Ominous signs from China


Author Cam Hui

Posted: 12 June 2012

As I write these words, markets are surging in the wake of the news of a bailout of Spanish banks. I had written before that the principal macro risk wasn’t coming from Europe, but China (see Focus on China, not Europe). I had expected that the eurozone would lurch in a crisis to rescue to crisis cycle and the Spanish banking rescue is more of the same. Already, there is a chorus of voices of why the bailout won’t work (see examples from Goldman Sachs, BoA and Bruce Krasting). For now, it doesn’t matter as the markets have interpreted the move as a stay of execution – as the cycle of crisis and rescue continues.

What is more ominous are the signs coming from China.

Technical outlook negative
First of all, the technical outlook has turned negative as the Shanghai Composite is in a wedge formation that has resolved itself bearishly.

Next door in Hong Kong, the Hang Seng Index is in a downtrend, which confirms the bearish technical outlook for China.

China’s economy is weakening
The signs of weakness in China’s economy are becoming more evident. There was a dump of economic data over the weekend and most of the numbers came in below expectations. The weakness is likely to spill over to the Chinese stock market. Thomson Reuters reports that StarMine expects severe negative earnings surprises out of Chinese stocks [emphasis added]:

StarMine models suggest that it’s still too early to embark on any bargain-hunting expeditions in Asia, where stock prices have underperformed most other regions of the world. In China alone, stock prices are down 16% from their March highs, but the value created by that selloff comes with big risks attached. Now, a new analysis of the most recent data suggests that the picture doesn’t appear likely to change any time soon. The “Predicted Surprise” – for earnings – the percentage difference between StarMine’s SmartEstimate, which puts more weight on recent forecasts and top-ranked analysts, and the mean estimate of all analysts – for emerging Asian markets earnings as a whole, currently stands at -1.6%. Among all markets in the region, China’s Predicted Surprise is -2%, second only to that of Sri Lanka, which comes in with a -2.8% Predicted Surprise.

No wonder we saw the surprise rate cut last week. Dong Tao of Credit Suisse (via Also Sprach Analyst) believes that actions by the PBoC won’t be enough, because the central bank is in a liquidity trap and rate cuts are pushing on a string:

However, we believe that a cut in the lending rate will only have limited impact in stimulating investment. We believe China is in a liquidity trap. With a low interest rate environment, further cuts in interest rates may not get much of an additional impact. Today’s problem in China is not about funding cost or bank liquidity, but demand for loans for real businesses. As companies in the real businesses struggle with surging costs, over-capacity, and weakened demand, the incentive to conduct real investments is low. It would take some structural changes to jump-start the momentum of investments in the private sector, instead of just through easing monetary policy.

As the economic picture deteriorates, expect more cranky commentaries like this one from John Hempton (The Macroeconomics of Chinese kleptocracy):

I start this analysis with China being a kleptocracy – a country ruled by thieves. That is a bold assertion – but I am going to have to assert it. People I know deep in the weeds (that is people who have to deal with the PRC and the children of the PRC elite) accept it. My personal experience is more limited but includes the following:
(a). The children and relatives of CPC Central Committee members are amongst the beneficiaries of the wave of stock fraud in the US,

(b). The response to the wave of stock fraud in the US and Hong Kong has not been to crack down on the perpetrators of the stock fraud (so to make markets work better). It has been to make Chinese statutory accounts less available to make it harder to detect stock fraud.

(c). When given direct evidence of fraudulent accounts in the US filed by a large company with CPC family members as beneficiaries or management a big 4 audit firm will (possibly at the risk to their global franchise) sign the accounts knowing full well that they are fraudulent. The auditors (including and arguably especially the big four) are co-opted for the benefit of Chinese kleptocrats.

This however is only the beginning of Chinese fraud. China is a mafia state – and Bo Xilai is just a recent public manifestation. If you want a good guide to the Chinese kleptocracy – including the crimes of Bo Xilai well before they made the international press look at this speech by John Garnaut to the US China Institute.

