China and its impact on the rest of the world

Transcription

1 GavekalResearch SEPTEMBER 2016 China and its impact on the rest of the world By Louis-Vincent Gave

2 What does the Chinese Ministry of Propaganda do all day? Option 1: Make the best of a very bad situation but situation is deteriorating too fast and Chinese spin doctors do not have enough lipstick for that pig Option 2: Hide China s reckless mercantilism as the country continues to export deflation into a slow growing world Option 3: Hide China s growing imperialism and desire to push the US out of the greater Asia region GavekalResearch 2

3 1- Is the Chinese economy spinning out of control of spin doctors? GavekalResearch 3

4 Construction has been the main drag on GDP growth GavekalResearch 4

5 Construction slowdown triggered massive disparity of growth China s northern and western provinces are the worst off Provincial nominal GDP growth in the first half of 2015 The economic slowdown China has experienced since 2012 has been marked by an enormous regional disparity. Above 7.5% 6-7.5% 4-6% Below 2% A group of northern provinces that are heavily reliant on mining and heavy industry are bearing the brunt of the slowdown. Three provinces had negative nominal GDP growth in the first half of 2015: the coal mining capital of Shanxi, and Liaoning and Heilongjiang in the northeast rust belt. CEIC, Gavekal Dragonomics The wealthy centers of Beijing and Shanghai, as well as the coastal provinces, have been doing much better. GavekalResearch 5

6 The government went back to working the pump This year s rebound in Chinese construction, property sales, and prices is possibly one of the least expected macro developments of Clearly, the government went back to working the pump. In the short term, this covers over the crack. In the longer term, it does raise serious sustainability questions. In the medium term, it means that 1H2017 will be tough for YoY comparisons GavekalResearch 6

7 Still, the main question is how long the debt increase can last? Chinese debt is a major concern amongst investors today. And while the level of overall debt still stands below the levels reached in the US, Japan, France etc the genuine concern is the pace of growth in China s accumulation of debt. If nothing else, the rapid pace of debt growth would suggest capital misallocation on a grand scale. Another concern is that, unlike in the US or Japan, the growth in debt has not come from the government but from corporates and now, with falling prices (PPI has been negative for 5 years) and weakening sales growth, the question of debt servicing is an open one. So does China face a debt crisis? GavekalResearch 7

8 Two kinds of financial crisis Country runs large current account deficits for years Becomes dependent on the willingness of foreigners to fund its lifestyle Banks lean too far above their skis, usually by lending too much to real estate Bank outgrow their own equity and so borrow short (money markets) to lend long Once foreigners want out (Argentina, Greece, Thailand ) the financial system implodes Money markets refuse to lend to banks and so banks need to raise equity quickly GavekalResearch 8

9 Scenario 1 is impossible in China GavekalResearch 9

10 Scenario 2 is also unlikely In order to see a banking crisis in China, it will have to be that either the government triggered it (by ending regulatory forbearance). Or because panic depositors take their money out. But what would trigger such a panic in government owned and backed banks? As Charles often puts it, people changes wives more often than they change banks GavekalResearch 10

11 The probable paths forward Growth Low odds Strong growth on back of large productivity gains thanks to investments in education & infrastructure Buy energy, copper, commodity currencies China Range of most likely outcomes against which investing makes sense Decent growth thanks to policy support and the steady increase in affluent consumers Buy China consumption & financials, tourism Long, slow-moving Nipponification of Chinese economy with deflation, ever-more zombies, ageing population, rising debt Buy long-dated Chinese government bonds Low odds Financial crisis on back of massive capital flight Buy: UST 30 years, Gold GavekalResearch 11

12 If China s future looks like Japan s recent past, we have a slam dunk opportunity GavekalResearch 12

13 Deflation is fundamentally bullish for currencies GavekalResearch 13

14 Is the short RMB trade the new widow-maker? GavekalResearch 14

15 As real estate prices rebound, is slowdown/bad debts an immediate concern? GavekalResearch 15

16 Low valuations and policy support = looking a gift horse in the mouth? PE ratios on H-shares are today about as low as they have ever been. Clearly the market is not pricing much growth opportunity out of China. At the same time, the difference between bond yields and dividend yields in China has never been this wide. Clearly, the market is pricing in many dividend cuts to come. This may of course happen though in an environment of ever-easier monetary policies, and loosening of fiscal policies, dramatic dividend cuts would be unusual. GavekalResearch 16

17 Option 2: Hiding China s Reckless Mercantilism? GavekalResearch 17

18 Uncompetitive countries don t have massive trade surpluses GavekalResearch 18

19 Nor do they keep gaining market share GavekalResearch 19

20 How come China is getting so little grief for charts like these? GavekalResearch 20

21 China is getting away with this because of RMB devaluation fears GavekalResearch 21

22 If capital flight was a problem, would every other SOE be allowed to export $? Is it not odd that, in the midst of a panic on Chinese capital outflows, a large Chinese SOE gets the green light on a CHF 45bn purchase of Europe s leading agri-chemical company? Meanwhile, the Syngenta deal was not a one-off, but one of many, mostly SOE, deals for foreign assets. Or, like in the mid 2000s, is China recycling its massive trade surplus through the purchase of foreign assets (perhaps less visible, and more profitable, than UST accumulation)? If so, are we back to the days of front running the Chinese? GavekalResearch 22

