After rising the last week, China stocks listed in the US reversed their gains, and dropped about -2.1% through Friday. The move broadly followed the wider US market, which saw the S&P 500 also slide lower, driven by a combination of factors. News pushing the markets around included earnings (big banks), lower energy prices (oil), sparks in the FX market (Swiss Franc), and noises from the Fed suggesting that rate hikes may be further on the horizon than originally thought.
Data out of China included exports and imports at the beginning of the week, RMB loans and money supply toward the end of the week, and FDI released on Friday. The trade data was decent, with both exports and imports beating consensus (however there is some debate as to whether or not stockpiling was a factor), loan data was mixed (increased shadow banking offset slower bank loan growth), and FDI showed growth YoY.
With the latest round of eco data, it’s clear that China is slowing down, with some debate about what will happen next on the policy front. The consensus view that another rate cut or dropping the RRR will fix everything seems to take a limited view of the cause of many of the problems China’s economy faces, something we think policymakers have tacitly acknowledged by waiting so long to employ these measures. Indeed, if more money was the answer, wouldn’t the PBOC have opened the taps already?
Instead, we tend to side with the argument that there are some structural challenges that need to be addressed for China’s economy to turn the corner to a more healthy growth model that doesn’t rely on heavy investment spending. That’s not to say that China doesn’t need infrastructure, it certainly does (a short trip outside of a tier-1 city proves that point). But it seems like after building the rail, bridges, and sprawl, how to generate a return on those investments deserves consideration. This may be one of the cases when the government puts ‘social stability’ ahead of economic interests (seeing tangible signs of ‘progress’ may assuage tension), which is not uncommon in China. So despite the near-term drag on the economy from big-ticket infrastructure that doesn’t cover its hurdle rate, perhaps Beijing is playing a long game, essentially juggling the near term costs while staving off the inevitable costs.
The obvious question is when will the chickens come home to roost, i.e. will China stave off a hard landing? In a similar tone to previous notes, we think that policymakers will successfully walk the tightrope and will manage to wean the economy off of the debt-fueled growth model. The process will likely take some time, and there are plenty of hurdles along the way (tuning up the financial system to operate on economic terms, really introducing a market feedback mechanism to moderate investment and production, and getting consumers to consume). But as we’ve pointed out before, the stakes are high for the Party, and we think selling their ability to create solutions with “Chinese characteristics” is worth keeping in mind.
There seem to be signs of progress in reforming China’s financial system, illustrated by recent announcements of allowing the operation of private banks (competition is good) as well as implementing depositor protection (raising the stakes of the aforementioned competition). The recent meteoric rise of China’s domestic share market points to the need for the overhaul; investment options are limited, and for urban residents, cost pressures are palpable (namely in the form of rents and food prices).
China’s overcapacity problem is nothing new, but will take some time to moderate, perhaps due to the fear of pitchforks and torches in the streets (the destabilizing effects of headcount reduction). The government has made some moves here, in the form of cutting back production capacity in some hard-hit industries like coal and steel, but must do so while avoiding a deflationary avalanche. To be more succinct, this problem wasn’t built in a year, so looking for a quick fix may be little more than wishful thinking.
Igniting consumption has been tricky. Official data indicated that retail sales were up +12% YoY from January through November, however the monthly trend appeared to be weakening in the second half. This could spell trouble ahead because waning corporate profits could lead to limited wage growth in the year ahead, thereby pressuring consumption going forward. (Many employees are on annual contracts, giving employers the option to ‘adjust’ headcount and staffing levels on an annual basis without too much impact on the P&L.) When combining a sputtering property market (and therefore the wealth effect on consumption) with moderating wage growth, the outlook for a strong consumer seems a bit more cloudy. Inflation data seems to broadly support the idea that consumers are cutting back on non-essential purchases; for example food price inflation averaged +3.1% YoY during 2014 while non-food was about 1.4% (source). This could be one reason for policymakers ‘encouraging’ equity market investors Q4 last year, offsetting the negative wealth effect from the property market to keep consumption hopes alive. Whether or not consumers will respond as hoped is of course an ongoing development. We remain optimistic that one of the ways this might happen is through innovative Chinese companies leveraging technology to disrupt industries that would be painfully slow to adapt without a strong impetus to do so. Alibaba’s Yu E Bao and its recent deeper push into healthcare are strong examples of this. Say what you’d like about Jack Ma’s corporate governance chops, but Alibaba has been on the forefront of attacking some sacred cows in the form of the banking and healthcare industries.