Hempton concluded that Chinese State Owned Enterprises (SOEs) depend on negative interest rates as a source of cheap funding and falling inflation is the real economic threat to the Chinese economy [emphasis added]:

The Chinese kleptocracy – and indeed several major trends in the global economy – depend on copious quantities of savings at negative expected rates of return by middle and lower income Chinese…

The more serious threat is deflation – or even inflation at rates of 1-3 percent. If inflation is too low then the SOEs – the center of the Chinese kleptocratic establishment will not generate enough real profit to sustain the level of looting. These businesses can be looted at a negative real funding rate of 5 percent. A positive real funding rate – well that is a completely different story.

The real threat to the Chinese establishment is that the inflation rate is falling – getting very near to the 1-3 percent range.

Low Chinese inflation rates will mean reasonable returns on savings for Chinese lower and middle income savers. Good news for peasants perhaps.

But that changing division of the spoils of economic progress will destroy the Chinese establishment (an establishment that relies on a peculiar and arguably unfair division of the spoils). The SOEs will not be able to pay positive real returns to support that new division of spoils. The peasants can only receive positive real returns if the SOEs can pay them – and paying them is inconsistent with looting.

If the SOEs cannot pay then the banks are in deep trouble too.

If the banking system gets into trouble, then we are not just looking at a hard landing scenario, defined as sub-par economic growth, but a crash landing, which I define as zero or even negative GDP growth.

Ursa Minor romps in China?
For now, the good news is that the risk of a crash landing appears to be off the table. I had written in my previous post that systemic risks in the Chinese shadow banking could result in a crash landing and speculated about the possibility of Chinese capital flight.

Those risks appear to be contained for now. I had written that I was watching the share price of HSBC as a barometer of financial risk in China. A Hong Kong based investment banker informs me that HSBC is not thought of as a good gauge of the risks to the Chinese financial system as the bank had diversified its exposure. Better to watch the Chinese banks listed in Hong Kong, such as:

  1. Agricultural Bank of China (1288.HK)
  2. Bank of China (3988.HK)
  3. China Merchant Bank (3968.HK)
  4. ICBC (1398.HK)

Right now, none of the shares of these banks are falling in a way that suggests market fears of an uncontrolled implosion of the shadow banking system. But watch this space!

Current conditions are suggestive of an attack by Ursa Minor, or a minor bear market, in China. Nevertheless, such a scenario is one that hasn’t largely been discounted by the global financial markets. So watch out.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Can the bears take control from China?


Author Cam Hui

Posted: 21 Mar 2012

In the wake of the BHP Billiton warning about slowing steel demand growth in China, global equity markets deflated overnight. This incident illustrates the point I made earlier in the week about how the health of this equity rally depends on the American consumer.

Another market analyst made the point to me succintly about the lagging performance of commodities and commodity related stocks. The Aussie Dollar is underperforming the Canadian Dollar. Australia is more levered to China (and more weighted to base metals) while Canada is more exposed to the United States. If CADUSD is outperforming AUDUSD, then it’s a sign that the market believes that there is more near term economic upside in the US compared to China.

Bullish tripwires
I have made the point that depending on the American consumer to fuel this equity rally is a risky bet. If this rally is have any real legs, then we need to see a broader based rally around the world. Right now, the weak link is the Chinese outlook. As a pre-condition, commodity prices ideally should start to recover more and begin to take a leadership position in the next few months in order for this bull to get a second wind.

Here are what I am watching for. First, commodity sensitive currencies like the Aussie Dollar need to, not only hold support, but to show some strength and rally through resistance at 108.60.

Similarly, the Canadian Dollar, which has held up better than the AUDUSD exchange rate, needs to rally through resistance at 101.60.

Finally, I am watching the Hang Seng Index, which rallied up to 21,800 but couldn’t overcome the overhead resistance at that level. I view the more established Hong Kong market as an important barometer of Chinese policies towards the teetering property sector.