23 Option 3: Is China masking a growing imperialism? GavekalResearch 23

24 What are Xi Jin Ping s priorities? Anti-corruption drive China Dream Put a third of Petrochina management in jail Establish China as genuine imperial power within Asia (OBOR, Silk Road, AIIB ) Stop paying wrong price for commodities Avoid open conflict with USA Are those goals moving forward or backwards? GavekalResearch 24

25 The real threat: will China overplay its hand? Riga Moscow Silk Road Economic Belt Duisburg Kiev Almaty Khorgos Urumqi Istanbul Kashgar Lanzhou Zhengzhou Lianyungang Gwadar Chengdu Chongqing Wuhan Quanzhou Chittagong Guangzhou Sanya 21st Century Maritime Silk Road Colombo Hambantota GavekalResearch 25

26 History: if you want to eclipse leading power, do so discreetly GavekalResearch 26

27 Scarily, is this the most important man in Asia today? GavekalResearch 27

28 If you want to replace US$, offer better risk-returns than US Treasuries Over the past five years, RMB bonds have offered some of the best riskadjusted returns in the fixed income world. The excess returns against US Treasuries were provided by higher yields, and steady currency gains. Is this combination likely to last? If so, maintaining a position in Chinese fixed income makes sense for portfolio diversification and capital gains. GavekalResearch 28

29 The end of Pax Americana? Or simply the end of US outperformance? GavekalResearch 29

30 How should America s allies respond to the Trump phenomenon? Source: reaclearpolitics.com GavekalResearch 30

31 Does the end of Pax Americana explain why US$ is no longer rising? GavekalResearch 31

32 With deterioration in trade deficit, US needs to attract more capital GavekalResearch 32

33 Why the USD matters? GavekalResearch 33

34 A strong US$ tends to feed upon itself US$ strengthens Investors favor US$ cash-flow generating assets More capital flows into the US from the rest of the world Re-rating of US assets Lower US bond yields Massive outperformance of US growth assets against almost all asset classes (Nifty-Fifty, TMT bubble, FANGs ) GavekalResearch 34

35 In a strong US$ world, buy US growth stocks, sell global value GavekalResearch 35

36 While a weak US$ creates positive feedback loops for EM Strong growth in EM Western investors pour capital into EM EM upper class gets rich EM upper class leverages up, usually in US$ Weak US$ EM upper class buys jewels Commodities do well GavekalResearch 36

37 Will weak US$ mark the end of five years of EM underperformance? GavekalResearch 37

38 Why do assets have value? Jewels vs Tools Assets can have value because they are RARE Assets can have value because they are USEFUL In our research, we have called such assets JEWELS In our research, we have called such assets TOOLS Typical jewels might include high-end real estate, precious metals, collectibles and, of course, Gold The obvious proxy for tools is equities though anything that generates a growing cash-flow qualifies GavekalResearch 38

39 Jewels vs Tools In general rule, investors in emerging markets tend to favor investing in jewels. This reflects the fact that wealth in EM is newer and that newly rich people need to acquire jewels, if only as a status symbol (i.e.: rich people in developed markets already own jewels such as apartments on Park Avenue, beautiful paintings, fine wine etc ) and the fact that financial markets, and financial literacy, in emerging markets tend to be less developed than in developed markets. As such, periods of rapid wealth creation in EM tend to correspond with periods of jewel outperformance. By the same token, periods of falling real interest rates will typically lead to a re-rating of tools, able to provide future cash-flows. And of course, rising inflation will hurt the value of tools in that all too often, inflation will eat away at the value of future discounted cash-flows. GavekalResearch 39

40 Trending markets are announcing period of jewel outperformance GavekalResearch 40

41 A dollar driven decision tree Q1: Do you think the US$ is done rising? No Buy US Stable Growth Stocks and US Treasuries Yes Yes Q2: Does Chinese economy implode over the coming year? No Buy EM yields, EM Growth, Energy, Value stocks in DM GavekalResearch 41

42 Whether the US$ goes up, or down, remains most important question Between 2012 and 2015, markets were there but are they now moving to here? GavekalResearch 42

43 Playing the tails, or the consensus trade? We like a bar-bell approach Where consensus started the year GLOBAL GROWTH MUDDLES THROUGH Keep on buying tools US tech, global healthcare, global staples, US mortgage debt, US corporate debt GLOBAL GROWTH DETERIORATES Pick your poison: US recession, China implosion, Bank crisis, EMU crisis Own nothing but the safest cashflow generating assets: UST 30 years, USD cash, Gold, Bets on negative Fed rates Less perceived risk & volatility US$ HIGHS ARE BEHIND US China/Asia growth holds up thanks in part to massive improvements in terms of trade Back to the days of front running the Chinese and loading up on jewels? Buy MLPs, CAD REITS, RMB & EM & HY debt, China equities, Metals, Energy More perceived risk & volatility GavekalResearch 43

44 GavekalResearch Head Office Suite 3101, Central Plaza 18, Harbour Road, Wanchai, Hong Kong Tel: Fax: For more information contact Beijing Office 603 Soho Nexus Center 19A Dongsanhuan Beilu, Beijing Tel: Fax: