China would like foreign businesses to keep their profits in the country and reinvest them, Premier Li Keqiang said in his keynote speech at the World Economic Forum in Dalian on Tuesday, although he added there would be no restrictions on the movement of their money.
China’s economic growth is gaining fresh momentum and there will be no hard landing in the world’s second-biggest economy. The unemployment rate in May dropped to 4.91 per cent, he noted, the lowest level in many years.
China will continue to open its markets in the services and manufacturing sectors. It will loosen restrictions on shareholdings by foreign companies in joint ventures and will ensure China will continue to be the most attractive investment destination.
The Chinese government will not rely on stimulus to bolster economic growth. Instead, it will use structural adjustment and innovation to maintain economic vitality. The government will keep stable macro policies – a prudent monetary policy and a proactive fiscal policy – to ensure clarity and stability in financial markets.
China is fully capable of containing financial market risks and avoiding systemic ones. There are rising geopolitical risks and increasing voices opposing globalisation. China will keep its promises in combating climate change and will work to promote globalisation.
Absolutely nothing new there. In fact it is a little reassuring to those of us that think reform is on the verge of returning.
But the market has been heavily sold and so it got excited. There is a little room for it to run given lowish mill iron ore inventories:
But, in all honesty, I’m stretching to be positive. The price jump will very quickly arrive at Chinese ports as bowel-shakingly higher inventories in short order:
And the economy is still going to slow at the margin as housing comes off leading to a destock in the foreseeable future:
The great thing about markets is they always off[er] second chances. On this occasion it is to get even more short.
Iron ore rallied slightly during the week. But this is a bear market. Expect resistance at $60 to hold and breach of support at $50 is likely, signaling another decline.
The ASX 300 Metals & Mining index is testing support at 2750. Breach is likely and would signal a primary down-trend.
Banks are also under pressure, with the ASX 300 Banks index consolidating between 8000 and 8500. Breach of 8000 is likely and would confirm the primary down-trend.
The ASX 200 displays a broadening wedge consolidation. A failed down-swing, recovering above 5800 without reaching the lower border, would be a bullish sign. But this seems unlikely with a bearish outlook for the two largest sectors.
But Iron ore continues to fall, headed for a test of 50.
The ASX 300 Metals & Mining index respected resistance at 3000 and is headed for a test of primary support at 2750. Breach would confirm the primary down-trend.
The ASX 300 Banks index respected resistance at 8500 and is likely to test primary support at 8000. Again, breach would confirm the primary down-trend.
The ASX 200 has formed a broadening wedge consolidation, in a down-trend. Declining Twiggs Money Flow indicates some selling pressure. Expect a test of primary support at 5600. Again, breach would warn of a primary down-trend. But a failed swing (that respects 5700) would warn that all bets are off and the index may be preparing for a rally.
Last week I wrote: “I believe that the latest rally is a secondary reaction and that the ASX is headed for a down-turn, with miners and banks leading the way. But it’s no use arguing with the (ticker) tape.” This week the ticker tape backs up my bearish sentiment, so I am a lot more comfortable.
Iron ore continues to fall, headed for a test of 50.
Banks’ bear market rally also petered out, with the ASX 300 Banks index headed for a test of support at 8000. Breach would confirm the primary down-trend.
The ASX 200 broke support at 5700. Declining Twiggs Money Flow signals selling pressure. Breach of primary support at 5600 would warn of a primary down-trend.
And the broader DJ-UBS Commodity Index is testing support at 82. Breach would signal a decline to test the 2015 low at 74.
But the Aussie Dollar rallied Friday, the large engulfing candle suggesting another test of resistance at 75 US cents.
Miners finished strongly, with the ASX 300 Metals & Mining index reflecting short-term buying pressure. 13-Week Twiggs Money Flow recovered above zero.
The ASX 200 is testing resistance at 5800. A 21-day Twiggs Money Flow trough above zero indicates medium-term buying pressure. Breakout above 5800 is likely and would suggest another test of 5950/6000.
