October 28 – November 3, 2016 – the janus observer

Declining global trade. Chinese bank loan loss provisions. Pending auto loan crisis?

Headlines

FT – Hong Kong car park space fetches $620,000 10/28. The stall at 55 Conduit Road (exclusive Mid-Levels district) sold for a record HK$4.8m. For comparison the previous record (also same road) was for HK$4.4m and for the 1,574 parking stalls that traded hands in the third quarter, the average price was HK$1.3m ($167,917).
NYT – 300 Million Children Breathe Highly Toxic Air, Unicef Reports 10/30. “The vast majority of these children, about 200 million, live in South Asia, in places where air pollution is at least six times the level that the World Health Organization considers safe, Unicef said.”
FT – China signals return to strongman rule 10/27. President Xi Jinping has recently been anointed as the “core” leader of the communist party, Jiang Zemin was the last to have the title – after the Tiananmen Square protests in 1989.
FT – Assets at top 500 funds fall for first time since 2011 10/31. “Total assets fell by $1.4tn to $76.7tn – the first decline in funds under management since 2011, with European investment houses experiencing the biggest falls.”

Special Reports / Opinion Pieces

Outkick The Coverage – ESPN Loses 621,000 Subscribers; Worst Month In Company History – Clay Travis 10/29
- Interesting perspective, but doesn’t go down the possible/likely outcome that if ESPN continues to lose subscribers and revenues, that ESPN and other content buyers will put pressure on content sellers (NFL, NBA, MLB, NCAA, etc.) to lower their fees.
FT – 2066 history exam: The great powers sabotaged global prosperity 11/1
NYT – How the Internet Is Loosening Our Grip on the Truth – Farhad Manjoo 11/2
- Rather than provide the world with a better handle on ‘truth’ and ‘facts’ people are creating their own “echo chambers” filled with confirmatory articles and news sources. And of course, this doesn’t apply to me or you….

Briefs

Max Chafkin of Bloomberg Businessweek covered the slow correction going on in Silicon Valley.

“Earlier this year, One Kings Lane, the online home goods retailer once worth almost $1 billion, sold itself to Bed Bath & Beyond, one of the companies it was supposed to displace, for just $12 million. Jawbone, the maker of sleek wearable fitness hardware once seen as a threat to Apple’s, has seen its value fall 50%. Since 2015, researcher CB Insights has counted 80 ‘down rounds,’ instances of a startup accepting a reduced valuation to raise more venture funding. ‘There was this fog hanging over Silicon Valley in 2001,’ says Botha (Roelof Botha, partner at VC firm Sequoia Capital) referring to the last big tech bust. ‘And there’s a fog hanging over it now. There’s no underlying wave of growth.'”
Yet at the same time VC funds are flush. “A few years ago, a big VC fund might have had about $500 million to play with. Today, ‘big’ means well over $1 billion. VCs raised $12 billion in the first quarter of 2016, which the industry’s trade group says marked a 10-year high. ‘The world has never seen an investment climate like this one,’ says Bill Gurley, a partner with Benchmark who led the firm’s investment in Uber. ‘It’s hard to express how much money is out there.'”
As Benchmark’s Gurley puts it “we’re in a slow correction. You might see a unicorn go down once a quarter.”

Heather Haddon of the Wall Street Journal illustrated the challenges that grocers are having with millennials.

“Grocers are struggling to lure e-commerce-loving millennials into their aisles amid what experts say is a permanent shift in shopping patterns among consumers.”
“I don’t think we’ve seen shopping change so dramatically ever. Those things in the past that have been real drivers for grocery in terms of freshness and quality aren’t the key drivers for millennials.” – Marty Siewart, senior VP for consumer and shopper analytics at Nielsen
“Consumers between 25 and 34 years of age last year spent an average of $3,539 on groceries, about $1,000 less in inflation-adjusted dollars than people that age spent in 1990, federal data shows.”
Of course it doesn’t help that “the more than 75 million Americans born in the 1980s and 1990s are also delaying marriage and childbearing, milestones that traditionally lead people to start making big trips to the grocery store.”

Elaine Moore of the Financial Times covered that there continues to be strong demand for bonds with terms that are as long as a lifetime.

Austria just sold 70-year bonds at a yield of 1.5%. On the same day the country also sold 7-year bonds at a sub-zero yield.

