Dec 7 FT Thoughts China bond market, China/US three steps, Valuations, Emission standards, Iron Ore

07 Dec

MARKETs @ 1:45pm  Mixed with Japan, China and Hong Kong trending lower. S Korea and Taiwan higher; as Tech continues to lead markets higher.
Nikkei 225 opened higher at 26,894 but sold down through morning and first part of the afternoon to 16,500 before finding support around 1pm when the Leading Economic Index and Coincident Index preliminary numbers cam out better than expected and prompted a rebound in the market. Currently -129pts (-0.5%) @ 26,622
Topix traded in a similar patten; currently -10pts (-0.6%) @ 1,766
Pre Market Foreign Exchange Reserves Nov $1384.6bn vs 1384.4b Oct
Out 1pm
Leading Economic Index Prelim Oct 93.8 vs 92.5 Sept (F/cast was 93.2)
Coincident Index Premin Oct 89.7 vs 81.1 Sept (F/cast was 80.5)
Kospi opened higher and traded sideways initially in choppy trading but sold down ahead of the China Trade Data and then worked higher as it was much better than expected Currently +4pts (+0.2%) @ 2,736
Kosdaq traded in a similar pattern but the rebound was much stronger currently +9pts (+1%) @ 923
Opened higher but sold down in theorist hour in choppy trading to 14,140 (Above Friday’s Close) and has since traded sideways in the range 14230/215 currently +98pts (+0.7%) @ 14,230
CHINA CSI 300 opened flat but sold down ahead of the trade data with a small bounce into lunch after the data was released.   Opened higher after lunch currently -24pts (+0.5%) @ 5,042
Balance of Trade Nov $75.42bn vs 58.55b Oct (F/cast was $49.6b),
Exports Nov +21.1% vs +11.4% Oct (F/cast was 10%),
Imports Nov +4.5% vs 4.7% Oct (F/cast was +5.2%)
After market Foreign Exchange Reserves due
Opened at 26,871 +35pts vs +10pts ADR’s but sold down to 26,256 ahead of the China data then a small bounce into lunch. PM opened slightly higher currently -374pts (-1.4%) @ 26,462. Ecommerce and Chinese Financials weak leading the declines but broadly weaker.
EUROPE Expect market to open flat, encouragement from the better than expected China Trade data but still with Brexit overhanging the market and concerns about whether the US will agree a new stimulus package.Data Due UK Halifax House Price Index
US Futures opened higher but have eased back to flat.  China data +VE but investors will be watching for agreement in Congress on a new stimulus package.Data DueConsumer Credit Change.

Front Page
Push for US stimulus gains momentum as virus cases continue to break records. One of the main things that investors will be watching is whether politicians can agree a new package before Christmas.   The rise in covid cases is less of a concern to markets but now that vaccines are becoming available but they will still put pressure on the economy; as seen by California announcing a ’stay at home’ notice on large areas including Silcon Valley and Los Angeles.  With the onset of winter the US Govt is warning that there could be a significant resurgence in cases; partly due to those that travelled over Thanksgiving and then travel again for Christmas and partly just because of the cold weather.