Banks also rallied, with the ASX 300 Banks index headed for a test of 8500. Expect strong resistance.
Perhaps this UBS report had something to do with it.
I believe that the latest rally is a secondary reaction and that the ASX is headed for a down-turn, with miners and banks leading the way. But it’s no use arguing with the (ticker) tape.
A prudent speculator never argues with the tape. Markets are never wrong, opinions often are.
If you want to know why RIO is higher today than when iron ore was at $92 then check this out from UBS:
Hitting the Wall or Just a Wobble?
Australian equities performed poorly in May (falling 3%) despite global markets posting solid gains (rising 2%). The market weakness in May was overwhelmingly driven by the heavyweight banks sector. On balance we believe “hard landing” fears are overdone though we concede that the consumer outlook is lacklustre.
Staying Overweight Resources and Neutral Banks
We continue to overweight the resource sector on the basis of relative valuation, and benign (iron ore) to moderately constructive commodity expectations (copper, oil, mineral sands). With the bank sector off 10% (total return), we think the sector is once again looking “fair” in an absolute sense (12.8x and 5.9% yield) and notionally cheap in a relative sense. A constrained growth outlook and near-term capital uncertainty keep us neutral.
Other Favoured Themes
From a thematic standpoint two of our key themes remain 1) public infrastructure exposure (we continue to hold Boral and Lend Lease Group) and 2) domestic energy suppliers continue to be well supported by investors (we continue to hold AGL Energy, Origin Energy). We continue to overweight US$/US economy plays.
Iron ore broke support at $60, signaling another decline. The medium-term target is $50*.
* Target: 60 – ( 70 – 60 ) = 50
Resources stocks lost momentum, with the ASX 300 Metals & Mining index respecting resistance at 3000. Twiggs Money Flow seemed to be recovering after a strong bearish divergence but has again slipped below zero, warning of selling pressure. Expect another test of primary support at 2700.
The big banks face selling pressure, with Twiggs Money Flow falling sharply. The primary down-trend on the ASX 300 Banks Index, having broken support at 8500, offers a medium-term target of 8000*.
* Target: 8500 – ( 9000 – 8500 ) = 8000
The ASX 200 respected resistance at 5800. Breach of 5700 is likely and would confirm another test of primary support at 5600*. Breach of 5600 would signal a primary down-trend, offering a target of 5200*.
The Aussie Dollar met resistance at the former support level of 75 US cents, with a tall shadow on Tuesday’s shooting star candlestick pattern. Respect of resistance is likely and would warn of another test of support at 73.50. Breach of support would offer a target of 72, putting pressure on ASX stocks as international investors retreat.
The Aussie tends to take its direction from commodities. At present iron ore displays a weak rally that coincides with the rally on AUDUSD. Reversal through support at 60 is likely, and would warn of a decline to 50.
Broad commodity indexes like the DJ-UBS Commodity Index are consolidating in a rectangle, between 82 and 90 on the chart below. Commodities have been trending lower since 2011, as shown yesterday. Breakout above 90 is unlikely but would signal a primary up-trend. Breach of support is more likely and would indicate a decline to test support at the January 2016 low, between 72 and 74.
Growth in total monthly hours worked has slowed to 1.3% for the 12 months to April 2017. In fact, growth has been pretty lean over the last 5 years, except for the period January 2015 to February 2016.
High commodity prices in 2004 to 2008 and 2010 to 2011 coincide with periods of strong employment and GDP growth, as indicated on the chart above.
The current down-trend in commodity prices, depicted on the DJ-UBS Commodity Index above, and low growth in hours worked both point to anemic employment (and GDP) growth ahead.
Copper rallied off long-term support at 5400. The reaction is secondary and breach of 5400 remains likely, signaling a primary down-trend.
Iron ore is consolidating in a narrow bearish pattern above support at 60. Breach seems likely and would signal another decline, with a target of 50*.
