April 22 – April 28, 2016

Even Apple isn’t immune to Chinese oversight. China debt load is piling high. Retailer existential crisis.



    • Despite the growing number of bond defaults in China, “the fact is that China has the tools to manage these ‘defaults’ one way or another. As UBS’s Wang Tao has said, ‘the country’s high domestic saving, under-developed capital markets, government ownership  of banks and many larger borrowers, and relatively closed capital account mean that no one can easily ‘pull the plug’ on its credit cycle.'”
    • “More broadly, not much has changed in China in recent months…it remains a big, slowing economy, with a lot of debt, and all other things equal remains a deflationary force on the global economy (keeps commodity prices much lower than recent years). And most likely China continues to follow Japan in 1990s…periodically nasty for global financial markets but most of the time domestic policy keeps any problems local, and as with Japan it very rarely has a big negative impact on global growth. Latter changes of course with a genuine credit crunch.” 
  • While Keohane has a point, it doesn’t mean that toxic debt is anything other than that as Anjani Trivedi points out in the Wall Street Journal Why China Will Struggle to Turn Toxic Loans into Beautiful Bonds.
    • “The People’s Bank of China said recently one of its top priorities for the year is to advance a program to let banks securitize toxic loans into asset-backed securities, a type of bond. Unlike subprime bonds that triggered the financial crisis in the U.S., the banks openly acknowledge the loans are terrible before the bond is created.” 
    • “The last rub is that the banks will be managing the loans that make up these new securities. If they couldn’t work them out when they were on their balance sheets, investors should wonder what will make them be able to when they are packaged in a bond.”
  • Further, don’t forget about accounts receivables… Gabriel Wildau with the Financial Times highlights the growing amounts of unpaid bills from receivables.
    • “Listed companies had to wait a median 70 days to receive payment last year, the longest delay in 14 years, as cash flows tightened amid slack final demand. That compares with a median 60 days in 2014 and 46 days in 2011, according to Wind Information, a Chinese financial database.” 
    • “Ms Yu (Shanghai Caison Color Material Chemical) says that an increasing share of customers now insist on paying with a bankers’ acceptance rather than cash. Similar to a postdated check, bankers acceptances are a kind of IOU from a company and its bank. Ms Yu says that a few years ago, 5 to 10% of her sales were paid this way, but that has now risen to 20 to 30%. Most cannot be cashed for 90 or 180 days.”
    • “It looks like liquidity is very ample, but a lot of that is being used to help the real estate sector refinance. It’s not circulating widely through the economy.” – Shao Yu, economist at Oriental Securities in Shanghai.
  • Sorry if it feels like I’m harping on China here…not intentional.  Edward Wong of the New York Times points to a new set of rules that will restrict operations of foreign Non-Government Organizations (NGOs) in China starting January 1, 2017.
    • “More than 7,000 foreign nongovernmental groups will be affected, according to state news reports.” 
    • “Foreign groups working across Chinese civil society – on issues including the environment, philanthropy and cultural exchanges, and possibly even in educations and business – will now have to find an official Chinese sponsor and must register with the police.
    • “Those organizations that do not receive official approval will be forced to stop operating in the country. Many groups will probably curtail or eliminate programs deemed politically sensitive, such as training lawyers, in order to remain.”
    • “The new law is the latest in a series of actions taken by Mr. (President) Xi against the kind of Western influences and ideas that he and other leaders view as a threat to the survival of the Communist Party, such as an independent judiciary and media.”
    • “The most draconian aspect of the earlier drafts remained, despite widespread outcry from foreign groups and governments. It requires that foreign nongovernmental organizations register with the Ministry of Public Security and allow the police to scrutinize all aspects of their operations, including finances, at any time.”
    • “The law states that any employee of such a group can be interrogated at any time.”
  • Back to the U.S… John Authers of the Financial Times drew attention to the rising use of debt by U.S. corporates over the past few years for stock buy-backs and acquisitions that are starting to be more of an issue now that earnings are stalling.
    • “According to Andrew Lapthorne of Societe Generale, the reality is that “US corporates appear to be spending way too much (over 35% more than their gross operating cash flow, the biggest deficit in over 20 years of data) and are using debt issuance to make up the difference.” The decline in earnings and cash flows in the past year has accentuated the problem, and brought it to the top of investors’ consciousness.” 
    • “A further issue is the uses to which the debt has been put. As pointed out many times in the post-crisis years, it has generally not gone into capital expenditures, which might arguably be expected to boost the economy. It has instead been deployed to pay dividends, or to buy back stock – or to buy other companies. Shifts in these uses of cash are now affecting markets.”

