December 2 – December 8, 2016 – the janus observer

Inflation running away in Venezuela. The ‘whale’ in the market is you – or really your proxy by way of the government. Barbarian insurers in China are pissing off the securities regulators. China’s banks hiding more than $2tn in loans. A rise in US interest rates are likely to put the hurt on China (among other places).

I know, lots of featured articles this week…

Headlines

WSJ – China Debts Just Keep on Rolling 12/6. Earlier this year Chinese corporate-bond defaults were taking off and now – all of a sudden – defaults are gone and companies are issuing lots more debt and at lower rates – some of which are the same companies that were on the edge of default; go figure.
FT – Profits in China: not safe 12/6. Now that the new rules from China’s State Administration of Foreign Exchange are taking effect, foreign companies are having difficulties repatriating earnings.

Special Reports / Opinion Pieces

Mauldin Economics – Putting the Boot into Italy – Charles Gave 12/6
- “Matteo Renzi has joined a long line of Italian prime ministers who failed to ‘reform’ their country. This is another way of saying that he could not wave a magic wand and make Italy competitive with Germany. The grim reality is that no Italian leader stood a chance of changing their country once the fateful decision was made to peg its currency to Germany’s. At the time of the euro’s launch in 1999, I argued that the risk profile of Italy would change from being an economy where there was a high probability of many currency devaluations to the certain probability of eventual bankruptcy. Sadly, that moment is not far away.”
Project Syndicate – Italy on the Brink – Philippe Legrain 12/8
FT – How driverless cars are set to reinvent and humanize our streets – Leslie Hook 12/7
- “City and strategic planners are starting to see that this is real. We expect there will be a 60% reduction in personal vehicles, and I think that is actually very plausible in the next 20 years.” – Jarrett Walker, public transit consultant

Briefs

James Kynge of the Financial Times drew parallels between China’s current liquidity flood and those during the times of the Mongols and Chairman Mao.
- “The dimensions of China’s liquidity splurge are startling. Ousmene Jacques Mandeng, formerly with the International Monetary Fund, has calculated that between 2007 and 2015 China created 63%, or $16.1tn, of the growth in the world’s supply of money.“
- “China now has more money coursing through the arteries of its economy than the eurozone and Japan combined – and almost as much as the US and the eurozone combined. Since the financial crisis, commentators have focused on the efforts of the US, European and Japanese central banks to print money through ‘quantitative easing’, but China’s output has eclipsed them all.”
- However, “the main issue is that debts are piling up almost as fast as China generates money to service them, creating what Jonathan Anderson of the Emerging Advisors Group calls a ‘debt funding bubble.'”
- We shall see where we go from here.
Jacky Wong of The Wall Street Journal pointed out that passive investors are getting sucked into Hong Kong market failures by way of their market funds.
- Bottom line, be very cautious of investing in companies with a thin float (very little shares traded), with a few insiders controlling most of the shares, and a large part of revenues generated from related entities… That goes the same for investing in passive index funds that invest in the same companies…
Oshrat Carmiel of Bloomberg highlighted that condominiums in NYC’s tallest luxury tower are being discounted by millions of dollars.
- “At 432 Park Ave., buyers who signed contracts and completed those purchases this year got price reductions averaging 10%, according to an analysis by appraiser Miller Samuel Inc. In one of the most recent big transactions to close, a penthouse on the 88th floor sold for $60.9 million, a 20% markdown from what developers initially sought, city property records made public Dec. 2 show.”
- “As new high-end projects mushroom across the skyline, developers of ones that came to market earlier are cutting deals to unload units before competition gets even more heated.”
- “The building isn’t the only recently completed ultra-luxury tower that’s lowered prices. A few blocks away on 57th Street, a 4,193-square foot apartment at Extell Development Co.’s One57 sold in October for $21.6 million, or 24% off the last asking price, according to listing website StreetEasy.”

Graphics

WSJ – Daily Shot – 12/02

Economist – Discounting the bull: Stock analysts’ forecasts tend to be wrong in reassuringly predictable ways 12/1

WSJ – China’s Yuan and the Trillion-Dollar Numbers Game – Nathaniel Taplin 12/7

NYT – A Bigger Economic Pie, but a Smaller Slice for Half of the U.S. – Patricia Cohen 12/6

WSJ – Daily Shot: Bloomberg Barclays US Corporate High Yield Average OAS 12/8

Featured

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

Venezuela struggles to tame triple-digit inflation. Andres Schipani. Financial Times. 5 Dec. 2016.

