Global Markets: The Short View
CFA Society of Nashville
January 22, 2015
James Chanos
Kynikos Associates
Risks Are Rising…
• Market No Longer Cheap
• Leverage At Record Levels Throughout System
• Bull Market Driven By Questionable Earnings and Buybacks
• Market Speculation Has Returned In Force
• Geopolitical Tensions Rising
• Market Complacency Reigns
• Central Bankers No Longer Predictable
• China Risk Increasing
2
US Market Reaching New Valuation Highs
S&P 500 Median EV/Sales Multiple
Source: Goldman Sachs, Compustat
3
Equities At Highest Percentage Of GDP Since Early 2000
Corporate Equities in % of Nominal GDP
Source: Federal Reserve Bank of St. Louis
4
A Market Fueled By Cheap Credit
Sources: NYSE, Bloomberg
5
The World Has Not Really Delevered
•
•
US domestic nonfinancial debt as a
percent of GDP was 233% at 3Q14
compared to 217% at Year End 2007
Other debt is growing rapidly
– Global debt markets have grown to
Estimated Size Of Global Debt Securities Market
$100T in mid-2013 from $70T in
mid-2007
– Governments have been the largest
debt issuers reaching $43T in June
2013, up close to 80% since mid-2007
– Debt of non-financial corporations has
grown at a similar rate
•
Debt investors are more local
– The share of debt held by cross-border
investors has fallen to 26% in late 2012
from 29% in early 2007
– Non-financial issuance has been
primarily domestic
•
Emerging market and high yield credit
are benefiting from search for yield
FI = financial corporations; GG = general government; II = international institutions;
NFI = non-financial corporations; NPISH = non-profit institutions serving households
Sources: Credit Suisse, Federal Reserve, Bank for International Settlements – March 2014 Quarterly Review, IMF, Dealogic, Euroclear, Thomson
Reuters, Xtrakter
6
Sustainable Earnings?
Profit Margins At Record Levels
Sources: Federal Reserve Bank of St. Louis, Deutsche Bank
7
Can Record Corporate Buybacks Continue?
S&P 500 Buybacks Vs. US IPOs And Secondary Offerings
Sources: BoA Merrill Lynch, FactSet, Bloomberg
8
Hype Rules The Day Once Again
• Experts everywhere
–
–
–
–
Big name investors tweet new ideas
Chasing market ‘celebrities’
Business Insider presents the “20 Under 20” list of young investors
Market price targets are continuously being raised
• Hype vs. fundamentals
– Concept stocks with top-line growth go parabolic
– Wider adoption of non-GAAP metrics
– JOBS Act IPOs
• Silicon Valley/Tech back in vogue
– Tesla’s peak valuation at 67% of GM, despite vehicle sales of only 0.3% of GM
for the 12 months through September 2014
– Alibaba, GoPro IPOs and other tech frenzies
– Uber valued at $41B in latest funding round with competing services launched
Sources: CNBC, Business Insider
9
Bubble Déjà Vu
January 1999 – March 2000
January 2013 – January 2015
•
•
IPO Volume
– 665 IPO deals priced in North
IPO Volume
– 648 IPO deals priced in North
America
America
– Total value of $85B
•
Valuation Metrics
– Total value of $128B
•
– Number of page views
– Click-through rate
– Revenue growth, not profits
•
Market Darlings
– Subscriber/user growth
– Mobile monetization
– Revenue growth, not profits
•
– Yahoo’s peak 2000 $145B valuation
– Cisco’s peak 2000 $557B valuation
– Time Warner buys AOL for $164B
•
Yahoo message board ‘experts’
Source: Bloomberg
Valuation Metrics
Market Darlings
– Apple’s peak $700B valuation
– Facebook’s current $215B valuation
– Twitter’s first day $25B valuation
•
Social velocity alerts drive stock
momentum
Source: Bloomberg
10
Geopolitical Tensions Rising
• European elections no longer
routine
Nations And Regions Of
European Free Alliance Parties
– Syriza leads Greek polls
– UK elections could be influenced
–
–
by the Green Party and UKIP1
Front National leader Marine Le
Pen prominent in French President
polls2
Podemos Party surging in Spain3
• Reaction to Islamist terrorism and
•
•
•
immigration
Military confrontation in Ukraine
and escalation across Europe
Syria and Iraq as recurring
geopolitical hotspots
China increasingly assertive in
pursuing territorial claims
Sources: 1) “The Greens, like Ukip, are good for politics”, The Telegraph, January 19, 2015; 2) “Unprecedented in France: Front National's Le
Pen tops presidential poll for first time”, The Guardian, September 8, 2014; 3) “Spain’s surging Podemos party rushes to get to the top”,
Financial Times, November 21, 2014; European Free Alliance
11
Energy Complex Upended
• High oil prices and cheap credit fuelled ramp in energy exploration
and production
– Shale in the US
– Large Liquefied Natural Gas (LNG) projects in Asia and Africa
• OPEC cracks
– Saudi Arabia launches price war
– Politics pressuring economics
• Tensions rise as budgets are under pressure
– Higher breakeven costs for government promises
– Social stability at risk
• A challenge to global growth
– Petrodollar economies
– Reduced capital for investment
12
Who, Me Worry?
