market reaction to good news might have become irrationally exuberant. There seems to be a natural tendency in markets for past successes to lead to more risk-taking, more leverage, more funding, higher prices, more collateral and, in turn, more risk-taking… [S]uch endogenous market processes … can, indeed must, eventually go into reverse if the fundamentals have been overpriced.”

Apart from financial imbalances, the report argues the world economy also displays dangerous misallocations of capital. In its “recent rates of credit expansion, asset price increases and massive investments in heavy industry, the Chinese economy also seems to be demonstrating very similar, disquieting symptoms” to Japan in the 1980s. “In the United States, it is the recent massive investment in housing that has been unwelcome from an external adjustment perspective. Housing is the ultimate non-tradable, non-fungible and long-lived good.” In other words, the U.S. could be stuck with a lot of houses that are hard to sell to each other and impossible to sell to foreigners, and won’t need replacement for a long time.

What does the BIS say central bankers should do? Essentially, relax their single-minded focus on price stability, and tighten monetary policy when “a number of indicators — not just asset prices but also credit growth and spending patterns — are simultaneously behaving in a manner that indicates increasing exposures.” In other words, when easy credit is fueling excesses, raise interest rates to end the party, even if inflation is quiescent.

In practical terms, few central banks are ready yet to heed the Austrian prescription. Federal Reserve Chairman Ben Bernanke spent a lot of his life arguing just those sorts of prescriptions helped bring about, and deepen, the Great Depression. (See, for example, his 2002 speech, “Asset-Price ‘Bubbles’ and Monetary Policy.” Under him, the Fed remains focused on inflation. The European Central Bank has recently reasserted the importance of money and credit growth in its deliberations, but its policy for practical purposes also remains focused on inflation. The Bank of Japan comes closest to sharing the BIS view and has routinely cited the risk overinvestment as a reason to raise rates, but it has recently stopped tightening as inflation remains near zero.

As Mr. White has acknowledged, the Fed can rightly argue its practice of leaving bubbles alone and cutting rates to mitigate their bursting appears to have worked well. The post-stock bubble rate cuts may have in turn created a housing bubble whose consequences haven’t fully played out. But the strength of economic growth since 2002 appears to have placed the burden of proof on advocates of an alternative policy.

This isn’t to say Fed officials are unsympathetic to some of the BIS’s diagnoses. Some, in particular New York Fed president Tim Geithner, regularly warn that risk-taking is at an extreme and a reversal could trigger a self-reinforcing spiral of price declines and asset sales. Yet, having thought it over, they’ve concluded anything the Fed does with interest rates to address this risk would likely make matters worse.

Wednesday, June 24, 2015

Re-Interpreting China's New Economic Foreign Policy.

Over the past year, China’s increased drive to re-align international institutions has led many observers to view these moves as further indicators that China will surpass the United State’s influence in Asia specifically, but also other emerging markets. In July 2014, China led the introduction of the New Development Bank, a financial institution created to counter the International Monetary Fund and World Bank in the Brazilian, Russian, Indian, Chinese, and South African spheres of influence. In May 2015, Chairman Xi began a tour of South America as part of a program called International Capacity Cooperation. Although many see these actions as signs of China’s growing strength, they should actually be seen as signs of China’s weakness.

For members of the New Development Bank, the stated goal is to allow each member to have investment opportunities outside of their countries (mainly China), and have access to capital for domestic infrastructure projects (mainly everyone but China). The more important function deals with currency bailouts. As the Washington Post explained:
"BRICS countries have also created a $100 billion Contingency Reserve Arrangement (CRA), meant to provide additional liquidity protection to member countries during balance of payments problems."
The BRICS were the biggest beneficiaries of the Quantitative Easing program launched by the Federal Reserve. As yields were artificially pushed down, borrowers could access more artificial credit and savers had to seek out more risky investments in the developing world. Now, the monetary authorities of these countries may understand that as this flow of artificial credit slows or reverses, they will be hit the hardest. The Contingency Reserve Arrangement could possibly slow down the process once it begins.

On the real economy front, China’s investment in and exports to developing countries are being promoted by Chairman Xi through the International Capacity Cooperation program. Xinhua explained the focus of this proposal:
"The government has issued a list of prioritized sectors in which it wishes to enhance such cooperation, including steel, non-ferrous metals, construction materials, railways, electric power, chemicals, textiles, automobiles, telecommunications and machinery."
These sectors received much of the new credit that was created by the People’s Bank of China in response to the Global Financial Crisis. Now, they are dealing with excess debt and low demand for all the capacity they brought online. Instead of being seen as China’s growing strength in the world, they should be seen as recognitions by the Chinese authorities that China overbuilt capacity and will run out of dollars when it has to repay its debts.

