2000 Proud Years

From: Derek Hillen
Sent: Friday, February 10, 2012 11:54 AM

“Capitalism without bankruptcy is like Christianity without hell.”  - Kyle Bass

Markets have had a raging start this year with consensus confidently taking the view that the Greek problem is “solved.” This is generally comfortably explained by superficial analysis such as, “Everyone knows how much is at stake so Greece won’t default.” Excuse me, have any of these people actually been to Greece? It is a democracy that has successfully been dodging taxes since the Romans took over in 146 BC. That is a long proud history. Of course they will default. The bigger question is: have markets priced that in already? And what about contagion spreading like ebola virus to other weak players? That is definitely a “known unknown.”

Another thing that might give one pause is insider selling has sky rocketed. According to the Vickers Weekly Insider Report, the current Sell:Buy ratio is 8.2:1 for companies listed on the NYSE. This is quite a bit higher than the sell to buy ratio of 0.8:1 we saw in November just after the market bottom. In fact, the ratio now is the highest it has been since July right before the S&P fell 17%. I am not saying the exact same result is ahead of us as history doesn’t repeat itself, it just rhymes. But that rhyming sound should make you think twice before hopping on the bandwagon. Markets are overbought and ready for a slip.


Corporate Bonds to the Rescue

Economist Joy Yang has an interesting note on what is for many investors an informational black hole – China’s corporate bond market. China’s economic model depends heavily on cheap money (like Russia’s depends heavily on cheap vodka) and this is measured by what the Chinese call “social financing.” A term with frigid Orwellian overtones, “social financing” encompasses bank loans, off-balance sheet financing through banks, as well as funds raised in the bond and equity markets. The PBoC believes this better explains GDP and inflation than reliance on bank credit or M2 numbers alone. Policy loans via the banks are the majority with a weighting of about 60% of the Rmb 12.8 trillion in “social financing.” We forecast bank loans this year will be around Rmb 8 tn compared to 7.5 tn in 2011. Our forecast is below consensus for loan growth and certainly below market “hopes” of Rmb 10 tn to get the party really going again. This weekend the January bank loan numbers are to be released. The total is likely close to Rmb 800 bn, less than market hopes of Rmb 1 tn or more.

To maintain FAI growth of just 20%, (and remember, FAI is half of GDP) there is going to be a Rmb shortfall of 2-3 tn. Where will that money come from? The corporate bond market is here to help, sort of. Currently making up only 10% of “social financing,” we forecast the bond market will grow 50% this year and average 20% p/a growth over the next 5 years reaching Rmb 3 tn in size by 2015.

Who Benefits?

As the market grows and deepens, and with funding costs for corporates similar to bank loans, corporate bonds will become a viable alternative funding source for larger SOEs and other asset rich companies. We think this means commodity suppliers and property developers will be active here first and foremost. The banks will also benefit, longer term. Currently, commercial banks are the biggest buyers in the market and hold 1/3 of issued paper. With a lower risk weighting for corporate bonds than loans (80% vs. 100%) this will help banks free up more capital. This capital could be lent to SMEs as the credit market expands organically. Of course, this is a longer term story as there are political bottlenecks to growth in the form of various approvals needed for bond issuance. Market infrastructure including independent rating agencies, centralized clearing and settlement is nascent and needs to be developed.


Lenovo (992 HK) came out with another strong Q4. The stock is up 61% since Roxy Wong raised his recommendation to a Buy back in May. The HSI, by comparison, is down 8% over the same period. (And Apple is up 48%). After these results Roxy sees more upside and raises his target price to $7.9 maintaining the Buy rec. Roxy is surprised at the strength of the handset division which more than doubled shipments q-q to 6.5 mn units with half of those being smart phones sold to China Unicom (762 HK). We estimate China will increase handset subsidies by 29% this year to Rmb 75 bn, making this an attractive business to be in. While margins are lower than that of PCs now, once the handset business reaches scale, say around 10% of sales in two years, margins should exceed that of PCs helping overall profitability.



Derek Hillen, CAIA


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