Peter Wells of the Financial Times pointed to the ‘real’ reason why AIA has a fall in insurance policies underwritten.
- “UnionPay customers from the mainland (China) will only be allowed to use their credit and debit cards to buy accident, illness and tourism-related insurance policies in Hong Kong, the state-backed bank card provider said on Saturday through one of its subsidiaries.”
- Why the sudden change…
- “UnionPay said it ‘has observed a significant increase in overseas insurance transactions by cards issued from mainland China’ and is now preventing its mainland customers from buying insurance products that include ‘investment-related contents.'”
- “The purchase of insurance products overseas, particularly in Hong Kong, had become a popular way to move money offshore, particularly after the devaluation of the renminbi in August 2015.”
Danny Hakim of the New York Times covered the new findings about genetically modified crops and how the results haven’t quite lived up to the promises.
- The skinny: “genetic modification in the United States and Canada has not accelerated increases in crop yields or led to an overall reduction in the use of chemical pesticides.”
- “An analysis by The Times using United Nations data showed that the United States and Canada have gained no discernible advantage in yields – food per acre – when measured against Western Europe, a region with comparable modernized agricultural producers like France and Germany. Also, a recent National Academy of Sciences report found that ‘there was little evidence’ that the introduction of genetically modified crops in the United States had led to yield gains beyond those seen in conventional crops.”
- “At the same time, herbicide use has increased in the United States, even as major crops like corn, soybeans and cotton have been converted to modified varieties. And the United States has fallen behind Europe’s biggest producer, France, in reducing the overall use of pesticides, which includes both herbicides and insecticides.”
Mary Childs of the Financial Times discussed some of the changes afoot in the private equity business.
- A new trend is taking place in the private equity world, one that is promising to hold investor money for longer periods in return for less returns.
- Granted, “private equity has become a victim of its past success: its strong performance relative to other asset classes looks increasingly difficult to replicate as high valuations and stiff competition among private equity groups make new deals more expensive.”
- Thus new funds are “offering investors vehicles that will run for 14 years or more, rather than the traditional 10 years, and offer 15% returns or less, lower than the 20% in a typical fund.”
- “Already the industry’s average returns are slipping below the 20% mark: for 2015, buyout funds generated an average internal rate of return of 17.1%, according to data from Preqin.”
- “Fund managers are deploying less money, sitting on a record $839bn of so-called dry powder at the end of the third quarter, according to Preqin. Many buyout chiefs say they are modelling potential investments with the expectation that they will be selling into a lower stock market.”
- Speaking to the timelines of these new funds, the intent is to match investment returns to investor’s long-term liabilities and to avoid forced sales due to too-short investment time horizons.
Michael Hiltzik of the Los Angeles Times posted about a recent agreement between Dalian Wanda Group and the City of Beverly Hills on a real estate development that sets quite a precedent – good or bad depending on which side you’re on.
- The benefits of being a city where entitled land is scarce and money flows abundantly… or a further sign that this real estate development cycle has been going on too long such that municipalities can continue to up the ante.
- The City of Beverly Hills and the Dalian Wanda Group (large Chinese developer) just inked perhaps the most advantageous deal to a municipality – ever. Granted, Dalian Wanda wouldn’t have done the deal if it didn’t make sense to them – at least on paper.
- “The terms are still subject to approval by the Beverly Hills City Council, which will launch a three-day round of hearings on the development Monday. The terms include a doubling of the upfront payment from Wanda to the City from $30 million to $60 million; a quadrupling of environmental mitigation and sustainability fees to 1.25% from 0.45% of the sale of any portion of the development, including the condos, and an additional 2% of any subsequent sale; and hotel occupancy surcharge of 5%, on top of the city’s statutory transient occupancy tax of 14%.”
- “The city says it expects the terms to yield $820 million in revenue over 30 years, an increase of $560 million over the previous terms.”

Graphics

FT – Spanish unemployment rate below 20% for first time in 6 years – Tobias Buck 10/26

Visual Capitalist – Prices Are Skyrocketing, But Only For Things You Actually Need – Jeff Desjardins 10/28

FT – Solar industry rollercoaster offers a bumpy ride – Ed Crooks 10/30

FT – US mobile advertising surges 89% – Anna Nicolaou 11/1

Daily Shot – Nigeria’s FX Reserves 11/1

Economist – Angling for the future of TV 10/29

Bloomberg – What Rising Bond Yields Are Trying to Tell Us – Mark Gilbert 11/3

FT – Millennials drive Chinese online consumer boom – James Kynge 11/2

Featured

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

A Little-Noticed Fact About Trade: It’s No Longer Rising. Binyamin Appelbaum. New York Times. 30 Oct. 2016.

“…Trade is no longer rising. The volume of global trade was flat in the first quarter of 2016, then fell by 0.8% in the second quarter, according to statisticians in the Netherlands, which happens to keep the best data.”

“It is the first time since World War II that trade with other nations has declined during a period of economic growth.”

