- China continues to shake the markets
The first chart that we want to start this analysis is the Shanghai CSI 300 Index (see below), down 40% since its previous high (5,380) reached on June 9th 2015. As you know, news from China has been the major ‘driver’ of the financial market, giving a harsh time for European and US fund managers. The index is approaching the psychological support of 3,000 and its August low of 2,952, two critical levels for the Chinese economy.
The volatility in China (which will affect global markets overall) is coming from its too-leverage banking system, which we believe cannot survive if we enter a Bear market in the EM world. As Kyle Bass from Hayman Capital reported in his late interviews, China bank assets totalled 31tr USD in 2015, up from 5tr USD in 2006 if we look at the chart below. If we express it as a share of the country’s GDP (roughly 10tr USD), the banking system (total assets) is 350%.
(Source: Hayman Capital)
The consequence of a [sharp] decline in equity and property markets will lead to a constant surge in NPLs in the medium term, therefore putting the whole banking system into huge troubles. Housing starts have fallen by almost 20% in 2015 (based on an average estimates) and the excess of inventory unsold properties have surged dramatically (Standard Chartered estimates the number at 9 million, with a further 40m to 50m homes being held vacant as investments). This is clearly problematic as it is widely known that China’s household wealth is mostly concentrated in housing, which account for 15% of the country’s GDP. To give you an idea, the 2003-08 housing market in the US represented barely 5% of the US GDP.
We believe that China is poised to print constantly lower-than-expected GDP growth rates due to this instability, therefore being the main risk factor for global markets in 2016 (Q4 GDP came in at 6.8% QoQ vs. 6.9% est.). One interesting chart to look at this year is the USDCNH – USDCNY spread analysis. Since the PBoC devaluation, we can see that spread off the offshore/onshore currencies has been very volatile, moving up to 1400 pips (i.e. USDCNH was trading at 1400 pips above USDCNY).
2. Commodities update: where is the low?
As we gave a quick [bearish] review on China, we have to give an update on commodities, which are still trying to find a new low. As you can see it in the chart below, the Bloomberg Commodity Index (BCOM) broke below its March-99 low of 74.24 yesterday and is down almost 70% since its July 2008 high. We wouldn’t see this new low as a buying opportunity as long as we don’t visualize any upside coming from the EM economies.
The end of this commodity super-cycle is dramatically hurting many energy companies, and corporate default is clearly becoming the biggest financial threat for this year. For instance, Glencore 2021 and Noble 2018 bond price recently plummeted to new lows yesterday, trading at 64.4 and 56 cents on the par and increasing the probability of bankruptcy.
3. The death of the commodity currencies…
This commodity meltdown has sent the Aussie (candles) to (almost) a seven-year low against the dollar, trading at 69 cents against the dollar, and the USDCAD (yellow line) has reached a 12.5-year low and is currently trading at 1.4530, down 25% in a single year. We will always remember Stanley Druckenmiller words from the Ira Sohn Conference in May 2013 when he talked about the Commodities Conundrum. He said he was betting that it was the end of the ‘supercycle’ for commodities (referring commodity currencies as ‘dead’) and he was already warning of a potential financial crisis in China. We have to admit thatwe would never have imagined such a drawdown; however, today we am still thinking there is potential downside risks.
Just to let you know, this article is just a quick-start of a series of more detailed analysis of economic areas (Japan, US and Euro), coming up in the next couple of weeks.