Bond defaults test China’s mutual fund industry. Knock-on effect as Beijing pulls back from implicit guarantees for risky state-owned groups.Looks at the impact on China’s onshore bond market after the recent defaults and with the expectation that there will be more ahead.  
China is trying to deleverage the SOE’s now the pandemic is ending. It notes that 'Beijing’s push to impose more market discipline on debt issuers has hit valuations for some bond mutual funds and forced some fixed income managers to suspend buying orders from local retail investors. The instability also threatens to disrupt Beijing’s carefully choreographed plans to draw more international investors into the bond market.’
Currently according to BNP Paribas global investors own about 3% of CHina’s onshore bonds but that’s expected to increase as China offers better yields than developed markets and has recently been included in a number of international fixed income indices. Of course the recent defaults to an extent highlight why they offer more yield its because there is more risk!
It notes that 'JPMorgan, Bloomberg and FTSE Russell are integrating China bonds into some of their widely followed fixed income indices, which will lead to substantial buying by a wide variety of tracker funds. ‘ Although I would think that some of those inclusions may now be under review. They will not want to include companies bonds that then default, so a lot more direct due diligence is going to have to be undertaken.
It notes that the new volatility in the bond market will cause problems for the mutual fund industry not least because most companies have just passed Beijing’s stress tests with flying colours. 'China’s central bank examined 5,906 equity, bond, money market and commodity mutual funds to assess whether they had sufficient liquidity to meet redemption requests. Only a single bond fund failed after a “light” redemption shock and just 52 bond funds failed after a “heavy” redemption shock.’
So whilst the government wants market forces to play a larger roll in pricing credit and default risks, it remains to be seen how hands off it will actually be.
The article notes that other problems could arise as in the search for yield some Chinese asset managers may have over exposed themselves to bond issuers that are now less financial sound than was previously thought. Keeping the public reassured will be difficult if there are more defaults ahead.
It notes 'The yield on five-year Chinese government bonds has risen from less than 2 per cent during the second quarter to 3.2 per cent. Subscriptions from retail investors have been halted into 13 bond funds since October by managers including China Fund, Taikang AM and Yingda AM.’
It also notes that the true extent of the problem might be being understated as some SOE’s and Local Government financing vehicles are concealing their true position and using private placements to access more funding.
A number of articles last week also noted the problems facing the sector not least the  implicit belief that local authorities or the government would step in. Whilst many foreign investors conducts their own due diligence it is not so clear whether the domestic fund managers do or whether they believe the government and Chinese rating companies assessments.  I think that it will take sometime for the truth of the situation to become evident only then will it be clear whether the yield differential being offered truly reflects the risks.

Japan top aide warns against letting EU set standards on emissions.  Looks at comments by 'Takeshi Niinami, chief executive of drinks group Suntory’ who highlighted fears that 'Japan’s competitive strength in areas such as hybrid petrol-electric cars will be destroyed if international standards discriminate against their technology and favour purely electric vehicles.’  Key being those set by the EU.  He is hoping that the Trans-Pacific Partnership will set standards that will be adopted and where Japan is able to exert some influence.  Comes as PM Suga said on Friday that 'the shift to carbon neutrality should be seen as a growth opportunity for Japanese industry, not just an environmental policy.’The key difference is that Japan wants to keep hybrid car of the road for longer whereas the UK is looking at 'phasing out all new petrol or diesel vehicles after 2030, including hybrids after 2035.’
Mr Niinami also stressed that Japan was aiming at net carbon neutrality, not zero domestic carbon emissions.
Highlights the different attitudes that are currently in play.  Key will be to agree global standards and objectives so that everyone is working towards the same goal.

Spare no expense US stock valuations that dwarf earnings leave some investors uneasy. Notes that currently valuations have only been higher during the Dotcom bubble and the 1920’s boom.  It notes that 'the degree to which stock prices have peeled away from corporate earnings is the metric that is leaving some investors uneasy.’It notes that the Cape ratio is at the level it was on the eve of the great depression and double its historic average.   Key has been the easing policies of central banks and the willingness of governments to provide stimulus and support.  It notes that the current valuations reflect great expectations.
There have been a lot of reports recently on what could go wrong but short term equities seem to be ’the only game in town’ largely due to low bond yields.
Concerns over the debt levels that companies now carry is one issue and how that could be a drag on earnings.  There are also questions about what the managements of some companies will do with that case as the end of the pandemic seems to be insight.  Some are looking at M&A others at paying down debt.  There are also concerns about the inflation threat and how if the Fed or other central banks move too quickly to quell inflation expectations that could impact the recovery.  
I also think that there will be more company failures ahead and those could have serious implications for the supply chains of currently sound businesses.Short term though we are seeing interest in cyclicals, value names and smaller SME’s.   Much of that seems to be money coming into the market from other asset classes as the tech names have yet to see a significant retrenchment.  Many believe that those tech names will still be key players in the post pandemic world.