• Bears close to ‘extinction’
– Percentage of bears in
Investors Intelligence Sentiment Index
investors intelligence sentiment
index at 14.9% on December
30, 2014
– 2014 showed lowest levels
since 1987
• Blinded strategists’ optimism
– “Why this stock market will
never go down”1 reflects
euphoria
– MS believes that an S&P peak
near 3,000 is possible as “this
expansion is different”1
Sources: 1) “2020 Vision: Long Live the Expansion”, Morgan Stanley, September 2, 2014; Bloomberg; Yardeni Research
13
Global Short Opportunities
• Remote Computing Revolution
• All Things Digital
• Shale Explosion
• State Of Big Oil
• Commodity Super Cycle Peak
• China Risk Increasing
14
Remote Computing Revolution
15
Death Of The PC
• The proliferation of mobile devices pressures PC demand
– Mobile devices have same key capabilities as PCs
– Market share not dominated by just Apple and Samsung after the rise of Xiaomi
– Apple shipped 16% more iPads in the 12 months through September 2014 than
the largest vendor shipped PCs
– Shipments of tablets increased by 14% in the 12 months through September 2014
– Shipments of PCs decreased by 3% in the 12 months through September 2014
– IDC expects PCs to decline through 2018
• Adoption of mobile devices pressures PC margins
– iPad bill of materials is ~50% lower than average notebook PC
– Tablets and smartphones change traditional Wintel/PC relationship
• Cloud services allow users to be device-agnostic
– Eliminates need for PC as a mass storage device
– Functionality migrating to the Cloud. Target market expanding with US
Department of Defense and CIA embracing the Cloud
Sources: Barclays, IDC
16
Mobility Is King
Sources: Gartner, IDC, Strategy Analytics
17
PC Decline Continues
Source: Gartner. Note: Split of PC shipments between Notebook and Desktop based on Bloomberg Industries data
18
Mainframe Computers Of Today?
• Global PC manufacturers in a vice
– Unit declines exacerbated by increasing price pressures from
Chromebooks and similar devices with reduced functionality
–
–
–
–
Windows XP upgrade cycle provided temporary lift
Original design manufacturers forced to transition to mobile devices
Large commercial customers developing white box solutions
Hardware-driven services less critical
• Changing priorities disrupt component suppliers
– Saving power, not processing speed is now paramount
– Miniaturization drives component changes
– Remote storage reduces need for traditional localized storage via hard
disk drives (HDD)
19
All Things Digital
20
Physical Distribution Disaggregated
• Retail stores now a liability?
–
–
–
–
Online shopping on mobile devices enables instant price comparison
Retail profit margins face continual pressure from price matching
Physical stores cannot offer same diversity of products
Best Buy struggling to avoid becoming Amazon’s showroom
• Videogame industry driving transition to digital gaming
– Digital downloads of new games will further reduce physical purchases
– Profitable distribution of used games faces eventual extinction
– EA’s CFO estimates that full-game downloads account for as much as 20% of
respective game purchases
• Physical media an endangered species?
