Via Bloomie comes the bull:
A financial crisis in China is no more likely in the coming decade than it was in the past 10 years, and pessimists predicting one have long done so without regard for fundamentals.
So says sinologist Andy Rothman, a San Francisco-based investment strategist at Matthews International Capital Management LLC, which oversees $26.1 billion. Before joining in 2014 he lived in China for two decades, working in the U.S. Foreign Service, including as head of the macroeconomics and domestic policy office of the U.S. embassy in Beijing. He later was a Shanghai-based strategist in CSLA Ltd., an investment banking arm of Credit Agricole SA.
China has no housing bubble and there’s no looming banking crisis, he says. His optimism rests on his view that the housing market is on a solid foundation. Leverage is the most important precondition for a bubble in any asset, and home buyer indebtedness in China is very low because down payment requirements are high, unlike in the U.S., he says.
“This isn’t like speculating in Las Vegas with zero money down,” he says. “China has a lot of problems, but they don’t tend to be the apocalyptic, catastrophic problems that we often read about. They’re more mundane, longer-term problems like how do you develop a rental market.”
While the country’s overall debt situation is serious, it’s still unlikely to lead to a financial crisis or economic hard landing, he says. That’s because potential bad debts are in state entities, which allows the government to manage how or whether they go bad, Rothman says.
He projects new home sales may fall 10 percent next year after rising about 30 percent in 2016 as the government continues to curb prices. While bears may see that as evidence of impending disaster, Rothman says it would still make 2017 China’s second-best year ever for new home sales because the base has grown so big.
I roughly agree on any debt crisis except to say that a hard landing is quite possible anyway. We basically had one last year. Moreover, if today’s outflow of capital were accelerate to crisis levels and China shut its capital account then although a financial crisis is averted a hard landing won’t be.
That’s where we come to Zero Hedge and Russell Clark, of Horseman Global:
Your fund lost 12.80% net this month. The short book, the bond book and the forex book lost money.
Since the election, the market narrative is that tax cuts and fiscal spending by the Trump administration will drive growth in the US, and this will drive inflation. The upshot of this has been for investors to sell bonds, buy USD, buy equities, and buy industrial commodities such as copper and oil.
The problem I have with this narrative is the way that Asian currencies have traded since the Trump election. They have been particularly weak. This is very unusual. Asia is the source of most global demand for commodities, while also a huge supplier of goods into the US. Asian currencies (as proxied by ADXY Index) have followed US bond yields higher and lower since the 1990s, as well as followed commodity prices higher and lower over that time. There has been one time when this relationship has broken down. In 2007 and 2008. At that time, as stresses in the US financial system became apparent, US bonds yields fell, and US investors became desperate to get out of the US, buying commodities and emerging markets. At that time, we saw Asian currencies rally, at the same time as US bond yields fell. And for a few months, this continued, but in the back half of 2008, the relationship reasserted itself and investors that had bought EM and commodities to avoid problems in US, lost more money than those who remained in US equities.
Today we are seeing the reverse, I believe. The Chinese financial system is showing signs of stress. Corporate bond yields are rising, the Chinese Yuan is weakening, and outflows are continuing. In my view, the Trump election has made a large Chinese devaluation more likely. Mainland Chinese investors are desperately trying to get out of the Yuan, and the People’s Bank of China is trying to defend the value of the Yuan. They are doing this by selling treasuries. The problem with this is that the more treasuries the PBOC sells, the more yields are likely to rise, putting more pressure on the Yuan. It seems to me that the PBOC is stuck in a doom loop. But as I noted in my market view, the PBOC is running out of options.
The rise in commodity prices, I think, is driven by increasing capital controls in China. Mainland investors are finding it harder to get money out of China, and so we are seeing Chinese investors putting more money in to real assets such as iron ore and copper, with a view to preserving some value. This view, which is wildly different to the prevailing view in the market, implies that bonds are weak, not because growth will be strong, but that the PBOC is desperately selling bonds to maintain an exchange rate. This implies that if China either institutes capital controls, or devalues enough to offset devaluation pressure bonds should rally. It also means that commodities are strong only on fund flow basis, not on a demand basis.
In my view, the macro model that I have been using to think about markets still looks valid, despite recent moves. The model indicates that it is impossible for countries that have engaged in QE to then normalise interest rates without causing financial crises with their trade partners. Since 2013, we have had the taper tantrum, devaluations in India, Russia, and Brazil, which all helped to drive long dated treasuries to new lows. Now the market is thinking the US will normalise rates, and the second biggest economy in the world is struggling. A rerun of 2007/8 is looking likely to me.
When the fund went net short in 2012, we spent many years all alone in our positions and worldview. This is how I prefer to be. In January and again after Brexit, the market has come much closer to our positioning, and returns have been poor as a result. In the month since the US election, I again feel all alone in our positions and ideas, while at the same time the macro indicators in China, as well as the increasing desperation of the authorities there to reduce capital outflow means we are getting close to the devaluation and crisis that I have long expected.
Your fund remains short equities and long bonds.
Readers will know that I sit somewhere between these two outcomes, bullish on the US and USD but equally of the belief that Chinese growth will only fade slowly until the Communist Party congress in October 2017, after which I still expect a revitalised Xi Jinping to have another crack at economic reform.
Thus I can see the Federal Reserve only raising rates slowly next year (two hikes) as inflation pressures come off with commodity prices which should, in turn, prevent the strong USD from turning the capital flight out of Asia disorderly.
