April 29 – May 5, 2016 – the janus observer

Beware of ‘investments’ being peddled by Chinese banks. China no longer getting the same bang for the buck. Industry concentration tends to result less money going to employees.

Headlines

FT – Will duration risk rear its head for bond investors? 4/28. “The duration on the Barclays global aggregate bond index hit a record high of 6.8 years this month. At the same time, the yield on the index has crumbled to 1.44% from 4.24% a decade ago.
NYT – China Lending Inflates Real Estate, Stocks, Even Egg Futures 5/1. Bottom line, money finds a home.
FT – Puerto Rico suffers most significant default in debt crisis 5/2. Puerto Rico just declared a moratorium on the Government Development Bank obligations, next up general obligation bond payment due July 1, will they make it?
NYT – American Pharoah Is Already a Champion at the Stud Life, Too 5/3. Some of you may recall the Bloomberg article about the concerns and hope about American Pharoah’s next act, well turns out he’s doing just fine.

Briefs

Lucy Hornby of the Financial Times drew attention to the reality that not all Chinese provinces are posting growth, in fact some are experiencing outright decline.

“The economy in China’s industrial province of Liaoning contracted in the first quarter, making it the first region to register negative growth in seven years as a severe downturn in energy and heavy industry sectors hits hard in the country’s north-east.”
“China’s national growth clocked in at an annual rate of 6.7% in the first quarter, but that headline figure masks sharp discrepancies between provinces reliant on heavy industry, mining or oil, and the southern and eastern regions with more diversified economies.”
“Chinese newspaper 21st Century Business Herald reported this week that Liaoning would book a 1.3% contraction in real GDP for the quarter…”

Daniel Thomas of the Financial Times covered that Global smartphone sales fell for the first time. It was bound to happen eventually.
- “Global smartphone shipments fell for the first time as “iPhone fatigue” dragged down sales for Apple’s once-unstoppable franchise amid a general weakening in the market for new devices.”
- “After close to a decade of stellar growth, analysts say a tipping point in the smartphone market has been reached as most people already have a phone, phablet or tablet device.”
- “Apple popularized the smartphone market with the launch of the first iPhone in 2007. The US group said this week that it had suffered a 16% fall in unit sales in the first quarter and warned that the next quarter could be even worse…”
- “Apple was not totally to blame, however, as global smartphone shipments fell 3% in the first quarter of 2016 to 334.6m, down from 345m units in the same quarter of 2015. The quarter was the ‘first time ever since the modern smartphone market began in 1996 that global shipments have shrunk on an annualized basis.'”
- “As the China market matures, the appetite for smartphones has slowed dramatically as the explosion of uptake has passed its peak.” – IDC, a research firm.
For those of us in Hawaii, we’re quite familiar with the concept of leasehold property, and generally if you can avoid it for your primary residence you do. Well in China all residential property is leasehold and some of those lease terms are rolling over in short order. Lucy Hornby of the Financial Times discusses the angst this is causing.
- “The simmering issue of property rights in China has burst into the open with the upcoming expiry of residential leases in several wealthy cities and a contentious plan to charge homeowners to renew them.”
- When the Communist party entered into power in 1949 property ownership was abolished only to be renewed via a mixed bag of leasehold rights in the 1980s and 1990s. Now these rights are “…in the spotlight with the upcoming expiry of 20-year residential land use rights in Wenzhou in eastern China… Leases granted in the 1990s will also soon come due in Shenzhen and other coastal cities, although the more common tenure of 70 years means most of the current generation of urban homeowners will hand the problem on to their heirs.”
- “Wenzhou has asked homeowners to pay up to a third of their homes’ value to renew their rights, according to a city government document, sparking an outcry across China. The Property Law of 2007 says land-use rights can be renewed but does not specify the criteria for doing so.”
- “Many Chinese bought their homes under the expectations that the long leases would be transformed into full ownership.”
Enough with all this bad news. No really, as Lingling Wei reports in the Wall Street Journal, China is pressing Economists to brighten their outlooks.
- “Securities regulators, media censors and other government officials have issued verbal warnings to commentators whose public remarks on the economy are out of step with the government’s upbeat statements, according to government officials and economic commentators with knowledge of the matter.”
- As Scott Kennedy, a deputy director at the Center for Strategic and International Studies (a Washington think tank), puts it “vigorous debate among economists and public confidence in this conversation is critical if China is to successfully navigate the choppy economic waters. If the party and government only want to hear good news, then they’d be better off hearing nothing because the value of the words would be less than zero.”
- “While restrictions on foreign media have always been tight, they are becoming tighter, with a growing list of foreign publications having their websites blocked from view within China, including The Wall Street Journal.”