Further, “the United States is no exception to the broader trend. The total value of American imports and exports fell by more than $200 billion last year. Through the first nine months of 2016, trade fell by an additional $470 billion.”

“In better times, prosperity increased trade and trade increased prosperity. Now that wheel is turning in the opposite direction.”

Worse, “there are also signs that the slowdown is becoming structural. Developed nations appear to be backing away from globalization.”

“The World Trade Organization said in July that its members had put in place more than 2,100 new restrictions on trade since 2008.”

“During the 1990s, global trade grew more than twice as fast as the global economy. Europe united. China became a factory town. Tariffs came down. Transportation costs plummeted.”

“But those changes have played out. Europe is fraying around the edges; low tariffs and transportation costs cannot get much lower. And China’s role in the global economy is changing. The country is making more of what it consumes, and consuming more of what it makes. In addition, China’s maturing industrial sector increasingly makes its own parts. The International Monetary Fund reported last year that the share of imported components in products “Made in China” has fallen to 35% from 60% in the 1990s.”

“The result: The I.M.F. study calculated that a 1% increase in global growth increased trade volumes by 2.5% in the 1990s, while in recent years, the same growth has increased trade by just 0.7%.”

Now, there is excess capacity in the world’s shipping lines. “In 2009, the world’s cargo lines had enough room to carry 12.1 million of the standardized shipping containers that have played a crucial, if quiet, role in the rise of global trade. By last year, they had room for 19.9 million – much of it unneeded.”

Further, automation is making it difficult, if not impossible, for developing nations to follow in China’s footsteps. “Dani Rodrik, a Harvard economist, calculates that manufacturing employment in India and other developing nations has already peaked, a phenomenon he calls premature deindustrialization.”

It doesn’t help that the benefits of globalization were oversold and that now nativists and protectionists are overstating the downsides.

China banks in stand-off with regulators on loan loss provisions. Yuan Yang. Financial Times. 30 Oct. 2016.

“China’s banks are in a deepening stand-off with regulators over the level of provisions they must make to protect against loan defaults as bad debts continue to climb.”

Current provisions call for a loan loss provision ratio target of 150%. As it stands at least two of China’s largest four banks are below the coverage ratio. As of the third quarter Industrial and Commercial Bank of China has a coverage ratio of 136% (down from 143% in the second quarter). And that’s based on officially recognized non-performing loans.

“Officially, 1.8% of all Chinese loans are non-performing, although the credit rating agency Fitch puts the true figure at more than 15%. Following a huge credit boom, the outstanding amount of non-performing loans doubled in the two years before June 2016, reaching Rmb1.4tn.”

Hence, will the banks have to raise their loan loss reserves or will the regulators reduce the target ratio?

As Zhang Yingchao, a banking analyst at NSBO China – an investment bank, aptly puts it “setting standards is a tussle between the banks and the regulators. Who gets the upper hand depends on the state of the economy. If increasing the credit supply is necessary to meet the growth target of 6.5-7%, then the regulators will need to relax standards.”

Fears rise over auto loan crisis as repo men see sales’ dark side. Joe Rennison. Financial Times. 1 Nov. 2016.

“Repossessions in the US hit 1.6m in 2015, the third highest level on record for data going back 20 years, falling short of the 1.8m and 1.9m peaks seen in 2008 and 2009, respectively.”

“That number is predicted to rise to 1.7m this year, according to Tom Webb, chief economist at Cox’s Automotive.”

However, one of the key differences between this cycle and last is that whereas many of the repossessions in 2008 and 2009 were from fraudulent schemes “people renting cars under a fake name and not returning them, for example,” this time there has been a boom in subprime auto loans and people just not able to repay their loans.

The auto market is booming and correspondingly or really as a result of the growth in the auto loan market. “The auto loan market has grown from $750bn in 2011 to $1.1tn at the end of June, according to data from the US Federal Reserve.”

According to Peter McNally, a senior analyst at Moody’s – the rating agency, “while we have seen a gradual loosening in underwriting in recent years it has gotten to a point now where it is becoming unstable.”

“The subprime auto ABS market has grown to $38.1bn, down slightly from its second quarter high of $41.2bn, according to data from the Securities Industry and Financial Markets Association. Fitch Ratings defines subprime ABS as a deal with expected net losses above 7%. Net losses across subprime auto ABS hit 9.29% in September, according to Fitch – 23% higher than a year earlier.”

“The fear is that if losses continue to climb, investors will stop buying bonds issued by less diversified companies. If their access to funding stops, it could impair the credit quality of the issuer itself, throwing doubt over the quality of existing bonds and ricocheting through the market, raising borrowing costs for other issuers as well.”