Special Reports

  • Knowledge @ Wharton – PIMCO’s Former CEO Mohamed El-Erian on the ‘Delusion of Liquidity’ 4/21
    • “In a world where you’re facing this T junction, you need three things. You need resilience. You need agility. And you need optionality. And I go through them in the book – resilience, agility, and optionality. The only thing that gives you these three things is cash. So suddenly cash becomes a part of the strategic asset allocation, which again is putting conventional wisdom on its head.” 


FT – SOE you think you can default? – David Keohane 4/21

FT_Source of Chinese bond money_4-21-16

FT_Accumulated shadow banking defaults - China_4-21-16

FT – China debt load reaches record high as risk to economy mounts – Gabriel Wildau and Don Weinland 4/23

FT_China debt woes - annual change_4-23-16

FT_China debt ratio_4-23-16

FT – Alphaville: “What if China lands hard?” they asked in 2013 – David Keohane 4/27

FT_Credit Expansion in China_4-27-16

FT – Unpaid bills add to China debt problems as receivables mount – Gabriel Wildau 4/26

FT_China accounts receivables_4-26-16

FT_China cash conversion cycle_4-26-16

FT – Alarm over corporate debt and stalled earnings 4/27

FT_Net Debt to Operating Cash Flow_4-27-16


*Note: bold emphasis is mine, italic sections are from the articles.

Apple Services Shut Down in China in Startling About-Face. Paul Mozur and Jane Perlez. New York Times. 21 Apr. 2016.

Not only did Apple just have its first quarterly fall in sales in 13 years, but business is getting tougher for the corporate innovator in China – which is why legendary investor Carl Icahn just dumped his entire stake.

“Last week, Apple’s iBooks Store and iTunes Movies were shut down in China, just six months after they were started there.”

“China’s pushback against Apple shows that the company may finally be vulnerable to the heightened scrutiny that other American tech companies have faced in recent years.”

As reported by Xinhua, the state-run news service, President Xi is quoted as saying “China must improve management of cyberspace and work to ensure high-quality content with positive voices creating a healthy, positive culture that is a force for good.”

The news is the news.  Content is both good and bad…

“Since the Snowden leaks, China’s state media identified eight American companies that it has labeled guardian warriors and that it has said were too deeply established in the country’s core industries such as energy, communications, education and military.”

“Sales in China for those companies, including Cisco, IBM, Microsoft and Qualcomm, have slid as government oversight has increased. Some have grappled with raids, investigations and fines. Some have also been pressured to sell of holdings, hand over technology and work with local partners to expand their China business.”

“Though Apple is one of the eight, it has had a much easier time.”

“Apple’s recent battle with the F.B.I over unlocking an iPhone for a terrorism investigation is unlikely to help it in China. Chinese lawyers have pointed out that the country’s antiterrorism law requires companies to help with decryption when the police or state security agents demand it for investigating or preventing terrorist acts.”

China debt load reaches record high as risk to economy mounts. Gabriel Wildau and Don Weinland. Financial Times. 23 Apr. 2016.

In case you were wondering why Keohane felt the need to clarify why China has the tools to handle its debts, consider that “Beijing has turned to massive lending to boost economic growth, bringing total net debt to Rmb163tn ($25tn) at the end of March (237% of GDP according to the FT).”

“While the absolute size of China’s debt load is a concern, more worrying is the speed at which it has accumulated – Chinese debt was only 148% of GDP at the end of 2007.”

“New borrowing increased by Rmb6.2tn in the first three months of 2016, the biggest three-month surge on record and more than 50% ahead of last year’s pace, according to central bank data and FT calculations.”

“Economists say it is difficult for any economy to deploy productively such a large amount of capital within a short period, given the limited number of profitable projects available at any given time.”

For comparison, according to the Bank for International Settlements (BIS), Chinese debt at 249% of GDP, is “broadly comparable with the eurozone’s figure of 270% and the US level of 248%.”

“Economists widely agree that the health of the country’s economy is at risk. Where opinion is divided is on how this will play out.”

“At one end of the spectrum is acute financial crisis – a ‘Lehman moment’ reminiscent of the US in 2008, when banks failed and paralyzed credit markets. Other economists predict a chronic, Japan-style malaise in which growth slows for years or even decades.”