The Hang Seng is now approaching a minor technical support level. Should it decisively break support, that would be a sign that the bears have won a round in the bull-bear tug of war.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Why I am still bullish


Author Cam Hui

Posted: 05 Mar 2012

As the stock market consolidates and the Dow flirts with the 13K level, there have been some calls for an intermediate term top. I remain bullish over the next few months for the following reasons:

  • The risk trade bull run remains intact
  • Positive funds flow are buoying the markets;
  • Panic levels are still elevated;
  • “Expert opinion, defined as the better market timers, are bullish;
  • The Bernanke Put and Draghi Put still lives; and
  • The China property bubble lives on for another day.

The risk-on trade is still “on”

If you were to view the stock market through the lens of the risk-on/risk-off trade, then the risk-on bull move remains intact. Consider this chart of the relative performance of SPY against IEF, which shows a short-term relative uptrend in the context of an intermediate term uptrend.

Positive funds flows
Josh Brown pointed to a Reuters article indicating that institutional equity funds flows are positive. He went to say that they are likely to continue:

In my experience, these types of raising and lowering equity exposure cycles take place at a glacial pace and they rarely turn or stop on a dime.

Scott Grannis wrote that individual investor equity funds flows are just starting to turn positive and there is a lot of room for them to go further into stocks:

…and out of bonds, whose flows are still positive:

Grannis’ conclusion was:

Adding it all up, I would say that we are a long way from seeing over-priced equities. Let’s wait to see many months or even a few years of inflows to equity funds before concluding that the guy on the street is too bullish.

Panic levels are still elevated
Also consider the readings of the Crash Confidence Index from the Yale School of Management. A low level indicates a high level of fear and a high level indicates a high level of complacency. While the ECB’s LTRO program has largely taken the risks of a banking meltdown off the table, investors confidence remain low and fear levels are still elevated. I interpret these conditions as being contrarian bullish.

“Expert” opinion is bullish
Mark Hulbert reports that the best market timers are leaning bullish, while the worst market timers are leaning bearish.

As an example, I don’t know where the Aden sisters are in Hulbert’s ratings, but I have tremendous respect for them and they are bullish. I have followed them, off and on, since the late 1970’s during the gold mania that took bullion up to its peak of $850 in 1980, which they correctly called. Unlike other gold bugs, they turned bearish on gold and turned bullish on equities in the intervening period. They correctly called the rebirth of the commodity bull about ten years ago.

The Bernanke and Draghi Puts still lives
Ben Bernanke, in his testimony to Congress last week, said in so many words that QE3 isn’t a done deal and they are watching the data carefully.

In light of the somewhat different signals received recently from the labor market than from indicators of final demand and production, however, it will be especially important to evaluate incoming information to assess the underlying pace of economic recovery.

The markets sold off but the flip side of this coin is that they are ready to act should the economy weaken.

The dual objectives of price stability and maximum employment are generally complementary. Indeed, at present, with the unemployment rate elevated and the inflation outlook subdued, the Committee judges that sustaining a highly accommodative stance for monetary policy is consistent with promoting both objectives.

So does that mean that good economic news is good news for the markets but bad news isn’t necessarily bad news?

As for the ECB, interbank lending in Europe is still seized up. This analysis shows that the European banking system needs another four LTROs to get through to 2013. Don’t be surprised if the ECB announces further rounds of LTRO.

In short, the Bernanke and Draghi Puts will “put” a floor on the stock market for now.

The Chinese property bubble lives on another day
Walter Kurtz, writing at Pragmatic Capitalism, noted that the property market in Beijing and Shanghai are recovering. Such a development should forestall any immediate concerns about a crash in the Chinese property bubble as official actions have kicked the can down the road and delayed the day of reckoning yet once more.

The Shanghai Composite has responded with a rally as a result of these measures. As the chart below shows, the index has rallied through a downtrend line and it has not even approached the first Fibonacci retracement level, which would serve as a resistance level.

Bearish tripwires
To be sure, not every market forecast is correct. Here is some of what I am watching for to see whether the bears are wrestling control of this market away from the bulls. These are some important questions that need to be answered in order to determine the next major move in equities.