–
–
–
–
Music now transitioning from digital downloads to streaming
Video rapidly moving away from physical media
Airlines now streaming in-flight entertainment to smart devices
HMV and Blockbuster: early victims of digitization
21
Digital Cannibalization Of Physical Media
Source: The Digital Entertainment Group
22
Twilight Of The Gatekeepers
• Marginal cost to transmit and/or store digital content approaches zero
• Video rapidly transitioning to digital distribution
– Proliferation of digital video distribution outlets, including over-the-top video on
demand and streaming services like iTunes, Netflix and Amazon Prime Instant Video
– Internet-ready television and mobile devices, such as tablets and smartphones, are
accelerating the shift to digital video consumption
– Emerging battle for the digital home with Amazon Fire TV, Roku and Apple set-top
box agreements
• Video bundling at risk
– Increasing viewership via streaming and/or DVR
– Time shifting of viewing habits away from scheduled programming
– Technology enabling greater selection of desired content
• Content/distributors fee disputes occurring with greater frequency
• US pay-TV companies lost 222k subscribers in the 9 months through
September 2014 compared to 167k subscribers lost in 2013 and 13k
subscribers gained in 20121
Source: 1) “Pay-TV ‘Cord Cutting’ Accelerates”, WSJ, November 6, 2014
23
Digital Money Changing Payment Landscape
• Customers increasingly “pay by click”
– Online/mobile purchasing made easier through stored personal data
– Transition driven by vendors such as Apple, Amazon Prime, PayPal, Google
Wallet etc.
– Improving biometrics technology to accelerate digital payments by eliminating
keyed passwords
• Financial institutions driving adoption of digital services
– Aggressively marketing services such as instant deposit or online banking
– Implementing new systems to process digital payments and fund transfers
• Disruption at the point of sale
– Current terminal network system bypassed by tablets, dongles and apps
– Secure smartphones (Apple Pay) may eventually eliminate the need for cardswipe and chip-and-pin devices
24
Shale Explosion
25
US Shale Revolution
• Shale revolution is a game
changer
– Crude oil production in the United
–
–
Shale Production Boom
States rose by 39% between 2009
and 2013
Net crude imports fell by 14%
between 2009 and 2013
The US will be the world’s largest
oil producer in 2015
• Companies large and small
•
seduced by shale bonanza
Fracking disadvantage is
aggressive decline in production
rates
– Wells can see production declines
–
by 70% in year 1, 50% in year 2
and 30% in year 3
Creates need to invest continually
Source: EIA and Baker Hughes via Bloomberg
26
Dark Side Of The Boom: Levered US Shale
• Shale exploration and production (E&P) in the US is an unconsolidated
sector with little control over production and pricing
–
–
–
–
There are few barriers to entry
Largely funded in leveraged finance market
A typical horizontal well costs less than $15M over its lifetime
Sector lacks economies of scale with full cost method of accounting inflating
EBITDA
• Decline in oil and gas prices made worse by shale market dynamics
–
–
–
–
Production continues even with capex cuts
Held by production lease agreements drive continued development
Natural gas is often a by-product of shale oil wells
US energy infrastructure enables operators to easily capture natural gas
• US oil and gas supply currently cannot tap global demand
– Federal approvals beginning for exporting limited quantities of US oil
– LNG processing facilities in the US remain on the horizon
27
The Displacement Of US Thermal Coal
• Natural gas price declines lead
