UBS Lays Out Their China’s Big Four Themes. Forgets One

Tuesday, October 20, 2009 5:44

Working through my daily dose of analyst reports and journal articles, I came to UBS’s recent release The Four Big China Themes from Jon Anderson where he lays out the bank’s position on four of the key trends that they are following in China.. and closely.

Always stocked with impressive graphs, and supporting analysis, this recent report I think has highlighted several of the biggest issues that anyone (investor, operator, or retailer) should keep abreast of.  those items are:

1. Liquidity tightening
2. Property Sector Rebound
3. The ending of commodity restocking
4. falling trade balance.

However, in reviewing this items, I think it is equally important – if not more so – to understand the wider context of these issues in China, what drives them, and look beyond the standard quarterly outlook to understand what it means for you.

The first is perhaps the one that I have been the least exposed to, but the most concerned about given the wider implications of liquidity.  that, when the crisis first hit, there was no bank liquidity in the market and everyone had to move to a cash system.  A system that apparently many businesses were not so profitable under, and as a result a pullback in nearly ever sector occurred.  Longer term, where this was a concern was that without credit, there was no trade, and without trade there was no real recovery. Or perhaps I should say, the balance in the recovery was not there.  That we would all have to rely on government expenditures to get us by, and the hope that it wil be enough to sustain a measure of growth.

UBS’s picture supports that.  Short term banks, after blowing out the record books on money pumped into the system, have been reeling it in.  Of course, the last 6 weeks or so there are reports that this trend is now back on the upswing, but in general the figures are coming down.  Indicating that in the very near future we should begin looking for fruits of the recovery.

On the issue of property recovery, UBS paints a rosy picture about the role of the property sector:

(i) China’s recovery to date has been more broad-based (and more market-driven) than just a lot of “last-ditch fiscal spending”, and (ii) as noted above, the macro growth numbers are about to become even more impressive as the impact of fiscal-related spending starts to hit the real economy in full strength.

Of course, with a quick look out my window (and a few recent trips to the 2nd tier cities), I can tell you that what is being shown through the graph is really occurring.  there are buildings, highways, and other inanimate objects sprouting up all over the place.  Which is money spent.

But.. will these buildings ever be occupied?  Roads be driven on?  That is the real question for me (and others).  A question still unanswered, and sadly not addressed in the report, and really should have given the trajectory of the lines their graph above clearly show as being UNSUSTAINABLE

Next on their list was commodities, and the “restocking” of these items, which as you can see in this picture could only be described as an all out spending spree.  to date, NO ONE know exactly what has motivated these purchases, or just how many years of supply have been purchased by legitimate users of the stocks, but one thing is clear.. there were many buying commodities who had no business doing so, and that their involvement in the markets have distorted not only pricing, but the analysis of what is happening.

The last issue of highlight, trade balance, and the fact that the balance has become more balanced through the recession, UBS had this to say about the potential for future movements and speculation surrounding the statistical probabilities China enters a trade deficit:

to get from here to an outright deficit next year, Chinese import spending growth would have to outstrip export demand by a hefty 25 percentage points or so – a very unlikely outcome given (i) the sequential stabilization and recovery of exports already underway, (ii) the government’s moves to remove excess liquidity from the system and thus prevent a bubble, and (ii) a pending reversal of the recent commodity import boom discussed above. In fact, according to Tao the most probable scenario is a trade surplus of around US$200 billion in 2010, smaller than this year’s to be sure but still very much in positive territory.

this, I would agree on in theory (because I do not have the numbers).  that the probability that China enters a deficit is too small to even consider, and that were it to, I can only think that it would be caused by a complete collapse of western economies combined with a massive drought that wiped out China’s food stock.  Maybe that is a bit over the top, but it would certainly take a lot to push them into the red zone.

As a wrap up, if there is one issue that I feel UBS sidestepped/ glossed over is the fact that many of the trends that they are using to highlight progress are in many ways reflecting an issue of capacity.  Not only production capacity, but also consumption capacity.  It is one thing  that residential and commercial properties are being built all over a city, and it is another to say that they will be productive.  Commodity wise, it is clear that there are firms who have “overstocked” on steel and other commodities, and equally clear that many of them could potentially lose a lot of money should the market not react in a positive way (commodity based subprime anyone?)

So, while the short term analysis may be sound thanks to the government’s commitment to support the markets, the fact is that many of these trends are highlighting unsustainable trends that each present their out dangers and opportunities for different groups.

If you would like a copy of the report, send me an email, and I’ll be happy to provide.  Otherwise, I’ll encourage you to take some time to do research on the issues you feel are the most critical to you.  To think that we are somehow out of the woods because the DOW crossed 10,000 or because a few retailers are reporting in the positive I think is still premature.

For more on the overcapacity story, I HIGHLY recommend Michael Pettis’s post China’s September data suggest that the long-term overcapacity problem is only intensifying

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