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Daily Intelligence Briefing


Tuesday, October 15, 2019

Identifying Change-Driven Investment Themes – Five sections, explained here.

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I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Chinese Financial Failures Become a “Fact of Life” as Regional Banks Fade →

Summary: The outlook for China’s regional banks appears to have worsened in the months since the Baoshang Bank bailout, the first government takeover of a bank in over 20 years. 2 more financial institutions met the same fate as Baoshang since June and the Chinese government expects more to follow. They’re also now allowing losses to be absorbed by certain investors and creditors of these firms, largely other banks within the Chinese banking system. Demand is now drying up for shares of Chinese regional financials, even at deep discounts, as shadow lending quietly rebounds in the country that previously declared war on it. Read more +


II. Updates of Themes on MRP’s Radar

Follow-up analysis of key market drivers monitored by MRP.

Retail: The ‘retail apocalypse’ is an apparel apocalypse

Dollar: Why Central Banks Are Dumping the Dollar

Payments: Treasury Secretary Mnuchin says libra backers dropped out because the project is ‘not ready’ to meet regulatory standards

Payments: Blockchain turns cars into payment vehicle for drivers

5G: Verizon is looking to implement a fiber alternative to scale 5G deployments

Endnote: U.S. Recession Chances Hit 27% Within Next 12 Months: Tracker


III. Joe Mac’s Viewpoint

Founder Joe McAlinden’s big-picture analyses of macro issues. More about him here.

September 30, 2019: Verbal Intervention →

August 30, 2019: The Booming Buck →

July 26, 2019: Spiking the Punch Bowl →

June 28, 2019: A Review of MRP’s Change-Driven Themes →


IV. Active Thematic Ideas

MRP’s active long and short themes, with an archive of follow-up reports.

See Them Here →


V. Macroeconomic Indicators

Key data releases relevant to MRP’s Active Thematic Ideas.

See Them Here →



Chinese Financial Failures Become a “Fact of Life” as Regional Banks Fade


The outlook for China’s regional banks appears to have worsened in the months since the Baoshang Bank bailout, the first government takeover of a bank in over 20 years. 2 more financial institutions met the same fate as Baoshang since June and the Chinese government expects more to follow. They’re also now allowing losses to be absorbed by certain investors and creditors of these firms, largely other banks within the Chinese banking system. Demand is now drying up for shares of Chinese regional financials, even at deep discounts, as shadow lending quietly rebounds in the country that previously declared war on it.


Chinese regional lenders had boomed over the past decade with rapidly expanding balance sheets courtesy of a state-led spending spree. But there are growing concerns some may have grown too aggressively and will struggle to weather China’s economic slowdown as the central government is preparing to finally begin cutting back on huge support it used to guarantee for troubled banks. According to a research note published by S&P Global Ratings in late August, some lenders, particularly those in poor cities and rural areas, may have to merge with larger players or exit the market, the ratings agency said.


Just this past summer, the Chinese government had to bail out 3 mid-tier banks. MRP previously highlighted the deteriorating situation of China’s regional banks in May, following the first of those bail outs, which saw the government take control of Baoshang Bank Co. Prior to this, Chinese authorities had not seized a bank in more than 2 decades. Baoshang’s troubles ended up being a turning point for China’s attitude toward their financial sector as regulators saw to it that a portion of losses were absorbed by investors and creditors. This was an effort to end broad assumptions about capital injections and make creditors take responsibility for their evaluations of counterparty risk. South China Morning Post reports wholesale creditors like Bank of Guizhou suffered impairment losses of up to 10% of their net exposures to Baoshang Bank.


While this 10% is not a backbreaking loss in itself, a spree of financial failures could eventually set off a crisis that effects the broader Chinese banking sector, which may not be properly capitalized. A Financial Times analysis of 33 listed Chinese banks, using data from Wind Financial, shows 21 of them ― including the big four state lenders ― fell short of capital requirements set out by global regulators at the end of the second quarter this year.


Chinese banks are trading at a distressed level in Hong Kong, at an average of 0.6 times their forecast book value. Bloomberg reports that The MSCI China Banks Index, comprised of larger companies, has lost 2% this year, compared with a 1.8% gain for the benchmark Hang Seng Index. Among the country’s smaller banks, the worst performers include Bank of Jinzhou, which has tumbled around 58% this year, and Bank of Tianjin, which has dropped by almost a third.