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Monday, June 22, 2015

Will the China Century End in 2019?

The United States has dominated the global economy for much of the Post-World War II Era.  Its dominance has come from the sheer size of the U.S. economy.  No other nation has yet been able to surpass the gross domestic product of the United States at any time during the period.  To understand China’s rising status in the world, we must view gross domestic product in another way.

We can imagine annual gross domestic product as the economy standing still at the end of the year.  The United States has always been the dominant economy and will continue to be dominant for the foreseeable future.  However, if we measure economic dominance by the new amount of gross domestic product in dollar terms, we can see economic change in progress.  We can safely assume that new gross domestic product has more impact on the world economy than recurring gross domestic product.  This would explain China’s rapid rise in economic influence over the last few years, despite being significantly smaller than the United States.

According to the International Monetary Fund, between 1981 and 2001, the United States’ nominal gross domestic product increased by about $388 billion per year.  By comparison, China’s nominal gross domestic product increased by about $51 billion per year.  Not only was the United States economy much larger than China’s, it was adding much more new gross domestic product to the world economy.  The United States was the unchallenged world economic superpower.

In 2007, even before the Global Financial Crisis, that changed.  That year, China added $781 billion worth of new gross domestic product against the $622 billion created by the United States.  As of the most recent numbers for 2014, this trend has continued.

Even more astonishing is China’s proportional contribution to world gross domestic product.  In 2009, when the world lost $3.2 trillion in economic activity, China still added $470 billion worth of new gross domestic product.  In 2012, the world added $1.2 trillion in new gross domestic product, and China’s contribution to that number was $900 billion.  That means that in 2012, for every dollar the world made from new economic activity, China added about 75 cents.  As China adds one impressive year of economic results to another, it is no wonder than many people expect the 21st century to be the China Century.  It is surprising that China does not have an even greater say in world economic affairs already.

The challenge, though, is that as China’s growth slows, it will become increasingly difficult to continue this.  Any economy that is twice the size of another only has to grow by slightly more than half of a competitor to overtake its new output.  If China is expected to grow by 7.4% for the year, the United States really only has to grow by 4.0% or so to overtake China’s new contribution to gross domestic product.

Whether intentionally or not, the International Monetary Fund projects this scenario to play out in 2019.  Their projections foresee China’s economy growing from $14.0 trillion in 2018 to $14.8 trillion in 2019, meaning $800 billion in new economic activity, whereas the U.S. is expected to grow from $21.1 trillion in 2018 to $22.0 trillion in 2019, meaning $900 billion in new economic activity.  In that case, China will grow by 6.0% against 4.2% for the United States, but the United States will contribute $100 billion more new gross domestic product to the world economy.

Unfortunately for China’s long-term prospects, the only country that was able to outpace the United States for more than one year during the Post-World War II Era was Japan in the late 1980s and early 1990s.  Between 1986 and 1988, Japan added $1.6 trillion in new gross domestic product, whereas the United States only added $900 billion.  Alas, between 1989 and 2013, Japan added $1.9 trillion in new gross domestic product to the world economy compared to $11.5 trillion worth of new gross domestic product created by the United States during the same period.

Furthermore, the International Monetary Fund’s projections assume that China’s gross domestic product will continue to experience positive growth.  During the Asian Financial Crisis, the combined economics of Korea, Thailand, Indonesia, and Malaysia, the nations hardest hit by that episode, declined 7.4% in 1997 and 35.8% in 1998.  If from a starting point of $10.0 trillion at the end of 2014 China were to experience a similar event in 2015 and 2016, it would erase $748 billion one year and $3.3 trillion the next year.  That is more economic pain than the entire world experienced during the Global Financial Crisis in 2009, but instead it would only affect one country.  Even with the International Monetary Fund’s best-case scenario, the China Century will end in 2019.

Sunday, June 21, 2015

2015-05 Relative Price Trends

Consumer prices increased 1.2% year-over-year in May, whereas purchasing prices fell 5.5% over the same period. This marks China’s 42nd month of economic contraction.

Last week, the Financial Times ran an article titled "China Central Bank Admits Defeat in War on Deflation."  The Chinese people no longer have to worry about their renminbi purchasing power.  The Chinese central bank has shut down its printing presses.  Could it be that the managers at the People's Bank of China read Murray Rothbard's work, and finally agreed that the price of everything should drop to five mao?

