Addendum to the article below: Official China PMI was released this weekend and came in slightly better, at 51.2, than the HSBC/Markit survey. This indicates an expanding economy rather than the sub-50 reading, which is evidence of the world's fastest growing economy contracting. I consider this splitting some very thin hairs. And for those that say this is evidence of China being able to avoid a hard landing, I caution that this is hardly enough evidence to draw that conclusion. The primary problems remain which are that China's end markets are weakening and the property bubble in China is starting to show real signs of stress.
The best thing that can be said for China is Europe - but the worst thing that can be said for copper is China.
Europe continues to dominate the headlines, the immediacy of their issues relegating China to the back pages of the business press and investors’ minds. This puts China in a very tough position between rooting for the EU, their top trading partner, to quickly put their sovereign debt issues behind them, and hoping they stay front and center, keeping China’s significant woes off the front page. I know what Confucius would advise, but his teachings have gone by the wayside quicker than a Ferrari barreling down Nanjing Road in Shanghai.
The biggest issue with China of course is the property bubble. This exists not just for housing but also for commercial construction. Given restrictions on lending at the local government level and tightening measures imposed by the central government, property developers have had to engage in creative financing techniques to continue building buildings that reportedly have very high vacancy rates. The credit agencies have taken aim at the banks, who own the local government debt, believing that the liabilities are understated, $540 billion being the amount recently mentioned by Moody’s.
I’m going to wager that Moody’s stays true to its reputation for accuracy and has vastly understated the issue, which, given the lack of transparency and controls in China, is a safe bet. But using this figure and putting it in perspective, it is almost equivalent to the size of China’s stimulus package post 2008 crisis. Let’s see what happens when that large sum of money works in reverse, choking off the economy and triggering defaults.
What is most troubling is how much of the Chinese economy is dependent on this bubble. This quote from Bloomberg is alarming:
China Real Estate Information Corp., a Shanghai-based property information and consulting firm, estimates 40 percent of overall local government revenue came from land sales last year.
And, the local government involvement doesn't stop there as they set up trust companies, often in partnership with developers, to fund development.
For the third straight month, the HSBC/Markit release of China PMI indicated a contracting economy. The sub-indices were no better with new orders below 50 also for a second straight month and the new orders - exports contracting for a 5th month in a row. There was also a decline in manufacturing jobs. In fact the only meaningful increase in any of the numbers was in rate of inflation.
China's manufacturers seem to be managing their inventory levels well though as raw materials and semi-finished goods were also lower. No doubt the half-full crowd will look at the depleting raw materials numbers and opine on how this is great for the commodities because the manufacturers have to replenish. No doubt these are the same perennially optimistic individuals who regard hair loss as a positive because it saves on haircuts.
We’ll get official PMI tonight but I’m skeptical of all economic releases coming out of a managed society. The debate can be had about whether the economy is rapidly deteriorating, hitting a soft spot or even a ‘so-what’ approach with the tag line that China’s GDP will still grow well in excess of ROW but anything below 7%, perhaps 8% is a bad outcome for the people of China. They are used to a different standard of growth.
Of course, there are those that hang onto the vision of the central government acting like the mother of a rambunctious 4 year old who scraps his knee but mommy won’t kiss this boo-boo and make it all better. Sure, some of the developers who are closest to the ministers remaining open to receiving another Rolex Daytona in exchange for favorable treatment will not suffer as much but I doubt the government will bail out all the banks and developers. The WSJ had 3 articles, all appropriately yellow flags.
Interestingly, and to this point, one of the world’s and China’s largest banks may seek to raise another $11 billion from the capital markets to protect the balance sheet against increasing bad debts. When have you ever seen one capital raise be enough? Exactly, and not here either since this bank has already raised $20 billion over the past two years.
In the most recent survey of home property prices recorded by the statistics bureau, for the first time less than half of the 70 cities posted month on month gains although all cities showed an increase, also for the first time this year. This is troubling since it indicates that despite Premier Wen’s desire to cool off the overheated market, local governments refuse to participate relying heavily on higher prices on land sales.
Suppose I’m wrong and the government is more magnanimous than I estimate, writing checks to everyone who has wagered on prices forever climbing? The conclusion for copper won’t change since it will still take a long time to absorb the current developed property inventory. Construction is estimated to be between 50-70% of China’s GDP. That soaks up a lot of energy, copper, steel and construction equipment which all feed into the global economy.
Soft landing for China? That’s not what the direction of their bank stocks and property development companies will tell you. I doubt that Goldilocks, she of the “not too cold, not too hot, just right” school of optimism, will be including China on her world tour. Besides, she has signed on for additional dates in Europe and the U.S.
As to the U.S. indices, China surprisingly does not mean much for now until the tipping point becomes apparent to all and the fog from Europe burns off. All that matters for now is the impending U.S. earnings season and Europe. While I expect the ESFS to be approved, I’m not so sure the political appetite exists for the shock and awe leveraged fund that is needed to put a floor on the market. But opinions on the outcome are like iPads - everyone has one.
Disclosure: I am short JEC.