Jinzhou was another bank recently bailed out with $419 million in recapitalization funds. On September 29, however, the bank said it would need to raise an additional $866 million from domestic investors to shore up its capital base.


Jinzhou serves as a case study in how suddenly Chinese regional banks can go from boom to bust: the firm was previously one of the country’s fastest growing banks, raising billions through a successful IPO in 2015, along with a subsequent private placement and preference share offering over the next 2 years. In July, however, the bank reported a loss of $632 million in 2018, a sharp turnaround from its previous reports of profits of $608 million in the first half of 2018 and around $1.2 billion in 2017. Along with the Chinese government pulling the plug on capital support, Jinzhou announced it would have to skip payments to international investors on additional tier 1 (AT1) dollar bonds back in September as a way to weaken investor assumptions of implicit state support and encourage greater differentiation of risk pricing between financial institutions.


Confidence in Chinese financials is beginning to slip to such a degree that investor appetite for shares of rural and regional banks, even at steep discounts, is very weak.


On Alibaba’s Taobao platform, a Chinese court tried to auction off 1.5 million shares of a rural bank in East China’s Zhejiang province for a starting price of $162,000 ― about half their appraised value. After three failed attempts over two months, Bloomberg reports the latest relisting drew only about a thousand views.


That’s not an isolated case. Since May 24, when the Chinese government stunned the market with its first bank seizure in more than two decades, there have been more than 1,400 attempted sales on Taobao of mostly unlisted rural and city bank shares. Even with deep discounts, over half the auctions failed to attract bidders in their first attempt, transaction records show.


As a result, stocks and bonds issued by smaller banks ― companies that UBS Group AG has estimated are facing a potential capital shortfall of 2.4 trillion yuan ― are struggling to find buyers.


Worse, the Financial Times also reports that China’s $8.4 trillion shadow banking industry, an opaque grouping of off-balance-sheet lending from banks, peer-to-peer lenders and credit extended by asset managers, has surged back to life this year following deteriorating economic conditions. “For six months now the non-bank share of loans has been highest on record,” according to a report by China Beige Book International, which surveyed more than 10,000 companies’ credit conditions this year. While China’s government has attempted to crack down on shadow lending in recent years, cutting their total share of loans in the country to just 21%, shadow lenders bounced back, accounting for 39% of total lending in the third quarter of the year, and 45% in the second quarter. Bloomberg notes that many are worried products arranged by independent wealth managers will face mounting losses as China’s economic slowdown deepens and corporate defaults surge.


China’s onshore bond delinquencies peaked to more than $7.7 billion in Q4 of 2018. Although that figure eased to just about $4.5 billion in Q3 of this year, that’s still 1600% greater than it was in Q3 of 2016.


While some ratings agencies, including Moody’s, have maintained a stable outlook for Chinese financials in the face of worsening conditions for regional banks, those ratings are largely in regard to accommodative government policies and an assumption that contagion is unlikely and could be could be contained. Moody’s Investor Service did acknowledge, though, that “the authorities will become increasingly selective in providing support, especially where banks do not pose significant systemic risk”.


While it’s true that China will undoubtedly protect their 4 most systematically important lenders, larger banks are not wholly insulated from losses at smaller banks or backstopped by government funds like they had been in the past. The head of the country’s sovereign wealth fund, China Investment Corporation, Peng Chun, gave a more foreboding message last week, stating that financial failures would be a “fact of life” as economic growth continues to slow ― and that the country’s largest financial institutions had to be prepared to help “turn bad banks into good banks”.


Investors can gain exposure to Chinese Banking via the Global X MSCI China Financials ETF (CHIX).


China Financials (CHIX) vs S&P 500 (SPY)


Source material for today’s market insight…


China Banks

Investors Shun China’s Small Banks Despite Half-Price Deals


Investors are shunning China’s smaller banks as many contend with a growing pile of soured loans, weaker capital buffers and poor risk management following years of breakneck expansion, often through nontraditional financing.


