Keep your eyes on the government, they say. If the Chinese government decides to provide even the tiniest support through fiscal means or monetary means, the market would rally.
True in the past, but not this time!
Why? Because Hu (the ex–president) and Wen (the ex–premier) are gone!
Here’s a little history…
Just look at 2009 and 2012. 2009 saw the biggest stimulus package in Chinese economic history. It drove both the property market and secondary industries to even higher levels of hysteria.
This effectively ended the ‘market restructuring’ effort in 2008 (which was aimed at reducing overcapacity and depressing property prices). So this isn’t the first time the government has tried to balance the market (in fact, they have been trying to do it for over 15 years; starting from the time of Deng Xiaoping).
So for the next three years after 2009, the Chinese market became more unbalanced, until a double dip hit the scene.
What did the Chinese government do in response? They lowered interest rates and they provided subsidies to almost all oversupplied industries. Needless to say, this led to another round of production growth, which delayed market rebalancing.
By the time Xi Jinping took over, people were totally sick of the then Chinese premier Wen Jiaobao (Hu Jintao hardly appeared in press conferences, so people knew he was a weakling).
The western press proved to have great timing, with a number of special investigative reports on Wen and Xi’s massive family assets (including overseas assets). The Wall Street Journal and Bloomberg were both banned in China as a result.
Oh how they (the Chinese people) hated the Chinese leadership! So, in a big going–away gesture, Hu ‘unleashed’ China’s first aircraft carrier, which had been only a rumour for many years.
However, some of us in China knew the government was building it. I could see it in Dalian’s port from my hotel when I was there!
The new president, Xi, is supposed to fix all these problems.
This is why you shouldn’t count on any huge stimulus. Everybody has been frustrated for so long over the inaction of the last government that they aren’t going to make the same mistake. People are simply fed up!
All you need to look at is money supply. Money supply has been decelerating sharply since mid–2013. You see a policy–induced slowdown in the demand for credit in properties and secondary industries.
While secondary industries have not felt much direct policy influence from Beijing, they have certainly been left alone to sort out their own mess (apart from some provincial level deals to relieve their financial strains).
That brings us to the issue of China’s banks…
Are Chinese banks a good buy?
If the money supply growth is slowing, does that mean trouble for China’s banks? And if so, does it make sense to short–sell China’s banks? After all, banking is the business of supplying money.
China’s banks have stayed cheap for some time. Institutional investors have always been fond of them. Flit through a few fund reports and you will find that their top holdings are Chinese banks; and a significant proportion of their portfolios are in Chinese financials.
So on a value basis, what do these banks offer?
Good historical revenue growth; good historical EPS (earnings per share) growth; high profit margin; great return on equity; good dividend yield; low leverage.
So this sounds like a screaming buy! That’s arguably the position of funds, usually investing in value stocks.
However, Chinese banks have underperformed the All Ordinaries in the last few years. So why would you invest in them?
You probably need to take a step back when looking at these banking stocks, and remember that advanced country (equity) indices have been supported by easy money. The additional capital that has gone into indebted advanced economies took the forms of both debt and equity. A significant amount of that flew out of those countries and found home in high rating, high interest rate and stable economies such as Australia. The sentiment effect cannot be neglected as well.
How about China’s credit system? Since Fitch’s rating change and a whole wave of credit system risk warnings from banks and funds, China’s credit woes have been in the spotlight. Recent news with a corporate bond default and money market rate fluctuations seem to confirm some of the fears. This has undermined support for banking stock prices.
It’s true that China’s provincial level debt has hit a brick wall, simply because their financing mechanism is unsustainable. However, China’s ‘visible’ debt to GDP number has been improving, now forecasted to be 22.3%. Its credit rating at AA– (S&P), Aa3 (Moody’s) is sound.
This rating is defined by S&P as follows: ‘An obligor rated ‘AA’ has very strong capacity to meet its financial commitments. It differs from the highest–rated obligors by only a small degree.’
From the People’s Bank of China’s (PBOC — China’s central bank) own presentations in a conference, I could clearly see that they are well aware of the shadow banking risk — and we are seeing good progress against that.
There has been tightening of banking credit qualities; tightening of banking credit volume; and curbs on real estate financing. From my friends who run shadow banking operations in China, they are definitely affected by the policy push, and are switching to products aimed at small to medium enterprises. This is exactly where the PBOC wants them to be.
China’s debt is going to grow. There is no doubt about that. Financing China’s next phase of urbanisation requires provincial level financing to be worked out, through municipal bonds, corporate bonds and other bond products.
China’s banks aren’t going to collapse due to a potential collapse in the system. Their bad debt coverage is fine; their product types are simple with limited securitisation; and ‘the big brother’ is very watchful of risks in the banking sector.
Simply put, despite the mostly negative view on Chinese banks in the market, at these price levels you should have a great run with Chinese banks.
Ken Wangdong
Emerging Markets Analyst, Money Morning
From the Port Phillip Publishing Library
Special Report: Mining Boom Act II