First and foremost, the big question is can the Dow can overcome the 13K mark?

Looking at foreign markets, can the Hang Seng overcome resistance after rallying to fill the gap depicted in the graph below?

What about Europe? The Euro STOXX 50 appears to be undergoing a sideways consolidation. Can it rally to overcome resistance?

The cyclically sensitive Australian Dollar is temporary stuck in a trading range. Will it break out to the upside, which is bullish, or to the downside, which is bearish?

Another important cyclical indicator is the relative performance of the Morgan Stanley Cyclical Index against the market. Cyclicals started 2012 on a tear, but they have begun to consolidate sideways on a relative basis. Can the relative support level hold?

Lastly, technicians have been sounding words of caution because the Dow Transports have been lagging and have not confirmed the advance of the Industrials Average. Mark Hulbert writes that there is some disagreement about prominent Dow Theorists about the significance of this divergence:

Frustratingly, not all Dow Theorists agree on an answer. In fact, two of the three monitored by the Hulbert Financial Digest — Jack Schannep of TheDowtheory.com and Richard Moroney of Dow Theory Forecasts — think the appropriate point of comparison is not last summer but late October. And because, near the end of December, the Dow averages rose above their late-October highs, both Schannep and Moroney believe that the Dow Theory is solidly in the bullish camp — notwithstanding where the Dow transports might be relative to their July high.

In contrast, Richard Russell, editor of Dow Theory Letters, says he’s worried about the Dow transports’ weakness and, in part for that reason, is largely out of the stock market.

The chart below shows the relative performance of the Dow Jones Transports against the Dow Industrials. If relative performance were to fall below the 38% Fibonacci retracement support level, it would mean that the bears have taken control of the market.

In conclusion, I believe that equities are consolidating their gains but remain in an intermediate bull phase. During this consolidation period, doubts will appear about the legitimacy of the bull leg, as they are now. My view is that the next major move is up, but I am watching and open to the possibility that I am wrong and a correction can run deeper than I expect.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

China saves the world


Author Cam Hui

Posted: 18 Feb 2011

When my Asset Inflation-Deflation Trend Model flashed an asset inflation signal on February 6, 2012 to buy high beta and high octane inflation hedge and emerging market stocks, the major risk to the bullish forecast was a Chinese hard landing. One of the key indicators that I was watching at the time was the Shanghai Composite, which had been in a well-defined downtrend.

All that has changed. Since I wrote those words in early February, the Shanghai Composite has managed to stage a rally through the downtrend, signaling that China’s hard landing scenario is becoming less likely.

Indeed, Reuters reported the PBoC indicated that it is prepared to ease policy gradually in order to keep inflation in check:

In its monetary policy implemention report for the fourth quarter of 2011, the central bank said it will use a mix of policy tools, including interest rates, to maintain reasonable credit growth while keeping a lid on inflation.

Next door in Hong Kong, the Hang Seng Index has already rallied through its downtrend line and the 200-day moving average at about the same time, which is another signal of global healing and recovery.

Now that both the Shanghai Composite and Hang Seng Index have rallied through their respective downtrend lines and the fundamentals are becoming more positive, it seems that China is in the process of confirming the global bull move in risky assets. In fact, it’s saving the world as it indicated that it would continue to buy euro denominated debt, which it said it would do once the Europeans got their act together (and it is in the Chinese self-interest as Europe is a major export market).

These developments confirm my recent observations that we are seeing a intermediate term bull market in stocks and risky asssets.

So party on and let’s rock ‘n roll!

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

 

A “China is slowing” scare?


by Cam Hui

Posted: 13 Dec 2011 03:19 PM PST

It’s been a while since we’ve had a “China is slowing” scare, but we may be due for one. The chart of the Shanghai Composite shows that the index violated a key support level last night, which is an indicator of heightened stress.

