This week saw large cracks starting to emerge in China’s shadow banking industry, making it the most recent victim of the country’s prolonged real estate sector reset.
Key themes for the week include:
- China’s liquidity problem increases investor risk
- United Kingdom (UK) manufacturing reverses 19-month slump
- Hawkish Federal Reserve (Fed) weighs on United States (US) equities
- Iron ore buys into Chinese stimulus hopes
- US Dollar Index bounces off two-month highs
Over the last week a liquidity crisis involving Zhongzhi Enterprise Group (ZEG), a Chinese financial services company, came to light. ZEG has accumulated $137 billion in assets under management over its 28 years in operation through its offering of trust, asset management and private equity services, to name a few. To many, ZEG is considered a ‘shadow banking’ institution which essentially means that it is an alternative source of financing outside of China’s traditional banking system.
One of ZEG’s many subsidiaries, Zhongrong International, recently failed to make payments to investors across at least 30 financial products. It cited liquidity constraints, which are largely a downstream impact of China’s real estate sector downturn. Over the years, China’s shadow banking universe has quietly played the role of pooling excess savings from the private sector and households for deployment towards property finance. For many years this has been a win-win for most stakeholders but has ultimately played a role in causing a speculative property bubble which recently burst. Now, the slump in property valuations has caught up to Zhongrong’s asset and liability matching, and there are concerns of contagion across the broader financial sector.
ZEG has moved swiftly to initiate a debt restructuring process which will involve selling property assets to cover its investors. The fear, however, is that a fire sale could contribute to the cycle of real estate valuation pressure and asset impairment.
The Chinese government has not meaningfully responded to the situation, but has its finger on the pulse, having recently announced that liquidity constrained provincial-level governments are allowed to issue bonds to repay their shadow banking liabilities. Provincial governments run their own off-balance entities known as Local Government Financing Vehicles (LGFV) to raise capital. Beijing approved a maximum of $139 billion debt swap arrangements, which effectively transfers $139 billion of credit risk from LGFVs to the state. However, when compared to the estimated $9 trillion of LGFV and off-balance sheet debt, this figure fades into insignificance.
Amid the complex financial sector stresses, Chinese equity markets have lost ground, with the Hang Seng Index and Shanghai Shenzhen 300 Index falling 8.0% and 4.6%, respectively, since the start of August, following a rally by both indices of around 5% in July. The impact that shadow-bank weakness will have, adds to the factors investors need to consider when calibrating China’s risk profile. These include souring geopolitical relations with the West, a disappointing industrial recovery, deteriorating household sentiment, and deflation.
DATA IN A NUTSHELL
In the US, Advance Retail Sales increased 0.7% year-on-year, outpacing expectations of a 0.4% rise and showing improvement from the previous month. The Philadelphia Fed Business Outlook staged a 26-point swing, to 12 points, painting a brighter picture than the analyst expectations of 10.4 points. Initial Jobless Claims were slightly below the mark, coming in at 239,000 against the anticipated 240,000.
The UK witnessed some positive momentum in June. Manufacturing production showed a commendable growth of 2.4% year-on-year, ending a 19-month spell of declines and significantly ahead of market expectations of just 0.2%. The country’s GDP for the second quarter expanded by 0.4% year-on-year, doubling the forecasted growth of 0.2% and showing a consistent performance from the previous quarter. Core Consumer Price Index (CPI) inflation for July was largely in line with expectations, coming in at 6.9% year-on-year, mirroring the previous month’s figure and just above the expected 6.8%.
China’s economic indicators for July signaled mixed sentiments. New yuan loans came in at ¥345.9 billion, significantly below market expectations of ¥780 billion. M2 money supply growth moderated to 10.7% from 11.3% in the prior month, slightly undershooting expectations. Industrial production also disappointed, growing by 3.7% year-on-year, falling short of the anticipated 4.3% increase and down marginally from 4.4% in the previous month.
South Africa’s economic indicators presented a challenging landscape. June’s real retail sales contracted by 0.9% year-on-year, diverging from the market’s hopeful prediction of 0.2% growth and showing a steeper decline than the 0.7% witnessed in the previous month. The unemployment rate for the second quarter came in at 32.6%, slightly better than the 32.8% market prediction and showing a modest improvement from 32.9% in the previous quarter.
STOCKS CONTINUE TO SLIDE IN AUGUST
US stocks declined and government bond yields hit a 15-year peak after the latest Federal Open Market Committee (FOMC) policy meeting minutes revealed that central bankers are concerned about a possible resurgence in inflation. On Wednesday the 10-year Treasury yield closed at 4.258% marking its highest level since June 2008, up from 4.220% the previous day.
On Thursday US stocks were mixed after decent earnings results from major retailers such as Walmart and Target. The Dow Jones industrial Average rose 0.3% while the S&P gained 0.1% with the Nasdaq Composite losing 0.2%. The above indices have, however, all seen a drop of at least 2.2% in August thus far with the S&P 500 losing 1.7% so far this week.
Walmart lifted its full-year forecast while beating consensus estimates on both the top and bottom line, citing strong demand for its low-priced groceries and wellness products. The retailers US e-commerce sales surged by 24% and the company adjusted full-year consolidated sales to grow by between 4% to 4.5%. Despite the positive figures, the shares were down around 1% in early trading, but have climbed 12.5% so far this year.
Locally the JSE Top40 Index declined by 2.3% for the week, with all the major indices losing ground. Resources led the slide, depreciating by 3.8% for the week with precious metals taking most of the pain. Platinum Group Metals (PGM) miners, Amplats and Implats, lost 16.1% and 15.9% respectively, and were the biggest detractors, followed closely by Goldfields which lost 12.3%. Eastern-and-Central-European owner and operator of shopping malls, Nepi Rockcastle, was one of the few listings in the green this week, gaining 3.2% off the back of a solid earnings result.
CURRENCIES – DOLLAR INDEX HITS TWO-MONTH HIGH
The US Dollar Index bounced off a two-month high, of 103.58, on Thursday as rising bond yields have supported the greenback in August. The release of the hawkish FOMC meeting minutes on Wednesday further boosted bond yields. In addition, positive US economic data is pointing to a resilient US economy, which will further support the dollar and Treasury yields.
Elsewhere the Japanese yen edged slightly higher to ¥146.10/$, after weakening to its lowest level against the dollar since November at ¥146.56/$, having come under pressure due to interest rate differentials between the US and Japan’s extremely low-rate environment. The currency is being closely monitored since it touched the key ¥145/$ level last Friday for the first time in almost nine months, a level that previously led to interventions by Japanese officials in September and October last year.
The rand is trading at R19.07/$, R20.74/€ and R24.27/£.
Sources: Bloomberg, Yahoo Finance, Business Insider, Trading Economics, Reuters.