In the week ahead, there will be plenty of reason for market action. Official home price data was out over the weekend, which showed some signs of improvement for both new and existing homes, and we’ll get a look at Q4 GDP data as well as retail sales, fixed asset investment, investments in real estate development, and industrial production. The cherry on top is the HSBC/Markit Flash China PMI reading set for Friday.
Our take is that markets will likely react positively to the housing data from over the weekend, and look for further confirmation in the week’s data (GDP will of course be a big one).
Here is the weekly review of big moves in US-listed stocks, please get in touch on Twitter, Facebook, Google+, or email to add to the discussion.
ETF and Index Round-up
FXI: -0.1% (both US-listed and Hong Kong stocks, weighted toward financials)
PGJ: -2.1% (holds US-listed China stocks, weighted toward information technology)
S&P 500: -1.2% (index of US-listed stocks)
Nasdaq: -1.5% (index of US-listed stocks, weighted toward technology)
VIX: 20.95, +19.4% (volatility index, a gauge of implied volatility, the so-called “fear index”)
500.com (NYSE: WBAI): 21%; this stock had a few days of strong rallying after becoming very oversold heading into the week. There was no news from the company, so it’s not immediately clear why the stock popped as much as +33% in two days. After such a move, the stock then shed a little bit closing out the end of the week.
Pingtan Marine Enterprise (NASDAQ: PME): +15; management announced a dividend on Tuesday, which helped give the stock a boost, particularly because the announcement included a tidbit that management expected to continue the program. Based on the assumption that the annual dividend is about $0.04 per share (the last two dividends were for a penny each), the yield is about 1% a year; not great, but surely enough to pop up on a few stock screens. The company is still dealing with some fallout from restating FY2012 & 2013 financials (and some in FY2014), so volatility can be expected while it works out.
China Jo-Jo Drugstores (NASDAQ:CJJD): +6%; this drugstore stock has been on fire recently, rising about +30% in less than a month. Why? Online drug sales in China. The chart on this stock looks a bit dangerous though, with the stock making higher lows without being able to push higher highs (hitting a ceiling?). So far there haven’t been any details on how online drug sales will work (which drugs, B2B, or B2C, etc.), which could lead to some pressure in the stock going forward.
Weibo (NASDAQ:WB): -10%; “what is going on here?” is a great question. The stock has been on a grind lower since Q3, and picked up momentum last week (it was a down week though). We put out a technical note on this last week (here’s a link http://chinastockresearch.com/tech-analysis-notes/item/759-weibo-wb-improves-a-bit,-but-still-in-the-danger-zone.html) and so far that’s been spot on (unfortunately for longs). Based on the assumption that Q3 was the catalyst for the drop, it seems like this stock is a great candidate to revisit later…like much later, after some solid earnings reports.
Cheetah Mobile (NYSE:CMCM): -10%; this week’s move looks like a reversal of the prior week’s monster +24% move. Pull up the chart with a default RSI overlay and you’ll see that the selling this week kicked off right as the stock hit overbought. After it cools down a bit, it wouldn’t be surprising to see momentum traders come back to this name (i.e. this could be a solid play if the market starts heading higher).
Leju (NYSE:LEJU): -12%; the headlines this week about the on-again/off-again default by a developer in China weighed on all of the major real estate names (i.e. SFUN and EJ) this week. There was some positive news out over the weekend from the NBS on home prices, which could bring out the bargain hunters next week (provided that data isn’t overshadowed by GDP, etc.).
iDreamSky (NASDAQ:DSKY): -15%; this stock looks scary – five down days, and the pace of declines only grew through Friday. There wasn’t any news out from the company, and this week’s poor performance looks like a follow-on from the previous week. The stock has been banging its head against the 20-day EMA, and looks like it finally gave up on Monday. Optimists may note that the stock is approaching oversold, so there might be a bounce on the horizon.
BitAuto (NYSE:BITA): -29%; news on slowing growth in the Chinese auto market clipped the wings of this one on Monday, sending the stock down -17% on the highest volume in over a year. And then down -10% on Tuesday. Wednesday and Thursday weren’t much better. Relief didn’t come until Friday, after the market digested news that tech leaders Tencent and JD.com were going to invest 1.6 billion USD in BitAuto. The pace of the fall may also have been due to the recent run-up, BITA added over 19% last week, so perhaps some perspective casts this week’s drop in a slightly less awful light. The stock seemed to cut through some support at $64, so unless it retakes that level (quickly), there might be some more pressure ahead.
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