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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6 Responses to “UBS Lays Out Their China’s Big Four Themes. Forgets One”

  1. anon says:

    October 20th, 2009 at 10:59 am

    great stuff…thanks for the post

    speaking of over-capacity (yes, the pettis post was awesome)…here is another study that rips apart a lot of the “china is a layup” investment themes…

    China’s Investment Boom: the Great Leap into the Unknown from Pivot Capital – download here

  2. Duncan says:

    October 20th, 2009 at 7:10 pm

    This is something I’m trying to work my head around at the moment too. It’s really no surprise that the property market has taken off again, as on top of the liquidity dynamics the regional authorities have a big interest in inflating the real estate market. Local governments have gone on this wild spending spree (debt held by the local government vehicles set up to finance infrastructure build-out had risen from Rmb1trn at end 2008 to around Rmb5trn by the middle of the year – which really puts the November 08 stimulus package into perspective). Their taxes have also plunged, so of course they’re trying to push up the land sales. It’s the only source of real income they have! I think the key figure to watch will be the housing sales number. As you say, you can build this stuff but if noone’s buying then the boom is not going to have legs. My own feeling is that once the pent up rush of demand from buy-to-live buyers has eased (and there are already some signs of that), it’s going to be mainly the speculators again, and they’re not the most stable source of demand.

  3. Y Crane says:

    October 20th, 2009 at 9:16 pm


    Like Jon – whom I have known for many years and deeply respect – you offer consistently accurate perspectives on the enigma known as the Chinese economy. Thanks for this post.

    I suggest you look at Stephen Roaches latest on Asia as well:

    I also add a links to China DSP and AllRoads – FYI

    Best regards and hope to connect with you soon.

    Y. Crane
    (Currently in So. California – go Dodgers and go Angels)

  4. Rich says:

    October 20th, 2009 at 9:23 pm

    @anon – thanks. I made a quick update to your comment to embed the link, nad have it on my to do list (to read the report).

    How is STL weather (sorry.. I peaked at your ISP).

  5. Rich says:

    October 20th, 2009 at 9:26 pm

    @ Duncan.

    Thanks for addding some of what yo uare seeing.

    The point you made adds further concern for me about overbuilding:

    Their taxes have also plunged, so of course they’re trying to push up the land sales. It’s the only source of real income they have! I think the key figure to watch will be the housing sales number

    For me, it is not just about housing sales… it is about laundry and lights. How many people are living in these units (as investment or owner/ occupy), and what the returns are. Will these end up being none performing investments? Investments that the banks ultimately will have to write off?

    Or… will growth on a level like we have never seen before occur and eat up all the extra capacity?


  6. Rich says:

    October 20th, 2009 at 11:33 pm

    @ Yair.

    Long time!

    Jon is perhaps one of my favorite economists, and the first time I saw him speak about economics I was immediately angry that I got such a crap Econ professor. He, and his team, have a huge pool of data, and have some of the best all around analysis I have seen.

    That being said. Economists at major banks have an audience that is a bit different from that of All Roads, and I am trying to translate how a manufacturer (long term investor) or retailer (long term investor) should be reading the news and analysis.

    Were I a short term investor, equities/ commodities, I would find the data valuable and I highly suggest ST investors look at these reports… but again for my readers the context is different.

    Will respond to your email in a few – gotta run into a meeting