ProTips from Andrew Polk, Trivium China

On April 24, equity analysts interpreted a phrase used in a Politburo meeting readout to signal a new round of economic stimulus. And, the Shanghai stock market, one of the world's worst performers, spiked 2%. 

On April 25, having much earlier advised and protected clients, Andrew Polk of Trivium China published an analysis in Trivium's daily (and free) 'Tip Sheet' that explained why the market had gotten the signal wrong - there was no stimulus coming.

Later, Andrew and I talked about how he reached his conclusions. His explanation is a masterclass in how experience, discipline, and some tedious slogging, combined with a sound analytical framework, lead to good China analysis.

'With government restructuring, the biggest thing is the creation of an entirely new branch of government: the National Supervisory Commission. Its entire job is to overlook every single public official in China. It is an institutionalization and deepening of the corruption crackdown that we've seen over the past few years.'

In all, Andrew highlighted four major actions from the Two Sessions:

1. Chinese government restructuring 
2. The policy roadmap 
3. Personnel 
4. The legislative agenda + the constitutional amendments 

1. Supply-side Structural Reform
2. Innovation
3. The “three critical battles”
4. Deepening reforms
5. Rural revitalization
6. The regional development strategy
7. Increasing consumption and improving investment
8. Opening up
9. People’s wellbeing

U.S.-China trade war: collateral damage

Consider the soy bean. 'China is threatened retaliatory tariffs on U.S. soybeans. The U.S. is one of the largest producers of soybeans. If China's not going to buy them, we're going to have an excess capacity.'

• 'So, last week, we saw a soybean selloff.'

'But there was a complete dislocation in whole soybean supply chains. Downstream products, like soybean oil, didn't move at all in the same way.'

What's the root cause of the current friction between the U.S. and China? The West's disappointment that China did follow the western model but its own, argues Ed Tse, CEO of Gao Feng Advisory Company (a member of the China Analyst Network).

Ed's solution: look to the similarities between China and the West, especially in the tech sector, and be alert to China's evolution toward better IPR,  market access, and other contentious issues, not just the remaining shortcomings. 

Below is a video of my discussion with Ed and excerpts from both the interview and his South China Morning Post op-ed, 'Chinese innovation with US characteristics? Maybe China and the West aren’t that far apart, in business at least.'

Ed presents insights that differ greatly from the China Echo Chamber in the U.S. Let me know what you think.

'The currency markets are embroiled in trying to figure out whether the Trump tariffs on steel and aluminum are good or bad for the U.S. economy and the U.S. stock market.'

Ed Tse, founder of the Gao Feng consultancy and the leading expert on Chinese innovation, introduced me to New Retail in a recent conversation. You will find his explanation of New Retail below, along with a couple of videos showing New Retail in action - as amazing today as Minority Report seemed years ago. Perhaps even more amazing is the China business strategy, the 'Third Way,' that made things like New Retail possible. Ed explains the Third Way in Part Two of our discussion that I will be posting soon. Chinese do do things their own way, as the Third Way again demonstrates. For now, have a look at the future today. And, stay tuned for Part Two for Ed's explanation of the Third Way that made New Retail possible.

Leland points out that President Trump's really big trade move against China yet to come, that is, Section 301 penalties. If you aren't up to speed on 301, you will be after you read and watch Leland's comments. As Leland says, with Section 301, 'regardless of how Section 232 steel and aluminum tariffs end up in the next few days - you're seeing the beginning, not the end, of Trump's aggressiveness on trade.' 'And, I don't think people have prepared themselves yet for the fact that 301 is coming.'

What is not natural is China’s bad track record on debt: according to the Bank of International Settlements, every measure of debt — consumer, government and corporate — has risen as a share of GDP for the past decade. China went from a low-leverage country in 2007 to having a worse debt position than the US in 2017, despite the fact that the US itself has borrowed heavily.

Bill Overholt and I recently had a discussion about the points he makes in his new book, China's Crisis of Success. Here are five key points, each corresponding to a section below.

