Enzio's Clock

Background

1. Tea leaves

In today's Bloomberg we read that Premier Wen just stated that China would stay the course concerning her stimulative monetary and fiscal policy. The reason for staying the course, the Premier said during his three day visit to eastern Jiangsu Province, is because exports are dragging growth down. 

So most of China's officials have been saying loudly that China will keep expanding fiscally and monetarily. Indeed, the Vice Chairman of the powerful National Development and Reform Commission, Zhu Zhixin, just re-iterated that weak domestic demand requires government stimulus.

China is stuck between a rock and a hard place. If her leadership throttles growth overtly, the place will crash; however, if Beijing does nothing, the crash is merely postponed.

So how do you interpret "official" announcements? Just as you would anywhere else: ignore them and read between the lines, i.e. the tea leaves. 

Courtesy of our South China Morning Post of this Saturday, page B1, we were given plenty of tea leaves to read from.  Here is a synopsis of what really has been happening (as opposed to what is just being said officially):

• "Early June. The China Banking Regulatory Commission (CBRC) and the Ministry of Finance (MoF) urge mainland banks to strengthen their financial and risk management while further supporting the nation's economic growth;
• Early July. Wang Huaqing, the disciplinary secretary of the CBRC, warns banks should carefully control credit risks while extending loans to support growth;
• Mid-July. The Peoples' Bank of China (PBOC) tells commercial banks to more closely monitor rapid growth in lending over concerns that some of the new money is flowing into speculative stock and property investments rather than the real economy;
• Mid-July. The Shanghai Branch of the CBRC issues a notice to local lenders asking them to strictly review mortgage applications to ward off potential defaults;
• Late July. The PBOC says the relatively rapid decline in the capital adequacy ratio and enhanced risk management by mainland banks may contain growth in new lending in the second half;
• Late July. Wu Ziaoling, a former deputy governor of the PBOC, says it will not be surprising if the central banks raises banks' required reserve ratio soon, a move that can slow lending;
• Early August. The PBOC says it will use 'dynamic fine-tuning' and guide 'appropriate' loan growth, and
• 7th August. China Construction Bank (CCB) President Zhang Jianguo says that CCB will "...cut lending by about 70 per cent in the second half to avert a surge in bad debts."

Notice in all of these the amount of hinting that goes on, equating to a crescendo on 7th August when the very public CCB goes on-stage and tells the world of its lending intentions.

So the government wants stable growth - but it also wants stock market stability. The latter point was confirmed recently by MoF Vice Minister Ding Xuedong. 

The bottom line is this: watch the lending behaviour of individual banks. You can read the tea leaves far more accurately by what they are doing than by seeking to get guidance from official pronouncements. Officially, Beijing must tow the "eight percent growth" edict. But unofficially, it will tell banks to prune their lending exposures back to more prudent/safe levels. That goes not only for overall "macro" amounts of money being lent-out, but also applies to which sectors will feel the heat the most.  Do you need a PhD in clairvoyance to figure ou what CCB's Mr. Zhang was intimating when stating that 'I feel some industries are expanding too rapidly. For example, housing prices are rising too fast and housing sales are growing too fast."

My guess is that lending to asset classes such as the property and stock markets will be pruned noticeably, while the government will keep spending on "make work" infrastructure projects.

Next to lending of individual banks, watch out for the PBOC's open market operations such as changing reserve requirements and withdrawing funds from the money markets.

3. How to Make Money Off This Idea

1. Always consult your financial adviser first.
2. If you are brave, as I incorrectly have been for months, then short the Chinese market with the ETF, FXP:US, the ProShares UltraShort FTSE/XINHUA China 25
3. If you keep believing in the market, then rotate the sectors and move into infrastructure plays at fair value. Names like China Railway Construction spring to mind.
   
4. Avoid the RMB for now; if China's banks wobble, the currency will tumble in the short term. So don't get into CNY:US for now.