Unfortunately, no.  When the Financial Times says "admits defeat", they really mean "revised down its inflation estimate to half the level targeted by Beijing[.]"  When they say "deflation", they really mean "full-year CPI forecast [of] 1.4 per cent, down from the 2.2 per cent projection published in December. "  In our upside-down world of financial journalism, purchasing power is bad and deflation is low-digit inflation.

At some point, the world will realize that central banks cannot guide the economy more rationally than private actors can.  That point has not been reached.  In fact, most mainstream commentators are calling for more of the same.  According to the same Financial Times article:
Still, the gap between the inflation forecast and the government's official target suggests officials are well aware that monetary easing measures adopted so far are not enough to boost price growth to the government’s desired level.
There does not seem to be any discussion, either in the financial media or at monetary authorities, as to why the monetary easing measures adopted so far have been wildly successful at igniting one of the largest bull markets in history, but cannot lift consumer prices higher than 2.00%.  Could it be that central banks are not omniscient directors of the economy, nor is money neutral?

Saturday, June 20, 2015

China Joins the Developed World in Monetary Insanity

China’s stock markets just experienced the worst week since 2008. The Shanghai Composite and Shenzhen Composite dropped 13.3% and 12.7%, respectively, over the week that ended June 19.

Over the last two weeks, $9.1 billion has been pulled out of Chinese stock funds, despite the Chinese authorities approving about 50 initial public offerings per month, double the rate of previous months. The higher valuations are driven by the People’s Bank of China cutting interest rates three times and reserve requirements twice since November. In a recent Wall Street Journal article, the root cause of China’s economic woes were hinted at, but not intentionally:
“Morgan Stanley’s Mr. Garner said that despite the current policy-easing cycle that began in November, China’s economy is worse off compared with where it was in 2009, when massive stimulus efforts led the economy to bounce back strongly.”
Stimulus caused the current economic issues; it did not resolve the economic issues of the past. Without irony, the author also made this statement:
“Some analysts now think Beijing is more likely to step in with further stimulus, helping prop up the markets.”
Did monetary stimulus not work? Try more monetary stimulus.

Friday, June 19, 2015

Divergent Provincial Growth.

As China pumped new money into the economy to avoid the effects of the Global Financial Crisis, most of that new money flowed into fixed capital investment (capacity), natural resource excavation, and the property market. The north-eastern region of China led on industrial expansion, Shanxi’s coal market exploded, and Hainan’s real estate market attracted investment from all over the country. Now, those provinces are beginning to feel the adjustment as previous mal-investments are liquidated. According to Bloomberg, China’s slow down is not affecting all provinces equally.
“Plagued by overcapacity and a property slowdown, the industrial northeastern Liaoning province expanded just 1.9 percent from a year earlier, according to a report by 21st Century Business Herald. Nearby Heilongjiang and Jilin are the fourth and fifth slowest growing regions as China's rust belt gets rustier. … Northern Shanxi's dependence on coal weighted its growth to 2.5 percent, the second slowest. … The southern island of Hainan -- China's equivalent of Hawaii -- slowed to 4.7 percent growth in the first quarter from over 8 percent last year. Its pristine air and tropical climate failed to attract more home buyers, with property sales slumping.”
By comparison, Chongqing, Guizhou, and Tibet, three provinces that did not receive as much of the artificial credit that was created over the past few years, are still growing at double digit rates. The monetary stimulus that was meant to delay the re-adjustment is not flowing back into the real economy.
“As college students and pensioners queue for hours to open share-trading accounts, the country's financial capital of Shanghai benefited from the stock market's boom. Financial services contributed 16.6 percent to the city's economy in the first quarter -- higher than the most recent numbers in New York City, Hong Kong and Singapore.”
Unfortunately, as the real economy adjusts, the continued monetary expansion that was implemented to delay the process has only created more mal-investments, but this time in the country’s financial markets. Eventually, the process of artificial credit creation will catch up with itself.