The Rise of China: How Economic Reform Is Creating a New Superpower by Bill Overholt, published in 1993, was called 'nonsense' and 'too optimistic.' How did that work out for the reviewers? 

Now, almost three decades after The Rise of China, Bill believes that China's future has become 'much more uncertain.' And, he addresses his concerns in a new book, China's Crisis of Success.

Bill outlined some the key points from his book recently in an interview with me. And, I have conveyed these below. As you will see, I have let Bill speak for himself. 

Bill was right in 1993. 

China's Crisis of Success—1

'Why is this sense of terrible crisis a prerequisite for an Asian economic take off? Because it creates a certain political environment.'...'The counterpart, on the economic side, is an economic simplicity.' says Bill Overholt.

China's Crisis of Success—2

'Simple economies and politics have been replaced with immensely complex ones. And you gradually get to a point of complexity, where there is an economic and political crisis of some kind.'

China's Crisis of Success—3

'What the Chinese have effectively chosen is much slower reform in order to keep the economic growth rate up around 6.7%.'

China's Crisis of Success—4

'Second, they realized that these reforms are painful, and so there's going to be a lot of pushback from all the important power groups of Chinese society. So, they used the Anti-Corruption Campaign as a hammer to push aside these groups who were resisting reform.

China's Crisis of Success—5

Bill Overholt believes 'Xi Jinping may have gone well beyond what the consensus originally intended, and the politicization of the reform may not be exactly what some of the designers of the reform intended.

One of the highlights in our recent 'In Pursuit of Patterns' series of client notes, showed that the land sales growth had tended to lead the price growth and a significant increase in land sales would lead, with a lag, to the subsequent correction in prices.

Besides Alibaba and Tencent, companies like Ping An Insurance Group, Baidu and JD.com are building out mega ecosystems with incredible speed and intensity. Even some traditional manufacturers are moving in this direction. Zhejiang Geely Holding Group has gone from producing entry-level cars to selling premium models with the help of foreign acquisitions and has been the first Chinese carmaker to move into on-demand mobility services. It has also been experimenting with connected intelligent vehicles, shared ownership programs and flying cars, together assembling a sprawling transportation services ecosystem.

'The RMB did not like the trade data at all, and it weakened immediately - over 1% today.' 'Overnight, the world has moved a little bit away from its U.S.-centric obsession about equity volatility in the United States and around the world to what's going on in China,' says Bob Savage, CEO of TRACK and member of the soon-to-be-launched China Analyst Network.

But he can’t keep saying China is ripping us off and he’s going to stop it unless the US targets the biggest imports. The trade deficit with China is bigger than with the next eight countries combined. NAFTA? The trade deficit in cell phones and computers alone with China is bigger than the trade deficits for all goods with Mexico and Canada combined.

There's a lot to follow in China. And, I had missed reports about the opening of the Shanghai International Energy Exchange or INE, likely this quarter. But, during my interview with Bob Savage, the well-respected analyst of global markets and CEO of TRACK, he told me the INE could be the 'story of the year.' That's a big - and interesting - claim about something that seems like one more ho-hum Chinese entity. Bob explained that the INE will create the an RMB-denominated oil futures contract. The first such contract in a petrodollar world, where China is largest crude oil importer. If RMB oil contracts - even just for trade with China - catch on, then the whole global oil trading regime will change. And, given the massive size of the global oil trade, a shift from dollars to RMBs will both erode the dollar as a reserve currency, and push the RMB closer its goal of becoming a full reserve currency.

How does an obscure factor like hiring practices impact firm valuation? That was the question posed by Deutsche Bank’s quant strategy group in a 2015 whitepaper titled, “Macro and Micro Jobenomics.” The report concluded that online job postings could be used to predict U.S. macroeconomic statistics and equity market returns. This piqued my interest – I wondered whether a similar process could be used for valuing A-share companies in China.

The State & Party's technical prowess is somewhat limited.