Special Reports

FT – China’s robot revolution – Ben Bland 4/28
FT – Rise of the robots is sparking an investment boom – Richard Waters and Tim Bradshaw 5/2
Mauldin Economics – Where’s the Beef? “Lies, Damned Lies, and Statistics” – Rob Arnott and Lillian Wu 5/4
Washington Post – America’s great housing divide: Are you a winner or loser? 4/28
- Interesting interactive graphic to see how much home values have changed in your neighborhood since 2004.

Graphics

FT – Will duration risk rear its head for bond investors? 4/28

FT – Rise of the robots is sparking an investment boom – Richard Waters and Tim Bradshaw 5/2

FT – US producers Ultra and Midstates fall victim to low oil price 5/3

Featured

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

Chinese banks disguise risky loans as ‘investments’. Yuan Yang and Gabriel Wildau. Financial Times. 28 Apr. 2016.

“Chinese banks are using complex financial engineering to disguise risky loans as ‘investments,’ rendering traditional risk metrics such as non-performing loan ratios virtually useless.”

“Analyst say most of these assets are in effect loans but are structured to appear as holdings of investment products issued by a third party. Such financial alchemy allows banks to evade regulations designed to limit risk.”

“Banks are required to set aside fewer provisions against ‘investment’ assets than traditional loans.”

“Because the investments are not classified as loans, defaults are not reflected in these banks’ non-performing loan ratio. Many analysts believe China’s official NPL ratio of 1.67% is all but irrelevant in assessing banks’ overall asset quality.”

“Fitch, the rating agency, believes this practice, also known as channel lending is used to provide credit to the likes of ‘cash-strapped property developers and local governments’ that cannot obtain formal loans.”

“Now that overcapacity sectors such as steel and cement are facing restrictions on formal borrowing, channel lending could become even more important to zombie companies.”

“Banks classify the assets they hold in these third parties as ‘investment receivables’ or ‘debt receivables,’ not loans.”

“Shadow lending in debt receivables increased 63% to Rmb14tn ($2.16tn) last year, according to an analysis of 103 Chinese banks by Wigram Capital Advisors, equivalent to 16.5% of the formal loan book.”

“Aggressive balance sheet expansion by midsized lenders has also increased their systemic importance to China’s overall banking system. The big four’s share of total banking assets has fallen from 51% in 2009 to 38% at the end of 2015, according to Wigram’s calculations.”

China’s fizz goes flat, even with far bigger credit stimuli. James Kynge. Financial Times. 4 May 2016.

Bottom line: “money is losing the power to energize important economic muscles. Asset prices in the all-important property market – which drove China’s recovery from the 2008 financial crisis – are now so high relative to household incomes that it is hard to envisage another sustained rally.”

“On average, it would take 25 years, 33 years, 36 years and 19 years of household income in Beijing, Shanghai, Shenzhen and Guangzhou respectively for a family to buy a 90 sq m (969 sq ft) apartment, according to calculations by Mizuho Securities in Hong Kong. By contrast, London house prices are 9.2 times average earnings for first-time buyers, according to Nationwide data.”

“The International Monetary Fund estimates that $1.3tn in corporate debt – or almost one in six of the business loans on Chinese banks’ books – was owed by companies that brought in less in revenues than they owed in interest payments.”

“So unleashing a new tide of credit to ease debt problems is ‘like smoking opium to look healthy,’ said Professor Li Weisen of Fudan University, according to the South China Morning Post.”

“China expanded total domestic credit by Rmb12tn, or 34% of gross domestic product, in the year to November 2009 – significantly less than the Rmb27.9tn, or 40% of GDP, in the year to February this year, according to Bernstein Research.”

“But while the 2009 stimulus reinvigorated growth from 6.1% in the first quarter to a full-year GDP growth rate of 9.2%, the flood of credit seen in the year to February has been accompanied by a gentle decline in GDP headline numbers.”

Rising Profits Don’t Lift Workers’ Boats. Peter Coy. Bloomberg. 5 May 2016.

“Big business is getting bigger, and workers’ slice of the economic pie is getting smaller. Those trends have bred resentment toward large corporations. Now research shows a surprisingly tight link between the two phenomena: The share of the pie that goes to workers has been shrinking most in precisely those industries where ownership is becoming more concentrated.”

“Increasing industry concentration ‘may explain one of the transcendent issues confronting the U.S. economy,” namely labor’s declining share and profits’ rising share of the value a company creates, Michael Feroli, the chief U.S. economist at JPMorgan Chase, wrote in an April 25 research note.”

As an explanation of the trend, “Feroli says, is that industries with more concentrated ownership can charge higher prices. They pay out their extra profits to shareholders, or to the government in taxes, but not to workers.”

“One hopeful sign for workers: The share of national income going to wages and salaries has rebounded since 2012, erasing about 30% of its post-1997 decline.”

Other Interesting Articles

Bloomberg Businessweek

The Economist