Wednesday, June 17, 2015

Renhe Commercial Holding's Risky New Business

In our search for the company that will set off contagion in China’s capital markets, Renhe is a prime candidate. It could be another company that the Chinese financial authorities allow to go bankrupt for purely economic reasons. The timeframe for this to happen would be March 2016. According to the New York Times:
For Renhe, the business of converting bomb shelters into shopping malls has turned costly and unprofitable. The company has accumulated debt, reporting net losses and negative cash flow for the past several years. With only about 900 million renminbi, or about $150 million, in cash on hand, Renhe will have to find a way to repay or refinance a $1 billion bond it sold to international investors, which comes due for repayment in nine months.
Renhe is an example of a Chinese company that has borrowed from overseas markets, but is unable to cover debt payments because of purely economic reasons.  The most recent default in the offshore U.S. dollar debt market, Kaisa, is considered to be because of political or criminal reasons, not specifically economic reasons.  Renhe management is currently planning a new business strategy to leave the bomb-shelter-turned-shopping-mall business and improve its cash flow by purchasing a farmers’ market business. However, the details of the deal hint that it could be grounds for the authorities to consider Renhe’s future financial situation the result of improper transactions. According to the same New York Times article:
Renhe’s deal for eight farmers’ markets in six cities across China is meant to generate minimum annual profit from rents of 625 million Hong Kong dollars, or about $80 million. But it comes with a twist. Renhe is buying the markets from one of its directors, who is also the wife of the company’s chairman and controlling shareholder.
What could go wrong?

Tuesday, June 16, 2015

Waiting for China's Somprasong Land.

While doing a follow up on the Kaisa default, I came across a Financial Times article titled "Corporate China Goes on a Borrowing Binge", with the sub-line "Despite Some Alarming Numbers, Fears of a Debt Crisis have Dimished".  I couldn't help but feel a sense of déjà vu.

The alarming numbers that the article is referring to is the fact that Chinese corporations have issued $42 billion between the start of 2015 and the end of May, which is the highest year-to-date amount on record.  The total outstanding value of corporate debt is also 11 times higher than it was in January, 2007.

The sense of déjà vu I felt came from the way the business press talked about Thailand in the 1990s.  Below there are two quotes from newspaper articles, one discussing China in 2015 and one discussing Thailand in 1998, after the crash.
"Seven of the top 10 Asian borrowers in the US dollar high-yield market with bonds outstanding are Chinese property developers with low credit ratings. Combined, the group has raised almost $20bn in that market alone."  (Sender, Henry.  "Corporate China Goes on a Borrowing Binge."  June 9, 2015.  Financial Times.)

"The Thai economy was the global capital markets' flavor of the decade, a much favored venue for international investors in search of high returns. But by fixing the baht's exchange rate, the Government encouraged Thais to accumulate debts in foreign currencies. Worse, by fixing the rate in terms of dollars, exports became less competitive as the dollar soared."  (Passell, Peter.  "The Precocious Thai Economy Receives Its Comeuppance."  August 14, 1997.  The New York Times.)
Interestingly, both articles took the time to critique capitalism of some sort.
"This puts an ironic twist on the conventional tale of global capitalism undermined by speculation and short-term thinking. Narcotic-like inflows of capital may have lulled Thailand into complacency. But it was the reluctance of the private market to act that allowed the Thais to dig themselves so deep a hole."  (Passell, Peter.  "The Precocious Thai Economy Receives Its Comeuppance."  August 14, 1997.  The New York Times.)

"For investors in search of high returns, the lure of the Asian high-yield market remains strong despite some of the troubling fundamentals. Their belief in capitalism with Chinese characteristics is an impressive thing."  (Sender, Henry.  "Corporate China Goes on a Borrowing Binge."  June 9, 2015.  Financial Times.)

Monday, June 15, 2015

2015-05 Book Review

Book Review:  Privatizing China, by Carl Walter & Fraser Howie

When a book is written by insiders that shatters existing myths about a certain subject, it is worth reading.  Privatizing China is such a book.  It combines statistical data and analysis into a very enjoyable read on the subject.

Although the book is titled Privatizing China, the authors make it very clear from the beginning:  “In China, the market is operated by the state, regulated by the state, legislated by the state, and raises funds for the benefit of the state by selling shares in enterprises owned by the state” (p. 4).  The authors discuss both the financial and political implications of reforms.

The narrative on China’s financial market is that Chinese savers are fueling China’s market capitalization to be the largest in Asia, if not the world.  As of the book’s publication, official market capitalization figures put China second only to Japan in Asia.  The author’s point out that “if, however, market capitalization is calculated using the prices prevalent in the mergers and acquisitions market in China, China’s markets are only as large as Malaysia’s.  Big difference” (p. 16).  Overvalued tradable shares are being used to value non-tradable shares, thus inflating market capitalization.