“Most banking licenses are no longer valuable,” said Zhang Shuaishuai, a Shanghai-based analyst at China International Capital Corp. “With the ongoing deleveraging campaign, fiercer competition and tougher regulatory oversight, some smaller banks are fighting a battle for survival. Investors have no confidence in the healthiness and transparency of their balance sheets.”


Recent on-site checks at smaller banks by regulators found issues including loans to unqualified borrowers, the hiding of nonperforming debt and the acceptance of fake signatures. Officials have also clamped down on stockholders who used borrowed funds to pay for their stakes, forcing fire sales of shares, and tightened rules for new investors.


Bank shares up for sale on Taobao are yet another sign of financial distress. Local courts are behind almost all the postings, as they handle investor bankruptcies and try to raise money to pay off creditors. The number of listings on the site this year is up 30% from the same period in 2018.


Read the full article from Bloomberg +


China Banks

China’s troubled banks ‘engaged in blind expansion’ but financial stability remains solid, says central bank chief


PBOC governor Yi Gang has confirmed Beijing placing its hopes on stakeholders, including shareholders, creditors, local authorities as well as regulators, to save troubled banks.


“These [troubled] institutions must take the prime responsibility. Their shareholders must be responsible for their actions, while large creditors must also have the ability to identify risks,” Yi said.


China’s regional banks, which are often backed by local authorities to finance projects, boomed in the last decade with aggressive balance sheet expansion, but as regional economic growth losses steam, many of them are struggling with souring assets.


The problems of regional banks often surface at a time when their true controller is running out of the means to keep them afloat. In the case of Baoshang Bank, the Tomorrow Group, a private conglomerate owned by tycoon Xiao Jianhua, is in disarray since he disappeared from a Hong Kong hotel and returned China to assist with an investigation in early 2017.


Read the full article from South China Morning Post +

China Banks

Mainland banks, pro-Beijing businesses caught in Hong Kong protest cross-hairs


Protesters took aim at some of China’s largest banks at the weekend, spray-painting anti-China slogans on shuttered branches and trashing ATM machines of outlets such as Bank of China’s Hong unit.


Protesters’ growing anger toward the local branches of Chinese banks comes at a bad time for the lenders, as their businesses are also expected to take a hit from the city’s economy facing its first recession in a decade. Hong Kong had 22 licensed banks from mainland China in 2018, the most number of banks from any country, according to the Hong Kong Monetary Authority. The mainland banks accounted for 37% of total Hong Kong banking assets last year.


Also on Sunday, a group of protesters tried to smash cameras over ATMs of Bank of China Hong Kong branch in Wan Chai and spray-painted machine screens, while on Tuesday they threw petrol bombs at the shuttered branch of Nanyang Commercial Bank. On Wednesday, Bank of China Hong Kong said two of its city branches would remain closed due to vandalism. In a separate Chinese statement, the bank expressed its “deepest anger over the illegal violent behaviour”.


Read the full article from Reuters +

China Banks

China intends to boost bank dividends with proposed cap on bad loan provisions, but will this backfire?


China’s Finance Ministry has proposed a new rule that would cap the amount banks have to set aside for bad loans, a move that could boost dividends to shareholders but weaken banks’ capabilities to absorb losses in the future.


The minimum loan loss provision is currently set at 150 per cent of impaired loans – in other words, a bank has to set aside 1.5 yuan (0.21 US cents) for every 1 yuan (0.14 US cents) of loan losses it expects. The proposed new rule would cap the loan loss reserve ratio at 300 per cent.


The proposed rule, which would force banks to pay more dividends to their shareholders, who are mainly fiscal authorities, comes as Chinese governments at all levels are anxious to generate higher revenues.


Setting aside funds for bad loans is integral to China’s prudential banking regulations and is intended to protect the bank’s core capital. But it is not uncommon for Chinese banks to cover up loan risks and underestimate possible losses.


Baoshang Bank, the Inner Mongolian bank that was taken over by China’s central bank in May this year, reported in its latest available annual report a provision coverage ratio of 176.77 per cent at the end of 2016 and a non-performing loan ratio of 1.68 per cent. But the real picture of its asset quality and loan loss coverage is thought to be much worse.