“In an echo of Wiemar Germany, Venezuelan shopkeepers have resorted to weighing banknotes instead of counting them. In defiance of official pegs, the local currency has tanked on the black market, losing a jaw-dropping 62% of its value in November, making bills in circulation in the country virtually worthless.”

“The biggest note in use is the 100 bolivar bill, which is worth roughly 2 US cents on the black market.”

As a result vendors are counting money with weight scales rather than waste the day away counting notes. The rule of thumb “100 notes of any denomination of Venezuela’s currency weigh 110 grams.”

“In the midst of a collapse in the parallel market (there are two local exchange rates – one used for priority imports and the other for everything else) and crippled by triple-digit inflation, the country’s central bank said it would begin circulating higher-denomination notes, including 500, 1,000, 2,000, 5,000, 10,000 and 20,000 bolivares, next week.”

“Carlos Miguel Alvarez, a senior economist with the Caracas-based Ecoanalitica, sees the measure as shortsighted. ‘The new bills may facilitate transactions, but unless the inflationary economic distortions are corrected, they won’t last very long as relief.'”

“Economists list those distortions as currency and price controls, coupled with lower oil prices, mismanagement and a relentless printing press. Venezuela’s central bank has kept inflation data under wraps for a year, but Mr. Alvarez forecast it would top 511% this year. The IMF puts 2016 inflation at 476%.“

“Now prices in certain stores can change daily. Some observers are comparing the issuance of larger Venezuelan bank notes with Zimbabwe’s decision to print a new currency to tackle a collapse of trust in its financial system.”

There’s a Big New Investor in Stock Markets: The State. Gregor Stuart Hunter and Kosaku Narioka. The Wall Street Journal. 5 Dec. 2016.

“Two of the world’s most important stock markets have a big new investor: the state.”

“About 30% of all the companies in Japan’s three main equity indexes now count the country’s central bank as one of their top 10 shareholders, according to a Wall Street Journal analysis of data as of the end of September. Six years ago, the Bank of Japan’s presence in the market was trivial.”

“In China, two major state-owned investment funds that are part of the so-called national team have become top 10 shareholders in 39% of listed companies over the past year, according to UBS, which analyzed shareholdings as of the end of September.”

“The new wave of state buying is unique in that it is aimed primarily at propping up markets and economies.” AKA helicopter money.

“Traders say the buying distorts stock values as investors build strategies around government actions rather than company fundamentals. The state’s indiscriminate purchases also might reduce pressure on managements to fix problems that otherwise could weigh on their stock. And then there is the question of how governments will ultimately wind down their holdings, a concern that some say could be deterring investors with a longer-term outlook.”

“The BOJ (Bank of Japan) started buying exchange-traded funds that track equity indexes in December 2010. In July, it boosted its target to roughly ¥6 trillion ($53 billion) worth of ETFs each year. Its holdings had swelled to about ¥13 trillion by late November – equal to around two-thirds of the money held by all Japanese ETFs, according to a Journal analysis of data from the central bank and Morningstar.”

“In China, Central Huijin Asset Management, part of China’s main sovereign-wealth fund, and China Securities Finance Corp., which provides margin financing to the country’s brokerages, have been buying shares to support Chinese stock markets since the rout during the summer of 2015.”

“Any suggestion that the national team is active can produce a frenzy of buying among mom-and-pop investors, said Sean Taylor, chief investment officer for Asia-Pacific at Deutsche Asset Management.”

“Others say the national team’s presence has made the market more dull. Big state-backed funds have been selling down blue-chip shareholdings whenever the market rallies for a few sessions in a row, then buying them back if any selloff steepens. The main Shanghai market has traded in a much narrower range this year than in 2015…”

All this distortion can’t be good.

China’s regulators lose patience with ‘barbarian’ insurers. FT Confidential Research. Financial Times. 6 Dec. 2016.

“The chairman of the China Securities Regulatory Commission (CSRC) has sustained a public attack on aggressive stock purchases on the secondary market in recent months. Liu Shiyu, a former central bank deputy head, has accused this new breed of Chinese corporate raider of using illegal funds and morphing from ‘strangers at the gate to barbarians and finally to industry thieves.'”