* Target: 60 – ( 70 – 60 ) = 50
Shanghai’s Composite Index rallied to test its new resistance level at 3100, after breach signaled a primary down-trend. Respect would confirm the decline, with a medium-term target of 2800*, but government intervention may bolster support. Recovery above 3100 would mean all bets are off for the present.
The big banks fell sharply on the week’s turmoil, with the ASX 300 Banks Index breaking support at 8500. Breach signals a primary trend reversal, offering a medium-term target of 8000*.
* Target: 8500 – ( 9000 – 8500 ) = 8000
Resources stocks rallied over the week. Expect strong resistance on the ASX 300 Metals & Mining index at 3000.
Iron ore continues in a bearish narrow consolidation above support at $60. Breach would offer a short-term target of $50*.
* Target: 60 – ( 70 – 60 ) = 50
These are ominous signs for the ASX 200 which is testing medium-term support at 5700. A sharp fall on Twiggs Money Flow flags strong selling pressure. Breach of primary support at 5600* would signal a reversal, offering a target of 5200*.
Copper is testing long-term support at 5400, suggesting weak demand from China. Breach would signal a primary down-trend.
The Yuan has enjoyed a respite, consolidating in a narrow line for several weeks. But this is likely to prove temporary, with further advances of the Dollar against the Yuan eroding PBOC foreign exchange reserves.
Shanghai’s Composite Index broke support at 3100, signaling a primary down-trend, but the long tail indicates buying support. Recovery above 3100 would suggest a false signal (or government intervention) while respect of resistance would confirm the down-trend.
The big banks fell sharply on news of a new levy on bank liabilities in the latest budget. At this stage the ASX 300 Banks Index merely shows a secondary reaction. Breach of 8500, however, would signal a primary trend reversal, offering a medium-term target of 8000*.
* Target: 8500 – ( 9000 – 8500 ) = 8000
Resources stocks compensated, with the ASX 300 Metals & Mining Index rallying to test resistance at 2850/2900. Breakout is unlikely given the weak lead from iron ore. Reversal below 2700 remains likely and would strengthen the bear signal for resources.
Iron ore formed a bearish consolidation above support at $60. Breach would offer a short-term target of $50*.
* Target: 60 – ( 70 – 60 ) = 50
Selling of the Aussie Dollar continues, with a medium-term test of primary support at 71.50/72.00 now likely.
Consolidation of the ASX 200 above support at 5800 is a bearish pattern. Breach would signal a correction to test primary support at 5600*. Twiggs Money Flow still indicates long-term buying pressure and only a fall below zero would warn of a reversal.
Copper is widely considered to be a barometer of the global economy, with prices rising when the outlook improves. Currently A-grade Copper is testing support at 5400. Breach would confirm Chinese selling pressure, offering a target of long-term support at 4500.
Commodities are falling, with the DJ-UBS Commodity Index testing support at 82.
Despite the Dollar Index breaking support at 100.
Spot Gold followed, breaking medium-term support at $1240/$1250. A test of primary support at $1200/ounce is now likely.
Breach of $1200 would signal a primary down-trend. Respect would confirm the primary up-trend. I still view gold stocks as a form of “Trump insurance” and am reluctant to part with exposure to this sector.
The recent Iron ore rally has faded and the commodity is again testing support at $60. Twiggs Momentum (13-week) below zero indicates a primary down-trend.
The ASX 300 Metals & Mining Index broke support at 2850, warning of a down-trend. A Twiggs Money Flow peak below zero flags strong selling pressure.
Falling ore prices will place strong downward pressure on the ASX and the Aussie Dollar.
ASX 300 Banks Index retreated below 9000. Declining Twiggs Money Flow indicates medium-term selling pressure. Follow-through below 8900, or Twiggs Money Flow below zero, would warn of a correction.
The large red engulfing candle on the weekly ASX 200 chart also warns of a (secondary) reversal. Breach of support at 5800 would signal a correction. Twiggs Money Flow still shows long-term buying pressure and only a fall below zero would warn of a market top (primary trend reversal).