The other myth that the authors deconstruct is that of widespread stockownership amongst the general public.  The authors show with data from multiple sources that reports of stock ownership by private citizens are either double counting, counting inactive accounts, or counting fraudulent accounts.  Instead of being an investment opportunity for the middle class, the Chinese stock market is mostly made of large insiders that have vast influence over the market.

One contradiction with this reasoning appears in another part of the text.  The authors claim that the reason A-shares are overvalued is because the average household has very little other investment opportunities.  The authors compare this situation with investors that can buy H-Shares, who have access to almost any kind of investment in different markets (p. 178-179).  If individual investors barely make a dent in the A-Shares market, why would it matter if they have limited alternatives?  Because Chinese individual investors have limited options, it seems as though they should be over-represented in the stock market.

Privatizing China was written by insiders, but tells a different story than the usual narrative.  It backs up statistics with outstanding analysis.  If the book is still available new, buy it new.

Sunday, June 14, 2015

2015-05 Stock Market Valuation

The Shenzhen Composite ended May at 0.38 gold ounces, up 179.77% since May, 2014.  The index was trading at a price-to-earnings ratio of 61.41.

The May close of 0.38 gold ounces was the highest price paid in the data series.  The price-to-earnings ratio has yet to catch up to the series high point of 72.97 times in September, 2007.  To repeat that, the gold price would have to increase to 0.45 gold ounces without any increase in earnings.  The price-to-earnings ratio increased faster than the gold price, meaning May's appreciation was driven entirely by higher valuations, not underlying earnings growth.

May's big news story was the decline of Hanergy, Inc.  Although not part of the Shenzhen Composite, Hanergy, Inc. is another example of questionable valuations of Chinese companies.  According to Bloomberg, "Hanergy Thin Film’s market value had at one point risen to more than HK$300 billion. That’s larger than Sony and almost seven times the size of First Solar Inc., the biggest U.S. solar company."  Considering the majority of sales the company books are to its parent, Hanergy Inc. will most likely turn into China's Enron.

The other conversation that began to happen in the mainstream was the amount of margin debt individual investors have access to.  According to Bloomberg:
"About 29 million new stock accounts have opened this year through May 22, almost as many as in the previous four years combined, according to the China Securities Depository & Clearing Corp. Margin debt on the Shanghai exchange has soared more than 10-fold in the past two years to a record 1.35 trillion yuan ($220 billion) on Thursday."
The People's Bank of China has pushed down Shibor and the yield on time deposits, which is pushing money out of savings and investment into stock market speculation.  Eventually, the correction will destroy more wealth than it artificially created.

Sunday, June 7, 2015

2015-05 Relative Equity Trends

Both the Chinese materials sector and consumer sector continued their upward movements from last month, with both sectors seeing double digit growth. The materials sector represented by CHIM appreciated 46.23% over the twelve months ending in May. The consumer sector represented by CHIQ appreciated 13.12% over the same time period.

Fosun continued its acquisition binge in May as it offered to buy the remain shares in Ironshore Insurance for US$1.8 billion. Before that deal, it had already made $6.0 billion in acquisitions since the beginning of 2014.[1] Two issues stand out for these deals. The first is that until the Ironshore deal, most of these acquisitions had been financed with debt. The Ironshore deal will mostly be funded by issuing more shares in Hong Kong. Second, even though Fosun is considered part of the materials sector, all of its recent high-profile acquisitions have been focused on consumer spending. Its recent deals or offers have included Portugal’s Caixa Geral de Depositos SA, Italy’s Raffaele Caruso SpA, America’s Meadowbrook Insurance Group Inc., and France’s Club Mediterranee SA.[2] China’s largest private sector company is selling overvalued equities in China to invest outside of China in less-cyclical businesses than it traditionally has dealt with. Perhaps others should take note.

The other business deal of note was the US$298 million that Fujian-based Zijin Mining Group paid for 49.5% of Canada-based Barrick Gold’s Porgera gold mine in Papua New Guinea. Barrick’s statement on the transaction described the reasons for going forward with the deal: “Substantial synergies and value may be realised by bringing to Barrick the expertise and relationships that Zijin offers, including low-cost capital from Chinese institutions, leading Chinese engineering and construction skills, and Chinese machinery.”[3] Does Barrick really need outside help with engineering, construction, or machinery? The first reason, “low-cost capital from Chinese institutions”, was the main driver. The People’s Bank of China’s interest rate manipulation is now creating mal-investments outside of China.