Can iron ore’s meteoric rise continue?  Iron ore continues to rise in price as Vale cut it's forecast output for next year; with many thinking it could go to $150 a tonne.  China’s demand is seen as key to achieving that level.  Steel has been a key to kick starting the Chinese economy.  It notes that some think demand in China may cool although doesn’t say why. But profit margins at Chinese steel mills are under pressure not just from iron ore prices but also from the increase in coking coal prices since China banned Australian coming coal imports.  
China is lucky that Australia doesn’t link its iron ore exports in with the other goods that it used to export to China 

Opinion Three priorities for the US to de-escalate the China conflict. By Stephen Roach
Notes that the Biden administration will have to decide how to handle the conflict with China. He says it started with a trade fight, morphed into a tech war and is now at an impasse and so a new approach is needed.
I’m not sure it started with a trade war, so much as a realisation of what ‘Made In China 2025’ in its fullest sense really meant.
He suggest three things need to happen;
1. Dialogue not twitter; also not the biannual or annual summits of the prior administrations. He suggests ‘a permanent secretariat that has full-time responsibility for all aspects of the US-China relationship — from trade and technology, to cyber security and people (including educational exchanges, visas and human rights).’ The organisation to be housed in a neutral location and staff by professionals. I don’t think there is any chance either side would be prepared to accept that sort of delegation of power.
2. Trade. Notes that trade imbalances don’t 'occur in a vacuum’ but the result of macroeconomic savings issues. Says the US’s chronic shortfall in domestics savings and China’s saving surplus are the reason for the imbalance. So the current tariff approach will not solve the base issue. He suggests abandoning the Phase 1 trade deal and replaced with a saving agenda. The US to save more and China less. He notes 'That will be harder for Washington than for Beijing, as US saving is now under acute pressure with huge Covid-19-related budget deficits.’ He suggests 'That will require a polarised US Congress to commit to medium-term deficit reduction. Conversely, China needs to continue reducing its surplus savings — essential to fund a porous social safety net, temper fear-driven household saving and boost discretionary consumption. A rebalancing of savings is essential to reduce trade imbalances between both nations and their trading partners.
I think it is impossible. The money congress has access to comes from the American public. Members of congress are very well aware that being re-elected is about taking as few taxes off the people as possible. Increasing taxes so the nation can save has, in my view no chance of getting off the ground. Similarly China has been trying to get its people to spend more and drive domestic consumption for years, without success. I doubt it can make the people spend more; at least not without a revolt and President Xi is keen to avoid those.
3. On Tech he acknowledges that the Trump administration did bring this to the fore. He notes ‘While the allegations it raised in 2018 about China’s intellectual property regime and forced transfer of technology by US companies were based on weak evidence, they underscored serious concerns about practices that were counter to the terms of China’s 2001 accession to the World Trade Organization. Unfortunately, none of these thorny issues has been addressed in the current approach.’
So he suggests 'A bilateral investment treaty is a time-tested approach that both nations have long embraced as a means toward that end.’ The end being improved access to each other’s markets. He also notes that the Trump administration abandoned such a treaty ‘just when the finishing line was in sight’.
He thinks that would solve the many currently worrying issues.
He concludes by saying 'It won’t be easy for either nation to stand down. At first, small steps will be required to rebuild trust. But these are far preferable to staying the current destructive course.'
Whilst an interesting read I don’t think any of it will be seriously considered in such a radical form. It is also surprising in that it puts the emphasis on the US to act, I guess the presumption being that if it does then China will act too.  I do not think either side would be prepared to give up power to a joint secretariat; President Xi has shown that in the way he has consolidated power into a tighter circle around himself.  Biden has already said he will not remove the tariffs and that he is looking at working with America’s allies in his approach to China. I think the first half of 2021 will see a lot of re-examination but the world has woken up to the fact that China wants to dominate in the future more than merely share the world stage.  Whilst Trump’s approach had many faults it has brought many of the issues to the table.  There will need be compromise on both sides and it will be difficult but hopefully an acceptable result will be found.

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