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China is a Wildcard

What's going in China and why we should pay attention

A few months ago I co-authored a 3-part article on China with Mayhem. The country was pivoting to a lax monetary policy and pumping in fiscal stimulus. We identified three strong companies by the end of the series that one could potentially look at.

A major part of that series also entailed the political risks and the property market. But, as the government lowered the borrowing rate at the time and provided support, it seemed that things were under control.

But, over the last couple of weeks, I’ve been seeing signs that are not great. One thing that I’ve been saying is that China is a Wildcard because just when we think things are turning brighter, something always resurfaces.

I am keeping this article open for everyone because I think we have a storm brewing there and we need be vigilant. I will also try to keep this brief.

What caught my attention?

The 5-Year Credit Default Swaps have increased enormously in the last couple of months. This increase is seriously alarming and it’s driven by a number of factors which are primarily internal instead of external influences.

What’s driving this?

Property Market and the Ratings Revoked

The property market still remains in turmoil. Earlier today Moody’s and Fitch, the two global ratings agencies have revoked their ratings on 7 property developers citing inadequate information. The companies can’t reasonable assess the debt levels and are pulling back on their ratings.

The state-backed developer, CIFI, failed to pay their bond coupon payment on Oct 08, and it would seem that the Government’s efforts have not been sufficient to curb possible defaults since Evergrande’s default in December. PBOC added a net 108.2B yuan ($15.2B) in Pledged Supplemental Lending (PSL) last month, after a 2 year hiatus. More stimulus is being released to hold up the property market. The PSL has been criticized as a policy tool in the past for being a key driver in creating property bubbles.

China’s junk debt keeps falling and the measures are still falling short of expectations.

Political vs Economic

President Xi Jingping’s expected reappointment as the head of the Chinese Communist Party for a 3rd five year term and the military is set to be a historic moment. The party’s 20th congress begins on Sunday.

From everything we read, it would seem that the government is more focused on the political situation and security measures in the country instead of the economic situation. China’s Debt to GDP continues to soar and their GDP growth numbers have been revised downwards. GDP growth is set to decelerate to 2.8% this year compared to 8.1% in 2022.

Covid Zero

With the President’s reappointment around the corner, the state media has been heavily promoting Covid Zero as the right policy for the country. But, this policy has wreaked havoc on the manufacturing sector. Intercity travel is dipping below 2020 levels.

Why should we pay attention?

If there’s one thing we’ve learned in the last few years - the world has become increasingly interconnected. China has risen to a level where they have become influential enough that if they were to experience serious economic trouble, this would certainly affect markets across the world.

China is one of the largest investors in the US market for US sovereign debt. If they need to backstop the economy, they will pull the funds. That will suck out even more liquidity than the current QT program.

Sovereign wealth funds and pension funds around the world hold Chinese bonds and equities. Many of the bonds were issued by the property developers. If more developers begin to default, this could seriously hurt liquidity across countries and even hurt retirees. Just today, there was news that the Teacher Retirement System of Texas - a $184 billion public pension fund - is cutting its weighting in Chinese stocks.

2 Kommentare

Andy Featherston
Andy Featherston
16. Okt. 2022

Compelling research here Ayesha! Do you know how much US Sovereign debt China still owns and how much they’ve sold this year?

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Andy Featherston
Andy Featherston
16. Okt. 2022
Antwort an

Shorting China has been one of my best trades this year. Nervous to short anything right now though.

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