Granite Peak Advisory

The existing market narrative claims that government guarantees and FX reserves can contain a deleveraging in China's banking system. 

We disagree.

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 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.

Contact us for the complete auto loan data set.

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.

Last week, the IMF published the results of its 2017 Article IV consultation with China observing that the credit gap, the difference between the country’s current credit-to-GDP ratio compared to its historical trend, has begun to moderate – a sign for tempered optimism. However, I believe this is a flawed indicator and I propose a separate quantitative measure to track China’s debt-related macroeconomic risk.

The largest single-factor study of China's stock markets.

Although China’s stock markets behave differently from developed markets, they aren’t casinos where stock prices lurch with neither rhyme nor reason. Clear patterns have governed the behavior of stock prices in China, even if investors may struggle to take advantage of them.

Despite large and growing debts, China’s borrowers have yet to suffer from a rebound in borrowing costs. Should banks continue to extend credit at below market rates, China’s balance sheet recession will just have to wait.

I have a problem with most commentary on China’s debt. Allow me to propose a solution inspired by Hyman Minsky’s framework of the credit cycle.

Chinese banks have reached an inflection point in the accumulation of investment receivables assets, a source of systemic financial risk. However, 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.

Bond defaults in China’s corporate credit markets, once unheard of, are emerging with ever higher frequency. With a flurry of defaults over the past three months, the total value of defaulted corporate bonds now totals RMB 56 billion. Additionally, once considered immune from default risk, State-Owned-Enterprises now account for nearly half of all defaulted debt.

Chinese data is bad.

Terrible actually, when compared to the financial data standards of the top global economic powers. That statement is a matter of empirical observation, which we will explore later, but it also reflects a consensus and Narrative surrounding the ‘China Story.’ Like all capital-N Narratives, while this one did originate in truth, it now oversimplifies the matter and obscures subtleties which should be important to all strains of China watchers.

U.S. lawmakers are upset with China. Again.

The most recent object of their ire is the aluminum sector, which has amassed considerable overcapacity in the face of falling global demand. In October, eight senators asked the Obama administration to take action against China alleging unfair subsidies to the Chinese Aluminum industry.

Trade misinvoicing is not the main channel for China’s recent capital outflows; a better explanation is Chinese corporates unwinding their carry trade.

Investors have long shunned China’s state-owned enterprises (SOEs) over concerns of misaligned incentives between companies’ management and their shareholders. However, as with most things in China, determining the influence of the state in a given company, and what that means for investors, is a surprisingly nuanced exercise. Ownership is one measure, but financial, management or other avenues of control exist as well.