Strategy Bocom June 2013
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Transcript of Strategy Bocom June 2013
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10 June 2013
China Market Strategy Hao Hong, CFA
Outlook 2H13: Auguries of Turbulence (A Preview)
“To see a world in a grain of sand, and a heaven in a wild flower.” -- William Blake
The surge in US 10-year yield is approaching inflection; significant risk-off events looming in 2H: The US 10-year yield is of
singular importance for global markets. Indeed, the ebbs and flows of the 10-year yield have been a chronicle of global
crises and recoveries. It is hardly surprising – the Fed remains the central bank of the world and the lender of last resort
during crises. A surge in 10-year yield shows a drain in global liquidity, and serves as the finest risk-off signal. Indeed, the ’87
Black Monday, ’94 Mexican Crisis, ’97 Asian Crisis, ’00 TMT bubble and ’08 Great Recession were all concurrent with a
dramatic surge in the 10-year yield (Focus Chart 1). Recently, the surge in 10-year yield is once again in focus.
We believe the surge in 10-year yield is nearing inflection, even though the market is still besieged by concerns about Fed’s
tapering. But leading indicators are rolling over and inflation is tamed, and yields should fall, if history is a guide. The other
time the Fed’s balance sheet was at ~20% of GDP was in the early 40s, and the World War II helped normalize it. Once it is
clear that the Fed cannot immediately quit, yields will fall together with the dashed hopes for a strong recovery. And the
rally underpinned by the chimera of growth will soon falter, with the aftermath rippling through the global markets (Focus
Chart 2). If we were wrong and yield continued to surge, the advent of a crisis similar to 1997 or 2011 would simply be
sooner rather later.
China’s liquidity inflow reversing; rate cut won’t help: The inflow of speculative capital disguised under export trades has
plunged. The crackdown on suspicious trades, as well as a change in expectation of RMB appreciation must have disrupted
some carry trades. After all, the most important element of carry trade is the stability in basis difference, but it is vanishing.
And overseas risk-off events can exacerbate funds outflow and drain system liquidity when it is most needed. In the past
few days, China’s interbank market has been under the worst strain since the China bubble burst in October 2007, and
stocks have plunged, offering a glimpse of what is to come.
With deflationary risk looming, the PBoC could opt to cut interest rates. But excess capacity and significant leverage in
private sectors make the economy insensitive to the level of interest rates, and worry about the level of debt instead. And
the fact that 9 trillion yuan of total financing YTD has done little to spur growth evidences that even rate cuts won’t help.
That said, lower rates can alleviate the debt service burden. At this juncture, deficit spending may work, yet the public
sector’s leverage also makes this a difficult choice. It is an impasse that China is facing.
Stocks will struggle amid slowing growth and inflation; a capitulation can see 20% downside; stay put: The Chinese and
the US economies are a symbiosis, as shown by their highly correlated interest rates (Focus Chart 3). If the US stumbles,
China will, too. And vice versa. The drag from slowing investments on China’s economic growth is now evident. Many have
been advocating a structural reform, but are not prepared for the interim pain. As such, market sentiment remains elevated
despite a series of economic setbacks (Focus Chart 4).
In a highly leveraged economy, companies should be valued by their capacity to service debt, rather than their earnings
growth potential. After all, companies could succumb to heavy debt load before their potentials are even realized. Even
estimates of replacement value such as P/B will not serve as a reliable benchmark, as there will be no market to render a
fair price during liquidation. We would use the P/EBITDA ratio instead, as it measures debt servicing capacity. This ratio is
still ~20% above its 2005 and 2008 lows, hinting at further market dislocations ahead. As global risk-off events are looming
large, investors should stay put for now, and resist the temptation of oversold rebounds. Don’t fret about an impending
capitulation. It will be a sale that one wouldn’t want to miss.
(This is a preview of our second half outlook to be published on June 26, 2013.)
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Focus Chart 1: US 10-year yield is a chronicle of global crises and recoveries.
Source: Federal Reserve, Bank of Communications (Int’l)
Focus Chart 2: The surge in 10-year yield is about to turn; EM and China will face looming headwinds.
Source: Federal Reserve, MSCI, HKSE, Bank of Communications (Int’l)
'13 QE3
'93
'81 Oil Cris is
'86
'98
'03
'08 QE1
'10 US Relapse
'11 EU Cris is
'07 Subprime
'97 Asian Crisis
'00 TMT Bubble
'94 Mexico Crisis
'89 S&L Crisis
'87 Black Monday
'73-'74 Severe Bear Market
'70 Recession
'71 Bretton Woods
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1-62 1-67 1-72 1-77 1-82 1-87 1-92 1-97 1-02 1-07 1-12
0
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5yrs
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6-93 6-94 6-95 6-96 6-97 6-98 6-99 6-00 6-01 6-02 6-03 6-04 6-05 6-06 6-07 6-08 6-09 6-10 6-11 6-12 6-13
-100
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10yr Yield (Y/Y Chg, LS) HSI (Y/Y%) MSCI EM (Y/Y%)
?
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Focus Chart 3: The US and China’s interest rates are closely correlated.
Source: Federal Reserve, PBoC, Bank of Communications (Int’l)
Focus Chart 4: Our proprietary Chinese Market Sentiment Index is elevated, suggesting China has not yet bottomed.
Source: Bank of Communications (Int’l)
-2.5
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Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13
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3.0US 10-yr Yield (Y/Y Chg, LS)
China 10-yr IRS (Y/Y Change)
Feb-8-13
Ja n-6-12
Oct-31-08
May-4-12
Sep-30-11
Apr-15-11
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Feb-8-13
Aug-31-12
Ma y-4-12Apr-15-11
Jul -31-09
Jul -2-10 Sep-30-11Oct-31-08
Jan-6-12
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SHCOMP(Log Scal e, RS)
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BOCOM International
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LT Buy: Expect more than 20% upside but longer than 12 months Market perform (“MP”): Expect low volatility
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Sell: Expect more than 20% downside in 12 months
Research Team
Head of Research @bocomgroup.com @bocomgroup.com
Raymond CHENG, CFA, CPA, CA (852) 2977 9393 raymond.cheng
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