“As we (Financial Times Confidential Research – FTCR) have noted, the most aggressive buyers in the A-share markets, such as Anbang Life, Foresea Life and Evergrande Life, have tended to be aggressive sellers of universal life insurance products, short-term life policies that are very similar to wealth management products but with an added life insurance component.”

“Regulators worry that such policies are being sold primarily as high-yielding, short-term investment products, rather than long-term, conservative insurance products, and that their high returns are being achieved by means of high-risk, aggressive stock purchases designed to ramp up stock prices.”

“The insurers need to invest aggressively to match the generous returns offered by universal life insurance products.” However, “slowing sales of such products will pose a challenge in the coming year. The insurers depend on customers rolling over short-term policies to remain solvent; if they do not, insurers will be forced to sell their newly-acquired stakes, undermining their business model.”

The FTCR group does “not think Mr. Liu’s harangue marks an end to this battle. There is too much money involved and some insurance executives reportedly have better connections than their regulators.”

China’s Banks Are Hiding More Than $2 Trillion in Loans. Lingling Wei. The Wall Street Journal. 7 Dec. 2016.

Want to expand credit but not have the liability show up on your balance sheet? Well, in China make it an “‘investment receivable,’ a loosely regulated category of assets that allows bank officials to set aside little or nothing for potential losses.”

“As of June, 32 publicly traded Chinese banks had a total of $2 trillion in investment receivables, up from $334 billion at the end of 2011, according to a tally by The Wall Street Journal of the latest available information from data provider Wind Information Co.”

“The investments are equivalent to 20% of the same banks’ total loans in dollar terms, up from 6% at the end of 2011. The 32 banks have about 70% of all the banking assets in China.”

“The rapid growth in banks’ off-balance-sheet and investment activities, in essence, means hidden credit risks and could threaten financial safety.” – Shang Fulin, China’s top banking regulator

“Economists at Swiss bank UBS AG estimate as much as $2.4 trillion (16.5 trillion yuan) was ‘missing’ from the broadest measurement of credit disclosed by China’s central bank last year, up from $712 billion (4.9 trillion yuan) in 2014. The discrepancy is largely because Chinese commercial banks use so-called shadow lenders to mask loans as investments, the economists said.”

“If Chinese banks were required to count their investment receivables as loans, the banks would need to raise as much as $212 billion in capital, estimates UBS analyst Jason Bedford. That is not far short of the $262 billion raised by all Chinese banks in 2015.”

“As a result, the analyst said, ‘we expect any capital impact [on banks] to be dragged out over years to avoid a shock to the system.'”

“‘All banks are trying to move [loans] off balance sheets,’ said an official at Bank of Nanjing, nodding to a common belief that in China that Beijing always will stand behind the country’s banks. ‘The only risk we have is sovereign risk.'”

US interest rate rises set to expose China’s frailties. James Kynge. Financial Times. 7 Dec. 2016.

China is readying itself to tighten its monetary policy as the U.S. looks to do the same; however, right now isn’t the best time…

“The vast size of China’s debt mountain – which stands at over 250% of gross domestic product, up from 125% in 2008 – means that even minor increases in short-term interest rates may squeeze corporate activity and precipitate defaults, thereby hampering economic growth.”

“Alex Wolf, emerging markets economist at Standard Life Investments, argues that default risks are rising because more and more corporations are relying on the short-term money market to raise the finance they need to repay existing debts.”

“Estimates by Fitch, the rating agency, reveal a level of pain in corporate China that is not hinted at by official statistics. Some 15% to 21% of loans in the Chinese banking system are already non-performing, Fitch estimates, compared with official numbers of less than 2%.”

In this context, it is unsurprising that foreign exchange reserved declined by nearly $70bn in November.

“The Institute of International Finance, a global association of financial institutions, calculates that in the first 10 months of this year net capital outflows from China totaled $530bn, with October marking the 33rd straight month in which more money left the country than flowed in.”

Property companies are also finding themselves on the short-end of the stick.

“In November, property developers issued only Rmb12bn ($1.7bn) in bonds, down from a monthly average of Rmb86bn from January to September, according to FT Confidential Research, a unit of the Financial Times.”