1. 'China goes private.' Tony Saich discusses the Xi and the Party's move toward toward greater control of private business, especially the tech/Internet sectors. 
2. 'It's the politics, stupid.' Tony explains why Xi focused first on trying to bend Chinese society and the State to his and the Party's will.
3. 'The State and the Party.' Tony details the problems the Party has in getting the State to implement its policies, and why.

China Deleveraging Insider tracks the status of China’s financial de-risking initiatives and the state of deleveraging.

The most recent data from the PBoC and the CBRC show that bank asset growth hit a fresh all-time low in October. That means China is actually deleveraging – a little. It’s slow and slight, and done with a bit of trickery, but the debt load has shrunk in comparison to the size of the economy.

1. Pieter, in our interview, warned that China's shift from pragmatism to ideology could weaken the quality of the technocrats' economic policy making and regulation, and thereby hurt economic stability and growth. 

2. Pieter believes China has avoided a hard landing, thanks especially to technocrats who manage the property sector. 

3. I employ one of my favorite real estate graphics to demonstrate - using data - just how well, in fact, the technocrats manage the property sector. And, the impact less competent technocrats could have.

Real Estate Foresight has published a series of notes to clients under the theme “In Pursuit of Patterns”, revealing some interesting patterns (or lack thereof) found among the key indicators for the China’s housing markets (house prices, sales volumes, land sales) and their relationship to the overall stock market and Chinese developers stocks

The Chinese economy is strange in many ways. Not only is it a hybrid between private capital and state control, but very few people directly invest in the mainland — and yet everybody is interested in how the second largest economy in the world is going to develop. That’s because Chinese demand determines the prices of world commodities, and the operations of multinational companies in China impact earnings. When the yuan falls, markets across the world get jittery. China watchers accept the fact that official Chinese data is severely flawed, and often simply fabricated, yet they still use it to analyze the Chinese economy and markets because there are few alternatives. One alternative, however, is the China Beige Book International (CBB), a research service that interviews thousands of companies and hundreds of bankers on the ground in China each quarter. They collect data and perform in-depth interviews with Chinese executives.

For over a year, commodities bulls have feasted on China. In the aftermath of the recent Communist Party Congress, many investors are now drooling over the prospect the boom will continue, based on Beijing’s promises to supercharge its campaigns against overcapacity and pollution this winter. If such pledges are fulfilled, the thinking goes, substantial chunks of steel, aluminum, and other refining capacity will be taken offline, rebalancing markets and providing rocket fuel to already frothy prices. 2018 could prove to be an even more amped-up version of 2017.

The continued growth of China’s auto sales has relied increasingly on consumer credit, according to the WSJ; but, granular data is hard to come by. So, we created a process to collect, clean, and structure data from online auto loan offerings. Our findings imply that the auto loan market, like many credit markets in China, runs on two parallel tracks, and is woefully inefficient.

'The RMB did not like the trade data at all, and it weakened immediately - over 1% today.' 'Overnight, the world has moved a little bit away from its U.S.-centric obsession about equity volatility in the United States and around the world to what's going on in China,' says Bob Savage, CEO of TRACK and member of the soon-to-be-launched China Analyst Network.

China’s banks are directed by the state, without irony, to “vigorously promote reasonable home ownership.” Their most recent annual reports repeatedly bury in the notes this line, or some variant of it, as an explanation for the explosion of mortgage lending over the previous 12 months. Granular mortgage data however, is hard to come by – so we created a process to collect, clean, and interpret that information.

Price trends in China’s housing market are unsustainable, according to Real Estate Foresight chief executive Robert Ciemniak who worries that excessive leverage among homeowners could lead to a crisis. Real Estate Foresight founder and chief executive Robert Ciemniak has made it his business to gather and interpret real time data on China’s residential property market. He gives his thoughts on what’s to come in China’s housing market.

In the early 1990s, when China was still struggling to shrug off the straightjacket of its planned economy, the man appointed to lead the first business consulting firm allowed in the nation was immediately confronted with the scope of the challenge ahead.