to increasing viability as
alternative power source from
coal
Share of US Electricity Generation
(% of Total US Net Generation)
• Since 2009, relative prices have
become the driver for coal and
gas consumption
• Coal companies increasingly
exposed
– US coal demand and pricing
declined
– Free cash flow at mining
companies deteriorated
– Balance sheets increasingly
stretched
Sources: EIA, Bloomberg
28
LNG Under Pressure
• Decline in oil prices have upended
global LNG economics
Gas And Oil Price Comparison
• Capacity is growing
– High oil prices and Asian demand
led to increase in investment
– Projects from 2010/11 ready to
come online
• US LNG no longer as competitive
– Spread between US and Asian
LNG has fallen by 50%
– Arbitrage now negative with
$6.50/mcfe liquefaction and
shipping
• Questions arise regarding viability
of most proposed US LNG plants
actually being built
Sources: The Australian, Bloomberg, DOE, JPMorgan, World Bank, Bernstein
29
Impact On Costly LNG Projects
•
Massive Australian projects built for
market of triple digit oil prices
– Budget for Gorgon is $54B and
Wheatstone at $30B as of June 2014
Major LNG Projects – Break-Even Prices
($/mmBtu FOB)
– Australia has $200B invested in top 7
LNG projects with total capacity of
62Mtpa
•
With new energy price paradigm,
questions arise for LNG project
assumption of 12% internal rate of
return (IRR)
•
Investors must contemplate implication
of 50% price declines
•
LNG projects beginning to get shelved
– Excelerate Energy reviewing LNG
export terminal 10 months after
applying for permits
– British Columbia reassessing 18
proposed LNG projects
Sources: Wood Mackenzie / Macrobusiness, Bernstein, Bureau of Resources and Energy Economics, Australia, Oxford Institute
30
State Of Big Oil
31
Big Oil Under Pressure
•
•
•
Downstream is not a true hedge
In 2013, four of the Big 51 showed
YoY earnings declines and all but
one had production declines
Spending more to find less
Global Oil Demand Forecast (m b/d)
– Big 51 exploration and development
costs were $134B in 2013, 59%
higher than in 2010 and 85% higher
than in 2008
– Big 51 organic reserve additions
totalled 5,100mboe in 2013, 7%
lower than the average additions
seen over the previous five years
•
•
Searching in more volatile regions
Demand growth putting top line
under pressure
– Technology gains
– Slowing global economic activity
1) Big 5 include BP, Chevron, Royal Dutch Shell, Total, ExxonMobil
Sources: Citi, Macquarie
Source: Citi
32
Integrated Oil Companies (“IOCs”) As Self-Liquidating Trusts
•
“Cheap” oil now resides in government hands
–
–
•
–
–
Costly venues like Canadian tar sands or
Siberian Arctic resulting in ever-increasing
capital expenditures
Promising reserves often in politically
unstable regions around the world
$50B Kashagan project in the Caspian Sea
is two years behind schedule
Cash flow after distributions appears
permanently negative
–
–
•
Rising nationalism regarding state oil
reserves
Easy oil has most likely been found already
–
•
Heads-I-win/Tails-you-lose contracts with
many governments controlling vast
resources
The IOCs as Self-Liquidating Trusts
Total Cashflows 2009 - Q3 2014, ($bn)
BP Chevron
RDS
Total
Exxon
Operating cashflow
130.3
190.7
192.1
145.3
271.0
Capex
(123.4)
(160.5)
(175.6)
(134.9)
(181.3)
6.9
30.1
16.5
10.4
89.7
(42.8)
(53.1)
(58.1)
(40.7)
(156.2)
FCF post distributions
(35.9)
(23.0)
(41.6)
(30.2)
(66.4)
Total reserves CAGR, 2009-2013
(0.4%)
0.4%
5.0%
1.6%
3.6%
Free cashflow
Dividends and buybacks
Distributions support stock price
Debt funding the gap
Global overcapacity in downstream creates
even more pressure on IOCs
33
National Oil Company: For The Benefit Of The State?
