Monday, January 27, 2014

Year of the Charley Horse (excerpt)

The Chinese Lunar New Year starts on January 31. It is the Year of the Horse. For investors suffering in Chinese stocks, the pain makes it feel more like the Year of the Charley Horse. Many are wondering if this will be the year that China’s debt bubble bursts?

It’s hard to believe that global financial markets were roiled late last week by the release of the latest HSBC Flash China M-PMI on Thursday morning. The report showed that the overall index dropped from 50.5 in December to 49.6 in January, a six-month low. The output component edged down from 51.4 to 51.3, but that's above 50. At the same time, Markit reported that the Eurozone’s flash M-PMI jumped to 53.9 during January, the highest reading since June 2011. Furthermore, the US flash M-PMI remained solidly above 50 at 53.7, though that was down from December’s 55.0.

The outsized reaction to China’s weaker M-PMI reflects mounting concerns that decelerating growth in the country could lead to a financial crisis, which could then slam the brakes on growth. China’s forward profit margin is among the lowest in the world. I have data on it starting in 2004. It was 4.0% at its most recent cyclical peak during September 2009. In mid-January of this year, it was down to 3.5%. Slowing growth with such a low margin could squeeze corporate borrowers' ability to service their debts, creating problems for their lenders. That’s especially true for those companies that are borrowing from the shadow banking system.

On Friday, January 17, Chinese state media reported that China Credit Trust Co. warned investors that they may not be repaid when one of its wealth management products (WMP) matures on January 31, the first day of the Year of the Horse. The Industrial and Commercial Bank of China, the world’s largest bank by assets, sold the investment to its customers, and warned that it will not compensate investors for their losses.

The trust company loaned the proceeds of almost half a billion dollars to a coal company, which must have been charged more than 10% since that was the annual return promised to investors. There has never been a default of a WMP. Until now, perhaps. On Friday, Bloomberg reported that the China Banking Regulatory Commission ordered its regional offices to increase scrutiny of credit risks in the coal-mining industry and to closely monitor risks from WMPs, which are estimated to total $1.7 trillion.

Today's Morning Briefing: Something To Fear? (1) Nothing to fear but emerging economies and deflation. (2) Brewing since last spring. (3) More downside risk to the upside scenario. (4) Some EMs were up last week. (5) From most to least overbought sectors. (6) Finding support. (7) A cap on valuations. (8) Four challenges for EMs. (9) China’s Charley Horse. (10) China’s WMPs set to implode? (11) What will the Fed do? (12) “The Invisible Woman” (+). (More for subscribers.)

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