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Entries in China (6)


Keep Rotating

Either weak energy prices, a break down in copper, low iron ore prices etc are a sign of a deflation crunch in the making that will lead to a flush in all things risk related (Albert Edwards style). Or we are in a extermely powerful Goldilocks situation where low headline inflation finally lets the real economy release higher, and the market goes on towards a final mid-to-late cycle tantrum. I think that this is now the key choice that everyone must make before proceeding to call their broker on Monday morning. 

In the Eurozone, margins are getting squeezed and companies are being forced to cut prices to maintain market share. You need to tread carefully on cyclicals here, but on the other hand, many UK/Eurozone retail have already been crushed (and I admit I am donning the kevlar in some of these names). In addition, the market is probably underestimating the impact of private QE and TLTROs at the ECB, which is odd, but a natural consequence of the extreme obsession with when the ECB pushes the button on QE. 

On the US I it seems to me that in a world where you have disinflation and real GDP growth humming at 3% with ZIRP added to the mix, you can probably get some pretty spectacular runs in consumer oriented stocks. I would not discount that even as the run in Spoos seem to defy logic. Basically, low global headline inflation is allowing CBs to double down even as growth is not calamitously negative and this does extend the "Goldilocks" feeling noted above. We need to understand, though, that the UK and US economies are really running the show in terms of growth here ... if they fail, I think we are buggered! The question I am really asking myself now in relation to the puke in oil is how long this can go one before we see real debt distress in one or more US energy HY bonds. And when that happens, will this test the much debated "lack of liquidity in the non-fin corporate debt market" story?

My mantra, though, remains, as it has throughout the year ... sector rotation, sector rotation, sector rotation ... the big story for me this year is not the rally in Spoos but the alpha that you have been able to pick up this year being long/short the right sectors. We are talking risk neutral/adjusted returns of 20-30% on some cross-trades! I would expect the same next year based on what I am seeing now. As for the the perennial debate on the when the crash is coming, why bother. Polemic has done a good job explaining the issues here anyway. A friendly word of advice though, ignore Zero Hedge and similar proselytes to the altar of the Black Swan. It can be a lonely and frustrating experience marrying yourself to such a creature, most of the time it isn't there at all! When the crash comes, you won't be short, and don't be the guy or girl who waits endlessly to be able to say; "I called it!"

A couple of final points on leading indicators and the market in general. Firstly, China's LEIs are tanking here, with narrow money growth looking very weak. This is worrying me. Low commodity prices may be "benign" in one scenario but when you couple it with near-deflation, low narrow money growth, an no FX reserve accumulation in China you lose one of the big liquidity pumps of the last decade. PBoC easing will help at the margin, but the fact that they have to do it even as they have announced the desire to scale down the credit fuelled growth isn't exactly encouraging. 

Secondly, flat yield curves are customarily negative inputs into most cyclical models, but I would honestly strip them out now. The market has basically been conducting a huge Operation Twist in the past year, everywhere! I am not sure this is such a negative signal. But if the Fed is bullied into an aggressive move next year and/or the short end in the US goes crazy in some taper tantrum 2.0 I would obviously need to revisit that view. 

Safe trading out there, the week after giving Thanks is usually a sporty one. So, play it cool and keep rotating.


And the award for EM safe haven of choice goes to ...

... China!

At least this is the conclusion from some fascinating number crunching from JPMorgan's Flow & Liquidity team in their report last week. I had a feeling that this was the case looking at the surge in Chinese FX reserve growth (capital inflows) in the past 6-12 months, but it is still interesting to see such clear evidence from the data.

Here is F&L on the outflow data;

(...) around $80bn of capital left these 22 EM economies [read: essentially EM ex China and the Middle East] cumulatively since last May. This $80bn outflow is likely understated by $20bn due to the 1.6% decline in the dollar between the end of May and end of February, as a weaker dollar pushes up the dollar value of non-USD denominated reserves. Adjusting for this leaves us with around $100bn of estimated capital outflow from these 22 EM countries between May and February.