•
•
•
•
•
From China to Brazil, quasi-public is the new model for national oil companies (NOC)
– Step 1: Retain a majority stake
– Step 2: Push ambitious and costly investment strategy
– Step 3: Keep pump prices low to appease citizens
China shows how it’s done
– Big three oil companies are theoretically public
– Overpaying for overseas reserves
– Downstream margins often negative
Brazil remains a troubling prospect for outside investors
– Infrastructure is approximately 2% of GDP – barely covering depreciation
– Prosperity has bred complacency and reform has slowed
– Widespread corruption with massive projects comes to light elections
Mexico as the next LatAm play
– Mexico’s energy reform ends Pemex’s 75-year monopoly
– Foreign expertise needed for offshore and onshore shale
Domestic priorities supersede economics
– Bente Nyland, Director of the Norwegian Petroleum Directorate: "We are doing the socioeconomic calculations
and we are working with a 4 percent rate of return but when the industry is working with 6-8-10-12 percent,
then we have a real problem”.1
–
NOCs continue investment in face of price declines
Source: 1) “Oil firms demand excessive returns offshore Norway: directorate”, Reuters, November 19, 2014
34
Commodity Super Cycle Peak
35
First Came The Demand
• China’s growth model is
primarily fixed asset
investment driven
Production of Key Chinese Construction
Inputs (Index: 100 = 2001)
• Commodity intensity of
Chinese growth is relatively
high
• Created a sharp acceleration
in global demand for
commodities such as iron ore,
coal, and copper
Sources: NBS, CISA
36
Then Came The Investment
• 1990 – 2001: global mining capital
Global Mining Capital Expenditure ($B)
expenditure grew to $14B from
$5.7B, a CAGR of 9%
• 2001 – 2012: China’s fixed asset
investment boom sees global
mining capital expenditure grow to
$123B from $14B, a CAGR of 22%
• Mining equipment manufacturers
direct beneficiaries of boom – one
third mining capital expenditure is
spent on equipment
• 2012 to mark the peak in the
capital expenditure cycle
Source: Citi
37
Supply Is Poised To Exceed Demand
• Following years of multi-billion
dollar investments, new supply
of key input commodities is
becoming available
• Iron ore and copper remain
oversupplied
• Commodity prices should
weaken as supply grows faster
than demand
• Market expectations are muted
Growing Commodity Oversupply
Supply/Demand Analysis
Iron ore
Iron ore supply, seaborne
% change, year-on-year
Iron ore imports
% change, year-on-year
Annual surplus/(deficit)
Copper
Copper supply
% change, year-on-year
Copper demand
% change, year-on-year
Annual surplus/(deficit)
2012
2013
2014E
2015E
Mt
1,159
Mt
1,142
1,272
9.7%
1,240
8.6%
32
1,428
12.3%
1,364
10.0%
64
1,522
6.6%
1,428
4.7%
94
20,650
3.9%
20,565
4.3%
85
21,647
4.8%
21,445
4.3%
202
22,310
3.1%
22,287
3.9%
23
17
kt
19,881
kt
19,710
kt
171
with adjusting target prices
Sources: CLSA
38
The End Of The Rainbow: Winding Down The Mining Super Cycle
•
•
Chinese economic growth is slowing
•
Supply growth is set to accelerate as
new multi-billion dollar mines are
finally commissioned
•
A reversion to the mean
With China’s desire to rebalance
away from investment towards
consumption, this will further
decrease commodity demand
Iron Ore Price ($/dry metric ton)
– Retracing commodity prices
– Deteriorating operating cash flows for
mining companies
– Reductions in mining capital
investment
– Lower demand and pricing for mining
equipment manufacturers
Sources: Global Financial Data, Bloomberg
39
China Risk Increasing
40
The Illusion Of China
• Seduction of 1.3B customers
• Growth potential is unlimited
• Rising middle class
• Command Economy gets it done
• Government solves all
• Confidence in massive Forex reserves
41
The Economic Reality
•
Driver of global economic growth
– China accounted for 12% of global
GDP in 2013, up from 8% in 2009
– Over half of German GDP growth in
2013 estimated to be driven by
exports to China1
•
•
The world’s factory
– Bred in excess labor
– Developed expertise and logistics
– Squeezed by increasing costs
The ultimate consumer of
commodities
– Underpins bulk commodity capex
‘super cycle’
– Soft commodity driver as well
•
Desire to dominate
– Persistent overinvestment
– Trolling for international technology
and expertise
Sources: 1) “Eurozone on cusp of triple-dip recession as German
exports crumble”, The Telegraph, October 10, 2014; World Bank
Source: W-T-W Finance
42
Where Are We Five Years Later?
