Submitted by Gordon Johnson of Axiom Capital
We believe that exhibit 1 says a lot: it shows that despite a record level of new credit issued by China’s PBoC YTD through Oct. 2017 (which stands in stark contrast to government authorities continued statements that China is de-levering), China’s economic backdrop is currently experiencing:
- (a) monthly construction new start (commercial + residential + office) growth slowing Y/Y (Ex. 2),
- (b) monthly fixed asset investment growth slowing Y/Y (Ex. 9),
- (c) monthly cement output slowing Y/Y (Ex. 5),
- (d) monthly electricity production slowing Y/Y (Ex. 6),
- (e) monthly M2 money supply growth slowing Y/Y (Ex. 7),
- (f) monthly household loan growth slowing Y/Y (Ex. 8),
- (g) monthly private fixed asset investment growth slowing Y/Y (Ex. 10), and
- (h) monthly home price growth slowing Y/Y (Ex. 12) – in fact, select data points have turned negative Y/Y.
Stated differently, while the lion’s share of our client base continues to tell us, with respect to our bearish views on China… “President Xi Jinping will simply stimulate more if/when things get bad”, we would highlight, again as detailed in Ex. 1 below, China stimulated at a record pace in 2017, yet it did not resonate in improved economic activity (in fact, the exact opposite appears to be unfolding – i.e., economic growth is slowing across a number of data points).
Furthermore, underpinning our view that China’s debt stimulus was targeted specifically at the months preceding the 19th Party Congress in Oct. 2017 (i.e., when President Xi Jinping consolidated power to become the strongest Chinese leader since Mao Zedong), implying we may see a phase of debt fatigue, we note that in the first 10 months of 2016, incremental credit issued in China on a month-over-month (“M/M”) basis was negative three times (i.e., May, July, and Oct.), and averaged $189 billion on a monthly basis; yet, in the first 10 months of 2017, incremental credit issued on a M/M basis was positive in each month outside of Oct., and averaged $429 billion on a monthly basis (in Oct. 2017, the month the 19th Party Congress concluded, new credit issued fell by $11.9 billion M/M).
WHAT DOES IT ALL MEAN? The broader point is… when you issue an unprecedented amount of credit targeted at a growing number of negative ROI projects multiple decades, at some point the law of diminishing marginal returns sets in (since 1/1/09, China’s credit has grown by CNY153.9 trillion while GDP has grown by a much more modest CNY 48.5 trillion, or a multiple of 3.17x, meaning a lot of bad investments have stacked up over the years) – keep in mind that China’s $3.6 trillion in credit issued in 2017 YTD through Oct. is more than the entire developed world combined. Put in the simplest of terms, at some point the incremental dollar in new credit created actually does more harm than good.
Ex. 1: China New Credit Created YTD Through Oct.
Note: Credit created = TSF + Local Gov't Debt.Source: PBoC; NBS; ChinaBond.
SO WHERE FROM HERE? When considering China hit the afterburners on new credit issuance in 2017, yet the impact seems to be quickly fading, it would appear we may have reached the point of “no return” (while Consensus, at this point, seems completely oblivious to this possibility, the recent sell-off across the Chinese stock markets suggest investors on-the-ground in China may be catching on).
CONCLUSION: In the face of China’s TTM 3Q17 credit as a percentage of GDP coming in at 250%, to “keep the party going”, Xi Jinping would have to force new credit issuance far in excess of $4.0 trillion in 2018 (which could trigger a number of ratings downgrades, as well as a reassessment by the IMF of China’s “market economy” status).
Moreover, given what we’ve seen this year – i.e., 101.7% Y/Y new credit issuance growth YTD through Oct. 2017 – it seems the level of credit necessary to stimulate growth in China could prove elusive at this point (we don’t recall any economist’s forecasts exiting 2016 pointing to China’s new credit issuance more than doubling Y/Y in 2017, yet that’s exactly what’s happened – had this been our base case, we would have expected all economic indicators in China to be moving substantially higher at this point in the cycle). Thus, to the thesis that rests on a view that: “Xi will just stimulate more”, we would argue that the extent of the stimulus necessary may be so high at this point that President Xi Jinping may have lost sight of how much debt he needs to “get things going again”. Should this prove to be the case, China’s economy will continue slowing, putting pressure on bulk commodity prices, and, ultimately, industrial/steel stocks (CAT, URI, FMG, RIO, X, CLF, GATX, and TRN, all of which we have SELL ratings on).
HOW’S THE DATA LOOK IN THE FACE OF CHINA’S RECORD 2017 CREDIT “BINGE”? So how do the data points look? Well, here’s a few (we feel the charts say it all)…
Ex. 2: Monthly Construction Starts (Residential + Commercial + Office)Source: National Bureau of Statistics, Axiom Capital Research.
Ex. 3: GDP Growth Internals - China (FAI, Industrial Production, & Retail Sales)Source: National Bureau of Statistics, Axiom Capital Research.
Ex. 4: China Monthly Steel Production by YearSource: World Steel Association (WSA), National Bureau of Statistics (NBS), Axiom Capital Research.
Ex. 5: China Cement OutputSource: National Bureau of Statistics, Axiom Capital Research.
Ex. 6: Y/Y Growth in Electricity Production by MonthSource: National Bureau of Statistics, Axiom Capital Research.
Ex. 7: China M2 Money Growth, Y/Y% - Multi Decade Low (bearish)Source: Peoples' Bank of China (PBOC), Axiom Capital Research.
Ex. 8: 3MMA Household Loan Growth, Y/Y%Source: Axiom Capital Research, Bloomberg, National Bureau of Statistics.
Ex. 9: Monthly Total Fixed Asset Investment and Y/Y GrowthSource: National Bureau of Statistics, Axiom Capital Research.
Ex. 10: Monthly Private Fixed Asset Investment and Y/Y GrowthSource: National Bureau of Statistics, Axiom Capital Research.
Ex. 11: Private Investment in Industrial Sector and Y/Y GrowthSource: National Bureau of Statistics, Axiom Capital Research.
Ex. 12: Average Price Change of New Residential Buildings, by Tiered-Cities, %Y/YSource: National Bureau of Statistics (NBS), Axiom Capital Research.
In short, we feel China could be the “black swan” that ruins the stock market rally party for many in the industrials space. Caveat emptor.