Read the full article from South China Morning Post +



Select a theme to see when and why we added it. Also included is a link to all recent Market Insight reports we’ve written about that theme, allowing you to track its progress.


Agricultural Commodities









Silver Miners



U.S. Brokers









Robotics & Automation






U.S. Pharmaceuticals






Electric Utilities






U.S. Asset Managers








Eurozone Industrial Output Contracts More than Expected


Industrial production in the Euro Area dropped 2.8 percent from a year earlier in August 2019, following an upwardly revised 2.1 percent fall in the previous month and compared with market expectations of a 2.5 percent decrease. This was the tenth consecutive month of contraction in the industry sector and the steepest since December 2018.


On a monthly basis, industrial output increased 0.4 percent in August, recovering from a 0.4 percent fall in the previous month and above market forecasts of a 0.3 percent rise. It was the first monthly gain in industrial activity since May.


Click here to access the data +




China Total Vehicle Sales Decline for 15th Consecutive Month


Vehicles sales in China fell 5.2 percent from a year ago to 2.27 million units in September 2019, marking the 15th consecutive month of decline. It was the lowest figure for a September month since 2015, as sales of new energy vehicles (NEVs) decreased for the third straight month (-34.2 percent to 80,000 units), after the government reduced incentives for purchases of such cars.


Considering the first nine months of the year, vehicles sales declined 10.3 percent to 18.37 million units compared with the same period a year ago.


Click here to access the data +




Germany Wholesale Prices Slip Again


Wholesale prices in Germany declined by 1.9 percent year-on-year in September 2019, after a 1.1 percent fall in the previous month and compared with market expectations of a 1.3 percent decrease. It was the third consecutive fall in wholesale prices


Click here to access the data +




India September Inflation Rate Rises to 14-Month High


India’s retail price inflation rate rose to 3.99 percent year-on-year in September 2019 from an upwardly revised 3.28 percent in the previous month and above market expectations of 3.7 percent. It was the highest inflation rate since July last year, almost touching the central bank’s medium-term target of 4 percent, as food prices rose to an over 3-year high.


On a monthly basis, consumer prices increased 0.55 percent in September, the same pace as in August.


Click here to access the data +




Brazil Leading Economic Index Rebounds, but Weaker than Expected


The IBC-Br index of economic activity in Brazil advanced 0.07 percent over a month earlier in August 2019, rebounding from a downwardly revised 0.07 percent fall in July, but slightly below market forecasts of a 0.1 percent gain. Year-on-year, the Brazilian economy shrank a non-seasonally adjusted 0.73 percent, following an upwardly revised 1.62 percent expansion in the previous month.


Click here to access the data +




Turkey Industrial Production Declines YoY, but Higher MoM


Turkey industrial production dropped 3.6 percent over a year earlier in August 2019, following a downwardly revised 1.1 percent fall in the previous month. That was the 12th consecutive month of contraction in the industry sector, as output went down for capital goods (-5 percent vs 2.1 percent in July).


On a seasonally adjusted monthly basis, industrial output decreased 2.8 percent, after a 4.3 percent gain in the prior month.


Click here to access the data +







The ‘retail apocalypse’ is an apparel apocalypse


“According to the U.S. Bureau of Labor Statistics, from 1977 U.S. Households spent 6.2% on apparel and in 2017 that declined to 3.1% spending on apparel in U.S. Households,” Shawn Grain Carter, professor of fashion business management at the Fashion Institute of Technology, told Retail Dive in an email. “That is a 50% drop over four decades.”


So far this year, 10 of the 16 major retail bankruptcies were filed by companies that mostly or exclusively sell apparel and/or footwear: Forever 21, Avenue, A’gaci, Barneys New York, Charming Charlie, Diesel USA, Payless ShoeSource, FullBeauty Brands, Charlotte Russe and Gymboree.


In its latest analysis of CreditRiskMonitor data, Retail Dive found 28 retailers that could go bankrupt in the next year ― and half sell apparel. In the worse-off list, which includes businesses with a 9.99% to 50% chance of filing for bankruptcy (a FRISK score of 1) ― three are specialty apparel retailers: Christopher & Banks, Destination Maternity and J. Crew.