For those that believe in the likelihood of an acute financial crisis, a key concern is the amount of credit expansion that has occurred through high-yield wealth management products.  For the Japan-style scenario people point to the sheer amount of reserves the country has and the high savings rates of Chinese citizens.

Though, “it is wrong to assume that ‘too much debt’ is bad only if it causes a crisis, and this is a typical assumption made by almost every economist,” according to Michael Pettis, a professor at Peking University’s Guanghua School of Management.  Pettis points out “the most obvious example is Japan after 1990. It had too much debt, all of which was domestic, and as a consequence its growth collapsed.”

Department Stores Need to Cull Hundreds of Sites, Study Says. Suzanne Kapner. Wall Street Journal. 24 Apr. 2016.

Highlighting the existential crisis that the retail industry is facing is a report just put out by Green Street Advisors.  Essentially, “department store need to close hundreds of locations (roughly 800 or about 1/5 of all anchor space in U.S. malls) if they want to regain the productivity (sales per sq. ft.) they had a decade ago.”

“Sears Holdings Corp. alone would need to close 300, or 43%, of its Sears stores to regain the sales per square foot it had in 2006, adjusted for inflation, according to Green Street.”

WSJ_Department Store Excess Capacity_4-24-16

“Sales at the nation’s department stores averaged $165 a square foot last year, a 24% drop since 2006, according to company disclosures and Green Street estimates.”

But department stores are loathe to close physical locations considering many stores still make money, the physical locations facilitate their online sales within the same market, and when they do close stores it doesn’t mean that the same shoppers then migrate to their other retail channels.

“It may be unrealistic to expect that department stores could ever return to historical levels of sales or profits given the changing dynamics of retailing. Many retailers say they make less money selling goods online than they do in their physical stores. And with the Internet making it easier for consumers to comparison shop, discounts have become the norm.”

“The store glut has important implications for the country’s weaker malls, which rely on their anchors to drive foot traffic. ‘If department stores were to move forward and aggressively streamline their physical presence it could result in several hundred malls no longer being relevant retail destinations.’ – DJ Busch, senior Green Street analyst.”

Other Interesting Articles

The Economist

Bloomberg – Blackstone Weighs Opening Up Real Estate to Individual Investors 4/21

Bloomberg – Japan Post to Fight Negative Rates With Shift to Risk Assets 4/21

FT – China’s debt: not a cheap American copy 4/21

FT – Europe should forget Google and investigate its own shortcomings (Michael Moritz) 4/22

FT – Caterpillar says business in Brazil has ‘basically tanked’ 4/22

FT – US Reits: a sector to buy in May and then enjoy the summer 4/24

FT – Fund star Sudhir Nanda warns of threat to human role in finance 4/25

FT – Ant Financial raises $4.5bn in record fintech private placement 4/25

FT – China to unroll nationwide soil pollution survey 4/25

FT – Japan’s negative rate experiment is an alarm bell for the US 4/25

FT – Nigeria’s import curbs drain life from bustling Lagos ports 4/26

FT – Daniel Loeb warns of hedge fund ‘killing field’ 4/27

InvestmentNews – Schorsch’s AR Global looking to consolidate $10.5 billion of REITs 4/26

Mauldin Economics – Xi Jinping Takes Command of the People’s Liberation Army 4/25

NYT – Renewable Energy Stumbles Toward the Future 4/22

NYT – Fantasy Math Is Helping Companies Spin Losses Into Profits 4/22

NYT – Jimmy Buffett’s ‘Margaritaville’ Is a State of Mind, and an Empire 4/23

NYT – Don’t Blame Silicon Valley for Theranos 4/27

ValueWalk – Carl Icahn Dumps Entire Apple Inc. (AAPL) Stock, Blames China 4/28

WSJ – Everyone Wants a Raise – Except Investors 4/22

WSJ – Alphabet’s Next Big Thing: Building a ‘Smart’ City 4/26

WSJ – No One Believes It, but Inflation Is a Pretty Good Bet 4/27

WSJ – Chinese Property Giant Evergrande Invests in Financial Folly 4/28

WSJ – The U.S. Homeownership Rate Falls Again, Nearing a 48-Year Low 4/28

Zero Hedge – Why Goldman Expects The Japanese Yen To Collapse Within 12 Months 4/24


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