A look at last week’s markets
The vast majority of indices sit 50% below their 52-week high as markets remain bullish through the first half of 2016. At close on Friday,
- CSI 300 – 9% above 52w lows;
- HSI – 8% above 52w lows;
- Nikkei 225 – 25% above 52w lows;
- FTSE 100 – 36% above 52w lows;
- TSX – 58% above 52w lows; and
- S&P 500 – 78% above 52w lows.
A sustained two week sell-off in Hong Kong has resulted over concerns a strong US dollar, weak inflation, declines in property prices, and the contagion effect from a systemic bond default in China (by Chinese corporations with vested interest in Hong Kong listed equities) could derail an already depressed equity market.
Tell-tale signs are the rising yields and widening credit spreads in the Chinese. Weakened stimulus and bond issuance in China suggests that the 2016 GDP target of 6.5-7% may prove more difficult to achieve than previously expected.
In the midst of the two week sell-off, institutional investors have been buying into the weakness, as CCBI research below shows:
Forward looking, the Hang Seng Index could be set to rise like a rocket in the coming months (or drop to middle earth) as the Financials sector, which accounts for 55% of the weighted index, is looking to hold trend line support; however, there is material concern over the non-performing loan ratio and high indebtedness in China, both on the individual and corporate level:
The effect of a nationwide default of bonds would be devastating not just to China and Hong Kong equity values but overseas valuations as well. Rising defaults in Chinese corporate bonds pose the greatest short-term risk – 11 corporate bond defaults have occurred already this year – and tighter liquidity would not help the RMB760 billion in metal and mining company bonds due in 2016.
One solution would be another wave of bond issuance (rolling over) and greater fiscal spending to support industry growth at a time when metal prices could be going up. Paul Singer, and his hedge fund Elliott Capital, recently told investors that gold prices could see appreciation in 2016 as “Investors have increasingly started processing the fact that the world’s central bankers are completely focused on debasing their currencies.”
That said, the solution of debt issuance and fiscal spending would need to be followed by reform, specifically capital restructuring. Debt-for-equity swaps have eased the risk of NPLs for commercial banks but a larger wave of debt restructuring, not just rolling over and increasing debt-to-GDP, is imperative.
Concern over the global bond market is material given that they stand at the lowest yields, ever. Further worry that NIRP in Europe and Japan will damage banks’ ability to boost credit is not unfounded, but concerns that bond markets would likely crash is dumfounded – where would they go?
Positive March (51.3) and April (50.8) PMI composite data for China points towards production potential as April exports rose 15% from the previous month. China’s PPI rose to 57.6 in April (from 55.3 in March) – a rise attributed to strong commodity prices and inflationary pressure. However, numbers could appear weak later in the year as a strong base year would dilute moderated growth.
Collectively, industrial output weakened in April, registering a 6% growth from last year and down from 6.8% YoY figures in March:
There has been plenty of coverage over China’s capital outflows in the past year, which has dropped off the cliff since mid-2014, mostly due to currency intervention/movements measured against the USD. However, recent appreciation of the Yen (moving up 5.4% in April against the USD) has assisted Chinese yen-denominated assets appreciate in US Dollar terms – likely moderating the FX reserve drop.
Inflation numbers remain controlled at between 2-3% – characteristic of a developed country despite emerging market GDP growth. While CPI is not the main function of PBoC monetary policy, money supply (M2 velocity) is and any further sudden changes to the Renminbi will decrease confidence that the PBoC can maintain control of the onshore and offshore rates. Trilemma anyone?
The biggest dilemma the Chinese government faces moving forward is the choice between credit growth and banking stability. Concerns over NPL ratios of Chinese banks was not helped by several headline banks registering an NPL coverage ratio outside of the 150% regulatory requirement.
China’s TSF came in at RMB751 billion, missing expectations that a RMB1.3 trillion reading would continue expanding the economy. Total social financing is the broadest measure of credit growth in China. On aggregate, outstanding credit continues to grow, registering an 11.9% increase from last year but lower than the 12.3% registered in March.
Slowing loan growth in China is imperative to its sustainable growth and thus should be taken as a positive indicator the government has changed its policy stance. As monetary easing is expected to go on hold, PBoC rate cuts suspended for the year, further guidance to lending caps and control over shadow finance will help contain any further risks from developing.
Yet you should be concerned about slowing loan growth in China for two main reasons:
- China’s economic growth has become dependent on credit growth. In fact, every 1% drop in credit growth could reduce GDP by as much as 0.5%, according to Bloomberg Intelligence.
- Credit growth is likely being used to finance interest payments – given that servicing costs are estimated to account for 30% of GDP, a slowdown in credit would tighten the belts of borrowers already struggling to maintain previous output.Eugene Fama’s Efficient Market Hypothesis is a widely accepted notion for security pricing, however, this leaves me perplexed that the market as a whole lacks the interest to promulgate EMH into practice. Systemic development of the stock market, currently forwarded by FinTech, is necessary although bumps will be had along the way no doubt.
Eugene Fama’s Efficient Market Hypothesis is a widely accepted notion for security pricing, however, this leaves me perplexed that the market as a whole lacks the interest to promulgate EMH into practice. Systemic development of the stock market, currently forwarded by FinTech, is necessary although bumps will be had along the way no doubt.
Fama stated that, in theory, “on the average, competition will cause the full effects of new information on intrinsic values to be reflected “instantaneously” in actual prices.” I find this unreasonable in the true setting for three reasons:
- Intrinsic value: how do you measure a firms’ intrinsic value and does this methodology translate to the next firm? Investment criteria changes over time and thus the firm’s intrinsic value must follow. The formation of a corporation suggest that social and economic factors which aren’t directly profit-seeking are left to the way side in view of the all-holy profit-maximization.
- EMH assumes that the main engine behind price changes is a result he arrival of new information and that efficient markets allows prices to adjust swiftly and without bias, let’s posit this: Every citizen of a nation (with a stock market) decides to place ALL of their cash (their total financial spending) into the stock market at open of trading hours on Monday, who would match their buy order? EMH would not hold since movements of security prices would not reflect new available piece of information but a temporary spike in demand.
- Traders are measured against benchmarks, the most common of which is Volume Weighted Average Price. These benchmarks, such as Implementation Shortfall, require price movements to fill your position in order not to ‘move’ prices beyond the VWAP, thus defeating the point of EMH.