Wow, the economic data coming out of China is horrible. While, as I wrote in my recent article, despite China's GDP data remaining stable, recent trade and export data has fallen off cliff.
With the S&P 500 and its tracking exchange traded ETF SPY, have rallied nearly 30% from the summer lows of last year, Chinese equities and this indexes tracking exchange traded funds, such as FXI, have lagged most of the broader in indexes by a fairly wide margin.
Also, in addition to lagging most of the broader indexes by a fairly wide margin over the last year, Chinese equities have sold-off hard over the last month.
As we can see, as the economic data in China has gotten worse in the last couple weeks, Chinese equities have sold-off much harder than most of the broader indexes.
This is why I found it so interesting to read the recent report of major defaults by buyers of bulk metal and soft commodities.
I've been very negative in my past articles on the growth outlook in China's real estate and construction sector for over a year, although I did think the economic data coming out of China earlier in the year was strong. Still, I think the market is misreading some of the recent economic data coming out of world's second biggest economy.
With leading economic data in China, such as electricity usage, imports, and new housing starts, all crashing, this report seems to reconfirm the crash thesis.
Still, while the simple read of the recent data is that China's economy is slowing dramatically, given that Chinese stocks and U.S. companies heavily levered to the weaker parts of the Chinese economy, such as the real estate and construction sector are near a bottom.
Obviously, China is a harder economy to get a read on then other major economies because the world's second biggest economy isn't a transparent in releasing economic data. Still, equities are supposed to lead the economy by around six months, and given were the economic data is today, it is worth asking if we are near a bottom.
While the real estate and construction sector have remained weak in China for some time, new housing starts were positive the first two months of this year, companies such as YUM, Apple (AAPL), and Nike (NKE), GE and Boeing (BA), have all reported solid earnings in China. I think recent buyer defaults may be part of a bigger story.
To me this sets up opportunity. I would look specifically at many of the steel and coal names that are now off nearly 50% in the last year because of the weak Chinese demand for bulk and industrial metals.
What is interesting to me about the recent news of the buyer defaults, is that they occurred both in soft commodities and bulk metals. We already knew that demand for iron ore, metallurgical coal, and other industrial related materials, was weak in China. The defaults in the soy bean market are interesting, because they may suggest more is at play here.
China is known for being one of the most economically savvy countries in the world, and Chinese buyers often play hard ball going into the seasonal negotiations for the pricing of bulk metals and some soft commodities. While commodities such as oil and copper trade on futures markets where the price is set monthly, complex negotiations set the price of most bulk metals only twice a year.
To me, the news of the recent buyer defaults and shipment deferrals are more about leveraging the upcoming negotiations than any significant new weakness in the real and estate and construction sector in China.
The market has known for over six months that the Chinese real estate and construction sector has been very weak. Companies heavily leveraged to Chinese demand for bulk metals, such as Walter Energy (WLT) and Cliffs Natural Resources (CLF), have seen these company's share prices decline significant over the last 2 quarters as management has consistently warned of the significant weakness in the real estate and construction market in China for some time.
Today, Cliffs Natural Resources is 2 dollars above its 52 week high, at around $50 a share, after trading over $100 earlier in the year. Walter Energy is around $49 dollars a share, after trading up to $132 a share earlier in the year. Cliff Natural Resources trades at around 4x an average estimate of next years likely earnings, while Walter Energy trades at around 7x an estimate of next years likely earnings.
To conclude, the economic data in China has gotten significantly worse, and I do think China will slow dramatically in the next couple months, the real estate and construction sector in China has been extremely weak for nearly a year. With Chinese stocks trading at multi-year lows and U.S. companies heavily leveraged to the Chinese real estate and construction sector at these stock's lowest prices in years as well, now is likely a good time to start building a position in companies leveraged to the weakest part of the world's second largest economy. With low stock prices and cheap capital, many of these companies should be appealing takeout targets for these company's larger peers as well.