While we, as well as the few bearish peers we have, have warned of a pending “credit event” in China for some time now – admittedly incorrectly (China has proved much more resilient than expected) – the more recent red flags are among the most profound we’ve seen in years – in short, we agree with fresh observations made by some of the world’s most famous iron ore bears. Thus, while it is nearly impossible to pinpoint exactly when the credit bubble will definitively pop in China, a number of recent events, in our view, suggest the threat level is currently at red/severe.
WHERE IS CHINA AT TODAY VS. WHERE THE US WAS AT AHEAD OF THE SUBPRIME CRISIS? At the peak of the US subprime bubble (before the failure of Bear Stearns in Mar. ‘08, and subsequently Lehman Brothers in Sep. ’08, troubles in the US credit system emerged as early as Feb. ’07), the asset/liability mismatch was 2% when compared to the total banking system. However, in China, currently, there is a massive duration mismatch in wealth management products (“WMPs”). And, at $4tn in total WMPs outstanding, the asset/liability mismatch in China is now above 10% – China’s entire banking system is ~$34tn, which is a scary scenario. In our view, this is a very important dynamic to track given it foretells where a country is at in the credit cycle.
WHAT ARE THE SIGNS WE ARE SEEING? In short, we see a number of signs that point to what could be the beginning of the “popping” of the credit bubble in China. More specifically: (1) interbank rates in China are spiking, meaning banks, increasingly, don’t trust each other – this is how any banking crisis begins (Exhibit 1), (2) China’s Minsheng Bank recently issued a ghost/fraudulent WMP (they raised $436mn in funds for a CDO-like asset that had no assets backing it [yes, you heard that right] – link), (2) Anbang, the Chinese conglomerate who has used WMP issuance as a means to buy a number of assets globally (including the Waldorf Astoria here in the US), is now having issues gaining approval for incremental asset purchases (link), suggesting global investors may be getting weary of the way in which Anbang has “beefed up” its balance sheet, (3) China’s top insurance regulator, Xiang Junbo, chairman of the China Insurance Regulatory Commission, is currently under investigation for “severe” disciplinary violations (link), implying some/many of the “shadow” forms of transacting in China could become a bit harder to maneuver (which would manifest itself in higher rates, which his exactly what we are seeing today), and (4) as would be expected from all of this, as was revealed overnight in China, bank WMP issuance crashed 15% m/m in April to 10,038 from 11,823 in March, a strong indicator that faith in these products is indeed waning.
Exhibit 1: Interbank Rates in China
DOES CHINESE PRESIDENT XI JINPING HAVE ALL OF THIS UNDER CONTROL? In a word, increasingly, it seems the answer is no. What’s the evidence? Well, in March, interbank rates spiked WAY past the upper corridor of 3.45% to ~11% (Exhibit 2), a strong indicator that the PBoC is losing its ability to “maintain order”. And, admittedly, while there are levers the PBoC can pull, FX reserves are at scary low levels (discussed below), suggesting the PBoC is quickly running out of bullets. Furthermore, corporate bond issuance in China was negative in C1Q, which means M2 is going to be VERY hard to grow (when MO is negative); at risk of stating the obvious, without M2 growth in China, economic growth (i.e., GDP) will undoubtedly slow – this is not the current Consensus among market prognosticators who think things are quite rosy right now in China; yet, while global stock markets are soaring, the ChiNext Composite index is down -7.5% YTD vs. the Nasdaq Composite Index being up +12.8% YTD. In our view, given China’s importance to the global commodity backdrop, we see this as a key leading indicator (the folks on the ground in China are betting with their wallets, while global investors continue to place their hopes on: [a.] a reflationary tailwind that we do not believe is ever coming [China is now destocking], and [b.] hope that President Trump will deliver everything he’s promised [which, in this political environment, we see is virtually impossible]).