Globally, the top dozen apparel retailers, on average, saw earnings downgrades of nearly 40% since 2016, according to a note from Morgan Stanley Friday


Read the full article from Retail Dive +


Monetary Policy



Why Central Banks Are Dumping the Dollar


In last month’s quarterly report on central banks’ reserves, the IMF said that the share of the global total denominated in dollars was just short of 62 percent in the second quarter of this year, down 0.76 percentage points from the same period a year earlier. Euro-denominated reserves account for 20 percent.


While the dip is small, the apparent resilience is deceptive. As Alan Ruskin, chief international strategist at Deutsche Bank, points out, the dollar was, during that quarter, the highest-yielding currency in the developed world. In theory, that should have lured in investment at a faster pace than other currencies. Instead, central bank reserve managers ― a powerful force in global markets ― accumulated 3.5 percent more dollars over the year, far behind gains of 17 percent for the renminbi and even 8 percent for the pound, despite the latter’s Brexit-related troubles. Goldman Sachs analysts have said that dollar reserves slipped nearly 4 percentage points over 2017 and 2018


Claudio Borio, head of the monetary and economic department at the Bank for International Settlements, suggested in a speech earlier this year that moving oil trading and settlement into the euro and away from dollars “could limit the reach of U.S. foreign policy insofar as it leverages dollar payments.” But central banks face a tough choice. Neither the euro nor the renminbi has the deep liquidity that dollar markets offer. Yields on eurozone government bonds are deeply negative, while the renminbi remains tightly controlled by the Chinese government, in spite of recent liberalization efforts.


Read the full article from OZY +





Treasury Secretary Mnuchin says libra backers dropped out because the project is ‘not ready’ to meet regulatory standards


Last Friday, Visa, Mastercard, Stripe, eBay and Mercado Pago joined PayPal in announcing they would no longer be part of Facebook’s libra cryptocurrency, which originally had 28 corporate backers. Treasury Secretary Steven Mnuchin said Monday he thinks those companies may have feared government enforcement action.


Mnuchin told CNBC that he met with libra representatives on multiple occasions and has been “very clear … that if they don’t meet … our money-laundering standards and the standards that we have at [Financial Crimes Enforcement Network] that we would take enforcement actions against them. And I think they realized that they’re not ready, they’re not up to par. And I assume some of the partners got concerned and dropped out until they meet those standards.”


The loss of five payments companies could be a particularly large blow to the project, which is already facing scrutiny from governments around the world. The announcements came before the first Libra Association Council meeting in Geneva on Monday.


Read the full article from CNBC +


Blockchain turns cars into payment vehicle for drivers


Five major automakers including Honda Motor begin field tests next month in the U.S. for a blockchain-based vehicle identification system that would let drivers automatically pay for parking fees, highway tolls or even rest stop snacks without using cash or cards. The partnership, which also includes Renault, BMW, General Motors and Ford Motor, developed the vehicle ID system under the Mobility Open Blockchain Initiative, an international consortium supporting such projects.


The group sees the blockchain-based system being used for connected electric autos, with expenditures being recorded and then paid all at once when the vehicle is plugged in to charge.


Read the full article from Nikkei Asian Review +





Verizon is looking to implement a fiber alternative to scale 5G deployments


Verizon has concentrated on building up the fiber backbone it needs to support 5G service. 


The company is now considering Integrated Access Backhaul (IAB) technology as a way to deliver 5G service to areas where it’s prohibitively expensive to run fiber cabling. IAB will allow the telecom to link a tower that has fiber running to it with another tower that doesn’t via a wireless connection, so that traffic from 5G wireless equipment installed on the nonconnected tower is routed to the fiber-connected tower. This will enable Verizon to expand its 5G footprint to areas that are harder to reach using fiber optic cabling.


Reducing fiber costs through the use of IAB will help Verizon increase the speed and scale of its 5G deployment. The telecom is likely to continue to increase its wireline investment ― total capex for 2019 is expected to be between $17 billion and $18 billion, up from $16.7 billion in 2018 ― but it will also be able to capitalize on fiber it’s already deployed with a hub-and-spoke approach, using one fiber-equipped tower to connect one or more additional towers, which will spread its 5G network much faster.


Read the full article from Business Insider +


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