The chart of the Hang Seng Index also shows that it violated a key support level in September and attempted a failed rally above the support-turned-resistance line. The index is now testing the bottom of a triangle formation, while investors wait for either an upside or downside breakout as an indicator of near-term direction.

China’s deflating property bubble
Much of the stress comes from the faltering property market in China. The Los Angeles Times reports that China’s housing bubble is losing air:

Home prices nationwide declined in November for the third straight month, according to an index of values in 100 major cities compiled by the China Index Academy, an independent real estate firm. Average prices in the Shanghai area are down about 40% from their peak in mid-2009, to about $176,000 for a 1,000-square-foot home.

Sales have plummeted. In Beijing, nearly two years’ worth of inventory is clogging the market, and more than 1,000 real estate agencies have closed this year. Developers who once pre-sold housing projects within hours are growing desperate. A real estate company in the eastern city of Wenzhou is offering to throw in a new BMW with a home purchase.

Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management in Beijing, echoed the accounts about deflating housing bubble:

According to the China Real Estate Index, published by Soufun.com, the average primary market housing price across China’s top 100 cities dropped for the third month in a row in November, by 0.3% month-on-month, with prices in 43 cities still rising and 57 cities falling. However, other real estate agencies reported steeper drops in specific locations. Homelink said that in November alone, primary market prices in Beijing dropped 35% month-on-month, and industry sources told the Legal Evening Post they dropped 16.8% week-on-week in the last week of November, down 29% year-on-year. According to Caijing magazine, Beijing home sales volume (by area) in the first 11 months of 2011 was down 27% year-on-year, to a 10-year record low. A similar fall-off was evident in commercial as well as residential real estate. According to the Beijing Morning Post, sales volume for retail and office space in the capital dropped 18% and 7.4% respectively in October, month-on-month. Homelink’s chief Beijing analyst, Zhang Yue, told the paper he saw a growing supply glut developing.

The downturn was not limited to Beijing. Dooioo, another agency, said that primary housing sales volumes in Shanghai are the worst since 2006, while Chinese Business News reported that in Shenzhen, primary prices were down 10.7% and transactions down 11.3% week-on-week in the last week of November. Business China also reported a drastic drop in sales, despite generous discounting.

Chovanec writes that how the market behaves from now on will be a test of Chinese investor confidence in the property market, largely because property purchases are often fully paid for in cash with no leverage and represent a source of savings for individuals [emphasis added]:

How investors in the secondary market will react to the collapse in primary market prices is the biggest question of all. As I’ve mentioned many times, many people in China buy multiple units of housing in order to hold them empty indefinitely, as a form of savings. They do this because they have few attractive alternatives and because they have faith that housing prices will go up. Since many have paid cash, they aren’t under the same immediate pressure to sell as developers. But they do tend to look to rising primary market prices for assurance that their investments are profitable and safe, and now those prices are now plummeting. A great deal depends on whether they hunker down to weather the storm, or join the fire sale.

He does caution, however, that even though many apartments are paid for in cash, there may be other forms of leverage in property purchases. Depending on how pervasive the level of financial leverage, sales could create a cascade of falling Chinese property prices.

Beijing-based blogger Bill Bishop recently related the story of an email he received, which makes equally interesting reading. It came from a real estate agent representing a condo owner in one of the city’s top apartment buildings, in the Central Business District (CBD). Although he had no mortgage, and owned the unit outright, he was desperate to sell in order to raise RMB 20 million for his business. So it’s worth keeping in mind that, while many Chinese investors may not be directly leveraged on their real estate investments, given the credit explosion that has driven the Chinese economy these past few years, they may be highly leveraged in their business or other ways that could turn them into distressed sellers.

Watch for “China is slowing” stories
As the world has focused primarily on Europe and secondarily on the United States, my sense is that the consensus is that China will escape a hard landing. While I am of the belief that China should survive the next economic downturn in relatively good shape, stories like these will serve to heighten investors’ sense of emerging market risk. In addition, we are seeing stories about India slowing as well.
Should European or American economies get into serious trouble in the months to come, there may not be any place to hide.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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