• Rapid economic growth is
tapering
• Investment continues to lead the
Chinese GDP Growth
way
• Property market is wobbling
• Credit growth is evolving
– Still robust
– Shift towards more opaque
finance
• Sectors are being squeezed
– Limited liquidity
– Cost of capital is prohibitive
• Still waiting for economic reform
Source: National Bureau of Statistcs
43
Capitalism With Chinese Characteristics
•
•
•
•
•
GDP economy
– Upholds stability
– Based on inputs instead of outputs
Relationships drive business
‘Winners’ are selected
– Defend local companies
– Promote national champions
Changing playing field
– Local partners and joint ventures
– Technology transfers
– Polymorphic rules
Corporate priorities
– Top-line focus
– Cash costs vs. economic returns
– Know your price, ‘The China Price’
Source: Wikipedia
44
Giants On The Landscape
• State-Owned Enterprises (SOEs)
dominate the economy
Chinese SOE Net Profit Margin By Sector
– Total SOE assets represented
–
183% of GDP in 2013 up from
151% in 2009
In 2013, total revenues of SOEs
ex-financials were 83% of GDP,
up from 71% in 2009
• Core Chinese constituency
– Party appoints key positions
– Revolving door between senior
business and political positions
• Champions in ‘strategic’ sectors
– Party picks winners
– Support for major industries
• Corporate goals not always
economic
Source: Ministry of Finance, Credit Suisse, HSBC
Source: HSBC
45
The Investment-Driven Economy
•
Long-awaited shift to consumption has not
occurred
– Household consumption accounted for 37% of
GDP in 2013 compared to 36% in 2009 and
42% in 2003
–
•
Gross Fixed Capital Formation And
Household Consumption/China GDP
Gross fixed capital formation accounted for
47% of GDP in 2013 compared to 46% in 2009
and 39% in 2003
Calls for stimulus every time a number
disappoints
– 25,000 airports built since 2009
– Combined railway and highway fixed asset
investment (FAI) increased to RMB 2.7T in
2013 from RMB 1.7T in 2009
–
•
NDRC approved RMB 693B of infrastructure
projects between October 16 and November 5,
2014
Production capacity expansion even with
calls for rationalization
– Autos 12% CAGR from 2009 to 2014e
– Cement 9% CAGR from 2009 to 2014e
– Steel 7% CAGR from 2009 to 2014e
Sources: Nomura, Morgan Stanley, UBS, Civil Aviation
Administration of China, Global Insight, Reuters
Source: BNP Paribas
46
Stretching The Boundaries Of Investment
•
Buildings bloom
– Ghost cities and districts
– One skyscraper to be completed every
Three Gorges Dam
five days in the next decade1
•
Vanity projects
•
– Statues and monuments
– International cities and ‘duplitecture’
Reign of water
– As of 2013, China has built 87k dams
– South-North Water Diversion and
other megaprojects
– Nearly 60% of China’s underground
water is polluted
•
Foreign adventures
–
–
–
–
Rail in Africa
New Nicaragua canal
Stake in British high speed rail
Bid for Mexican high speed rail
Sources: 1) “China making room for 800 skyscrapers in next decade”,
Want China Times, September 4, 2013, The Guardian, International
Rivers
Source: WSJ
47
China Real Estate: The Bubble Gets Larger
•
2008 China urban housing stock was
near the beginning of the danger
zone
Residential Gross Floor Area
Under Construction (k sqm)
– 2008 urban housing stock value
estimated at RMB 68T
– 2008 GDP was RMB 31T
– Urban housing stock to GDP ratio was
217%
•
2013 China urban housing stock
value now in the bubble danger zone
– 2013 urban housing stock value
estimated at RMB 141T
– 2013 GDP was RMB 57T
– Urban housing stock to GDP ratio was
248%
•
Aggregate real estate value reaching
historic proportions
Source: CEIC
*90 sqm average unit size assumed for estimation of number of homes
Source: CEIC
48
Oversupply Becoming Undeniable
• Oversupply in the market place
continues to grow
– Top developer inventory
Completed Properties Held For Sale (RMB k)
balances increased to RMB
267B at the end of 1H14 from
RMB 48B at the end of 1H09
– Developers cutting prices to