At the heart of China's economic take-off during the last four decades is a fragile equilibrium between economic reforms and one­ party rule. The communist party has demonstrated pragmatism and adaptability - but just at a time when China seeks to fully enter the knowledge economy and participate in global markets, it has put the brake on further reforms.

The question we should ask ourselves is, how many of China’s corporate borrowers are paying off existing debt with new debt?

Outside observers paint China’s stock markets as a casino, where picking stocks requires as much skill as roulette, and investors avoid the country in their portfolio allocations. Patterns exist, however, if you know where to look.

The Chinese economy is strange in many ways. Not only is it a hybrid between private capital and state control, but very few people directly invest in the mainland — and yet everybody is interested in how the second largest economy in the world is going to develop. That’s because Chinese demand determines the prices of world commodities, and the operations of multinational companies in China impact earnings. When the yuan falls, markets across the world get jittery. China watchers accept the fact that official Chinese data is severely flawed, and often simply fabricated, yet they still use it to analyze the Chinese economy and markets because there are few alternatives. One alternative, however, is the China Beige Book International (CBB), a research service that interviews thousands of companies and hundreds of bankers on the ground in China each quarter. They collect data and perform in-depth interviews with Chinese executives.

'America's trade problems are not the consequence of China's policies.'

'America's trade problems are not the consequence of China's policies.' 'How much of that $650 iPhone - which adds to China's trade surplus with the U.S. - actually originates and stays in China? — Only $25.'

Prices spike in a city. The government puts the screws on the market, and prices go down. Investment then switches to a city with lax policies. Housing prices spike; regulations tighten; prices go down. Investors move on. And so on, and so on.

But, the biggest threat in the near term is that Xi Jinping will see OBOR as an alternative to completing the economic reforms promised - but not delivered - in 2013's Third Plenum.

'I find evidence for dramatic size and momentum effects; that is, small stocks and recent winners are the top performers in China’s stock market. Additionally, I find that high-beta stocks modestly underperform low-beta stocks.'

In fact, high yields still haven’t filtered down to borrowers. Using industrial enterprise economic indicators data, I estimated the actual interest rate paid by Chinese borrowers. Over the past six months – as corporate bond yields, SHIBOR, and WMP yields all rose dramatically – the actual interest paid by China’s industrial enterprises fell to an all-time low.

'What President Trump has done is to signal we are willing to move away from this formula that the North Koreans have to give up everything in their nuclear program before negotiations - only then we'll talk with them. I admire our U.S. negotiators, but that formula is simply absurd.'

In fact, high yields still haven’t filtered down to borrowers. Using industrial enterprise economic indicators data, I estimated the actual interest rate paid by Chinese borrowers. Over the past six months – as corporate bond yields, SHIBOR, and WMP yields all rose dramatically – the actual interest paid by China’s industrial enterprises fell to an all-time low.

Additionally, given the incentives of regulated institutions everywhere, it is likely that risks have simply begun to migrate to new and more opaque parts of the balance sheet. As China watchers, we should prepare for yet another game of financial risk whack-a-mole.

Last year, I debunked a popular measure of trade misinvoicing as the culprit for China’s capital outflows. Today, let’s scrutinize two other misconceptions bouncing around the China commentator echo chamber.

Almost everyone on the outside seems to have missed the biggest bull market in China housing in 2016, culminating in policy tightening cycle kicking in at the end of the year. But what's next?

Hard on President Trump's 'American First' inaugural address, Xi Jinping gave a rousing paean to globalism at the World Economic Forum. And, immediately the hot question became: 'Is the U.S. ceding global leadership to China?'

Yes and no, says Bill Overholt of the Harvard Asia Center. Yes, the U.S. is ceding global leadership. No, China won’t replace the U.S.

What will replace the U.S. is ‘G-Zero’, a world with no single global leader. Not China, not the U.S.

So, can his critics lay this outcome at President Trump’s feet?