Exhibit 2: Overnight Reverse Repo Rate
CHINA’S FOREIGN EXCHANGE (“FX”) RESERVES ARE DANGEROUSLY CLOSE TO LOW LEVELS THAT WILL LIKELY CAUSE AN INFLECTION LOWER IN THE CURRENCY. Based on a fine-tuning of its formula to calculate “reserve-adequacy” over the years, the International Monetary Funds’ (“IMF”) approach can be best summed up as follows: Minimum FX Reserves = 10% of Exports + 30% of Short-term FX Debt + 10% of M2 + 15% of Other Liabilities. Thus, for China, the equation is as follows: 10% * $2.2tn + 30% * $680bn + 10% * (RMB 139.3tn ÷ 6.6) + 15% * $1.0tn = $2.7tn of required minimum reserves. Furthermore, when considering China’s FX reserve balance was roughly $4tn just 2 years ago, we find it concerning that experts now peg China’s unofficial FX reserve balance somewhere in the $1.6-$1.7tn range. Why does this differ from China’s $3.0tn in reported FX reserves as of Feb. 2017? Well, according to our contacts, when adjusting for China’s investment in its own sovereign wealth fund (i.e., the CIC) of roughly $600bn, as well as bank injections from: (a) China Development Bank (“CDB”) of roughly $975bn, (b) The Export-Import Bank of China (“EXIM”) of roughly $30bn, (c) the Agricultural Development Bank of China (“ADBC”) of roughly $10bn, as well as capital commitments from, (d) the BRICs Bank of roughly $50bn, (e) the Asian Infrastructure Investment Bank (“AIIB”) of $50bn, (f) open short RMB forwards by agent banks of $300bn, (g) the China Africa Fund of roughly $50bn, and (h) Oil-Currency Swaps with Russia of roughly $50bn, the actual FX reserve balance in China is closer to $1.69tn (Exhibit 3).
Stated differently, based on the IMFs formula, sharply contrasting the Consensus view that China has years of reserves to burn through, China is already below the critical level of minimum reserve adequacy. However, using expert estimates that $1.0tn-$1.5tn in reserves is the “critical level”, and also considering that China is burning $25bn-$75bn in reserves each month, the point at which the country will no longer be able to support the renminbi via FX reserves appears to be a 2017 event. At that point, there would be considerable devaluation in China’s currency, sending a deflationary shock through the world’s commodity markets; in short, we feel this would be bad for the steel/iron ore stocks we cover, yet is being completely un-discounted in stocks today (no one ever expects this event to occur).
The early 2007 analogy is a good one. This is coming at some point in the next few years. I remain on guard but skeptical at this point given China does have other levers it can pull to keep the credit running and is indeed pulling them in fiscal policy. As well, the problem can always be made worse before it’s made better. Authorities are, after all, bringing this on.
It’s a fascinating question. Could China endure a “sudden stop” in credit if counter-party risk exploded, much like happened to Wall St in 2008? The usual analysis reckons that China’s publicly owned banks can always be ordered to lend more but what if they lose faith in each other? It’s probably true that Chinese authorities could still force feed credit into the economy but, equally, it’s difficult to see how an interbank crash in confidence would not slow the injection, at minimum via choked off-balance sheet vehicles like WMPs.
There is no doubt, at least, about what happens when it does arrive:
the final washout of commodity prices;
Australian house price crash;
multiple sovereign downgrades, and
an Aussie dollar at 40 cents or below.
It’s the great reset event for Australia’s bloated living standards. That is why we say to you get your money offshore today. We can help you do that when the MB Fund launches in the next month with 70% international allocation.
Comment from Colin:
I share Macrobusiness’ skepticism over the timing of a possible Chinese crash, especially because they have in the past shown a preparedness to kick the can down the road rather than address thorny issues – making their problems worse in the long run. But I do see China’s stability as a long-term threat to the global financial system which could precipitate a major down-turn on global stock markets.