move stale inventory
• At the same time, developers’
total on-balance sheet debt now
exceeds total equity
–
–
–
–
1H09 Total Debt: RMB 241B
1H09 Total Equity: RMB 260B
1H14 Total Debt: RMB 1,015B
1H14 Total Equity: RMB 805B
Source: Company filings
Source: Company filings
49
Unrelenting Credit Growth
•
China has not stopped stimulating over
the past five years
•
Recognized Total Social Financing
(TSF) as of December 2014 comprises
211% of GDP vs. 159% in 2009
•
New credit development has averaged
29% of GDP annually over the past five
years
•
Bank and non-bank lending continue to
be elevated
Total Social Financing As % Of GDP
– New bank lending remains elevated with
new loans of RMB 10.2T during 2014
– New non-bank lending of RMB 6.2T
during 2014, an 86% increase from RMB
3.4T in 2009
•
New debt increasingly paying off old
debt and financing losses
Sources: CEIC, South China Morning Post, PBOC, Macquarie, BoA Merrill Lynch
50
Domestic Capital Allocation
• Banks directed to lend
• Political vs. business needs
Annual New Bank Loans (RMB B)
– Government relationships
– Uneconomic lending
• Facing growing pressure
– Yu’E Bao siphons off deposits
– Non-performing loans (NPLs)
as a political decision
• Increasing capital via preference
issues
• Insurance companies expanding
alternative investments
Sources: PBOC, Macquarie, BoA Merrill Lynch
51
Shadow Financing Steps Into The Light
•
China’s credit growth is not limited to
bank lending
•
There is a growing cocktail of credit
products
– Wealth management products (WMPs)
– Trust loans
– Entrusted loans
– Trade loans
•
SOEs dominate bank borrowing while
other businesses scramble for credit
•
Once perceived as riskless, there are
growing wobbles in the shadow
banking sector
•
Banks, insurance companies, and
SOEs are key buyers
•
The systemic interconnection is
unknown
Annual New Social Financing
Sources: PBOC, Macquarie, BoA Merrill Lynch
52
The Quiet Credit Crunch
•
•
•
Lending growth masks underlying
reality
Borrowing is typically short duration
– WMPs four to six month maturity
– Trusts two year maturity
High-profile bailouts of trusts and key
borrowers
– Unwillingness to take losses
– Local governments protect own
Monthly Trust Product Maturities (RMB B)
interests
•
•
Consistent stories of lack of liquidity
across industries
– Macau junkets
– Property
– Steel
Preparing for the fallout
– Huarong Asset Management Company
–
(AMC) raising capital and rumored for
potential IPO
New regional AMCs formed
Source: Bloomberg
Sources: Wind, BoA Merrill Lynch
53
A Quest For Foreign Capital
• Bulls find comfort in huge Forex
reserves
• Chinese cash needs continue to
grow
Chinese Offshore Corporate Bond Issuance
($B)
• Increasing external financing
– Foreign bond issuance
– Bank borrowing in HK and other
markets
– Selected equity issuance
• Drawing in foreign investors
– Qualified Foreign Institutional
Investor (QFII) program
– Shanghai-Hong Kong ‘Through
Train’
• Proposed Free Trade Zones
Sources: Bond Radar, Bloomberg, WIND
Source: BoA Merrill Lynch
54
Local Money Exiting
•
Estimated outflow of money
– Chinese net capital outflows at $468B
in 2014 vs. net inflows at $69B in
20091
Château de Gevrey-Chambertin
– $3.8T cumulative illicit outflows from
2000 through 20112
•
Foreign property demand
– More than marginal buyers
– Dominate sales in key cities including
Vancouver, San Francisco and New
York
•
Chinese swamp foreign passport
programs
•
Affinity for luxury
– Gambling in Macau and Las Vegas
– Active in art market
– Growing taste for vineyards
Sources : 1) BoA Merrill Lynch; “net capital outflows” defined as FX
reserve change – FDI – trade surplus;
2) Global Financial Integrity “Illicit Financial Flows from Developing
Countries: 2002 – 2011”; Trading Economics
Source: Groupe Centre France
55
The Macau Microcosm
•
Outlet for China
– Domestic relief valve
– Avenue for capital flight
•
Gaming capacity continues to grow
– 4,770 tables in 2009
– 5,711 tables as of 4Q14