One is some of the local government-owned SOEs are the sources for overcapacity. The reason is because the local government also wants to ensure there's some degree of employment locally, and perhaps some source of taxation. The Chinese government is now going to need to start the so-called supply-side economics to try to consolidate overcapacity in a number of sectors. It's going to impinge on the interests of many of these local SOEs as well as the local governments who own them.

'...SOEs need to reform, because on one hand, many of them have achieved a lot for China. On the other hand, they've actually created quite a lot of harm, in particular in the areas of overcapacity but also in the areas of corruption we've talked about.'

One is some of the local government-owned SOEs are the sources for overcapacity. The reason is because the local government also wants to ensure there's some degree of employment locally, and perhaps some source of taxation. The Chinese government is now going to need to start the so-called supply-side economics to try to consolidate overcapacity in a number of sectors. It's going to impinge on the interests of many of these local SOEs as well as the local governments who own them.

1. Meet the AmCham China Chairmen

2. 'U.S. companies feel less welcome in China.'

3. 'On trade, reciprocity should rule.'

4. Trade & Innovation

5. Open China’s Markets to U.S. Business

6. ‘Is Jack Ma right, will e-commerce create U.S. jobs?’

• [Q&A] Dennis Wilder, Georgetown University, Assistant Professor of Practice & Senior Fellow at the Initiative for US-China Dialogue on Global Issues

7. ‘Has China decided Foreign Direct Investment isn't so important for them?’

• [Q&A] Pieter Bottelier, Visiting Scholar, School of Advanced International Studies, Johns Hopkins University (SAIS)

8. ‘How do we solve the problems between the U.S. and China?’

• [Q&A] Christine Vick, The Cohen Group

9. What's the most pressing challenge now? 

• [Interview] Bill Zarit, Chairman of AmCham China, Senior Counselor, The Cohen Group

10. 'China's Got To Realize The Gig's Up' 

• [Interview] James McGregor, Chairman, APCO Worldwide Greater China region | former Chairman of AmCham China (1996)

11. 'Re-look WTO agreements with China.'

• [Interview] Dennis Wilder, Georgetown University, Assistant Professor of Practice & Senior Fellow at the Initiative for US-China Dialogue on Global Issues

12. ‘Biosciences, healthcare, consumer, all opportunities.’ 

• [Interview] John Watkins, Former Chairman of AmCham China (2009 – 2010) and senior business executive] 

13. 'China: explain why markets not open.'

• [Interview] Lester Ross, Wilmer Hale, Partner-in-Charge, Beijing Office

James McGregor is being interviewed by Sheryl WuDunn at a CHINADebate event in Washington, D.C.

'One of the problems in the U.S. is we're always worried about the relationship. Let's make China worry about the relationship for a while. China's got to realize the gig's up, that they had a really good run, and that now it's going to be reciprocity. It's going to be fairness. If they want to do business with America and Americans, then they've got to open their markets the way we have.'

'China is a one–party state, but that does not necessarily mean Chinese leadership is a monolithic group with leaders who have the same ideas, same background, same world views, same politics. No, they're divided.'

In this interview, Mr. Malcolm Riddell warns of the potential for new conflicts if Donald Trump follows through with his campaign promises regarding China. As an investment banker, diplomat, lawyer, Harvard academic, and CIA spy, or Riddell brings 40 years of experience working on China issues. He is CEO of RiddellTseng, a China-focused boutique advisory firm, and creator of CHINADebate and CHINADebateTV, which bring together leading China experts and decision makers for discussions of the issues that inform China and China-impacted decisions.

The real force in Chinese economy is increasingly private companies, not SOEs. / Leading private Chinese companies are innovative and ambitious

100s of Cities Bubble Up & Down As Policy Makers Press the Levers China hasn’t collapsed. And, the bubble hasn’t burst because there may not be just one big real estate bubble. Instead, there are 100s of sizable cities, each moving in its own cycle, each responding to how its local policymakers stimulate & tighten-stimulate & tighten, and each having performance divergent from that of other cities. Watch here to see how city-level markets bubble up and bubble down...