This estimate of $100bn worth of EM outflows since the tapering scare began in May/June last year is not the controversial number. The main question is then where the money went and here it gets very interesting.

This capital outflow does not necessarily reflect capital leaving the EM universe as a whole. In fact it seems that China, perceived as safe haven, has attracted a similar amount over that period. Using similar calculations of FX reserve changes adjusted for current account flows, we arrive at a $125bn cumulative capital inflow into China between May and December, as the outflows of last May/June more than reversed in subsequent months. Of this $125bn figure, around $25bn reflects the 2% decline in the dollar between the end of May and end of December. This leaves us with around $100bn of estimated capital inflow into China between May and December.

What is particularly interesting about these numbers is that the breakdown reveals that only a small fraction of this, $20bn according to JPM, reflects net FDI. The rest represent so-called hot money flows in the form of portfolio flows and short term flows into demand deposits (to take advantage of sharply higher interest rates in China).

With the CNY just having seen its strongest bout of volatility in a long time last week it may seem rather inopportune to publish a note on the inexorable and inevitable rise of the CNY. Personally, I would be wary taking the consensus view at face value here. In fact, on many accounts the CNY looks overvalued here and this is exactly what the market is also telling us I think (at least in the short run). CNY volatility and weakness are also the two main markers I would be watching for signs of capital outflows and ultimately how China could become a big headache for the rest of the world. 

All this however does not detract from the fact that JPM gets the completely unofficial award this week for the best sell side data crunching exercise. The tapering scare that emerged last summer has been linked to all kinds of bad outcomes for emerging markets as a whole. Clearly, this is not an accurate description and something which investors should not lose focus of.


China Moves Towards More Easing ... 

Update: Here comes the confirmation with a poor flash PMI for March. From Markit; 

“Weakening domestic demand continued to weigh ongrowth, as indicated by a slowdown in new orders whichcame in at a four-month low. External demand remainedin contraction territory, but the decline was at a slowerpace, implying that there are no improvements in thedemand outlook. More worryingly, employment recordeda new low since March 2009, suggesting slowingmanufacturing production was hindering enterprises'hiring desire. The soft-patch in manufacturing was in linewith the recent downside surprise in industrialproduction growth. Growth momentum could slow downfurther amid a combination of sluggish export neworders and softening domestic demand. This calls forfurther easing steps from the Beijing authority.”


This may be a targeted and essentially pinpointed move, but looking at the data coming on China in the first quarter of 2012, I think there is plenty more to come as China tries to come to grips with a rapidly slowing economy. 

Quote Bloomberg

China boosted rural credit by cutting reserve requirements for an additional 379 branches of Agricultural Bank of China Ltd. (601288), the nation’s third-biggest lender by market value.Effective March 25, the ratio falls by 2 percentage points for the branches in the provinces of Heilongjiang, Henan, Hebei and Anhui, the People’s Bank of China said in a statement on its website yesterday. The move expands a trial that previously lowered requirements for 563 branches in eight provinces. The latest move means a total of 23 billion yuan ($3.6 billion) has been freed up, the PBOC said.

Money supply growth has effectively stalled in China and with the recent statement by BHP Billiton that Chinese steel output had flattened what they really meant was that they are now seriously concerned about a severe and lingering slowdown in China. Of course, there are considerable details that must be taken into account here. However, one thing that we must understand is that production capacity (supply) of hard commodities may turn out to have structurally overshot demand even in mighty China. 

So far, we must give Chinese authorities the benefit of the doubt and it is almost certain that they will now turn from a focus on inflation to a focus on growth. This is particularly the case as inflation has come down significantly in China and while base effects will be an important part of this story, the sharp retrenchment of liquidity will also have mattered. 

In my view, markets are likely to turn to growth in the next months where disappointing data out of China and the US are likely to put a dent in an otherwise strong rally.