– 7,325 tables forecasted for 2016
•
Tipping point arrived on gross gaming
revenue (GGR) growth
– VIP GGR growth turned negative in
Macau GGR January 2009 To December 2014
2Q14
– Mass GGR growth turned negative in
4Q14
•
Long term prospects in question both
from mainland economy and politically
•
Collateral damage of anti-corruption
campaign
Sources: Gaming Inspection and Coordination Bureau of Macau, company filings, MS, CLSA
56
Recent Backlash: Anti-Corruption Campaign
•
Corruption crackdown serves two
purposes
– Purge political opponents
– Restore Party legitimacy
•
•
Popular with the masses
•
Selected disclosure
– Targets for a purpose
– Crackdown on popular participation
•
Consequences
– Declines in luxury and other sectors
– Corrupt officials becoming more
Cognac Bottles Sold In China (M)
More widespread than expected
– Targeting ‘tigers and flies’
– Finding corruption in all corners
– SOEs being examined
creative
•
Fears for reversion after investigation
Source: Bureau National Interprofessionnel Du Cognac
57
Rise Of The New Paramount Leader
•
Defender of the Party and China’s
national interests
•
An unexpected strong leader
– Rapid consolidation of power
– Openly challenging rival factions
– Reaching for social control
•
Fortifying leadership
– Chairs key committees
– Replacing senior leaders
•
Personal allegiance pledge from
People’s Liberation Army (PLA)
•
A princeling portrayed as a man of
the people
•
Xi to Putin: “I feel our personalities
are quite similar”1
Source: 1) “Why Xi Jinping Is China’s Putin”, The Diplomat,
July 15, 2014
Source: ZUMAPRESS.com via WSJ
58
Re-Emerging Global Power
•
Many in China view the nation’s rise
as reasserting its rightful place
•
Increasing nationalist foreign policy
•
•
– Confronting neighbors
– Redrawing boundaries
Quest for raw materials expands
horizon
– Silk road strategy
– Foreign military bases
Overt support of key industries
– Protect access to raw materials
– Indigenous technology development
– Price manipulation investigations of
foreign companies
•
Active financing and building of
foreign projects
Source: The Economist
59
Projecting And Protecting China’s Interests
•
Rising military spending
– Chinese defense budget increased
68% to RMB 808B in 2014 from RMB
480B in 2009
– US defense budget decreased 6% to
$649B in 2014 from $694B in 2009
•
•
•
•
More active and confrontational
military
– Participation in international efforts
– Assertive in its own neighborhood
Advanced weapons development
– Accelerated building programs
– International knockoffs
Embracing cyberspace
– Government hacking
– Corporate espionage
Poll shows 53% of Chinese and 29%
of Japanese can see military
confrontation1
Sources: 1) “More than half of Chinese believe China could go to war
with Japan: poll”, South China Morning Post, September 10, 2014;
Global Security, US Department of Defense
Source: Davegranlund.com
60
Increasingly Divided Society
•
Wealth gap continues to grow
– Elites accumulate wealth and privileges
– Masses feel the Chinese Dream is
unattainable
•
Urbanization
– Rural vs. urban divide defines opportunities
– Long touted as next growth vehicle
•
Tensions are apparent
– Strife in Xinjiang
– Labor demonstrations dismissed as
‘criminal attacks’
•
Quality of life concerns
– Healthcare
– Pollution
– Food quality
•
Aging will be an issue
– One-child policy limits support for retirees
– Excess labor an asset of the past
Source: SCMP
Source: Reuters
61
The Law Makes The Party More Powerful
• Internet and media crackdown
– Expansion of real name
registration
– Foreign reporter visa restrictions
• Widespread surveillance
• Police has higher budget than
military
– 2013 planned police budget of
RMB 769B
– 2013 planned military budget of
RMB 720B
– Police budget disclosure
discontinued in 2014
• Irrational safety rules
• ‘The Party solves all’
Source: Quartz
Source: Wired
62
Thank You to the
CFA Society of Nashville
63
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