Crumbs
More Inflation … analysis
Labour costs are rising, even in the middle of a pandemic in which nobody of working age has died. Obviously, this is not literally true, but the supply of labour has not been hugely affected by the pandemic. The implication for this are that (i) wages will go up and (ii) housing services will go up in price. A lot of factors impinge on house prices, but over the long term they do track labour income pretty closely.
The other tip that Nordea has is to go long PLN vs EUR. The argument is that Europe is recovering quicker than expected and currencies like PLN and HUF have a ‘high beta’ with respect to the EUR. Sounds plausible, and is supported by recent strong performance of European stocks.
The Red Wall is comfortably orf
The metropolitan idea of what the North is like is out of date and misleading.
Margin requirements
The Fed has the ability to set minimum margin requirements. It has had this for many decades, probably since the 1929 crash, or shortly afterwards. In practice, prime brokers for Archegos could easily bypass these margin regulations. The meltdown of Archegos has faded from the news headlines, but the questions it raises are still relevant. If an unregulated ‘family office’ could be holding positions which represent weeks of normal volume in S&P 500 stocks, how can we believe that the regulations to ensure systematic financial stability are working correctly, and will prevent a crash next time?
As you know, I much prefer structural regulation, that creates an economic incentive for the banks to limit risk, rather than rule-based regulation that creates incentives for risk to migrate to unregulated parts of the market. Total return swaps are not very complicated things.
Fed plumbing
Eccles Building, we have a problem!. Chris Marsh is a wonderful communicator of the subtle problems around the Fed, the Treasury and monetary policy. In this post, he points out that the banks may be reluctant to hold any more longer dated T-notes and bonds. The risk seems to be that if the Fed actually does increase the duration of its funding, it will steepen the curve, and make banks even less willing to hold Treasuries, relative to other assets. The end of the SLR and the move by the public to hold assets in money market funds are all part of the bigger picture. My, uninformed, conclusion is that this is bearish for long bonds. This is certainly ING’s thinking but the markets haven’t responded as of today. The problem is that the primary dealers are well aware that prices signal information, and may be supporting the price on a temporary basis to get through the next auction.
China property market
Grant’s Almost Daily was good. It’s free, but there is no shareable link, so I copy it:
Last call in the Middle Kingdom? The People’s Bank of China has instructed banks to tighten lending standards in order to cool down a red-hot property market, reports the Financial Times. That follows last month’s warning from China Banking and Insurance Regulatory Commission chair Guo Shuqing: “Many people buy homes not to live in, but to invest or speculate,” Guo noted. “This is very dangerous.”
There looks to be plenty of room for a downshift. Medium and long-term consumer loans, mostly mortgages, ballooned to a record RMB 1.4 trillion ($210 billion) over the first two months of the year, up 72% from pandemic-addled 2020, while new home sales rose by 133% from a year ago. Last year, Nationwide house prices jumped 8.7%, far outpacing the reported 2.3% rise in GDP. On Jan. 1, Beijing debuted its “three red lines” policy, which limits developers’ net debt at 100% of equity and liabilities at 70% of total assets while mandating that short term borrowings must not exceed cash reserves. Those who fail to comply are barred from further borrowings.
To be sure, aggressive borrowing is endemic across China’s corporate sector, not least in housing-related enterprises. Citigroup economist Li-Gang Liu calculated that some 600 listed companies in China sport leverage ratios at least 20 percentage points above their sector averages, representing a combined RMB 11 trillion in market capitalization, equivalent to one-sixth of the total stock market. Among that highly indebted contingent, a 100 basis point increase in the benchmark lending rate would consume the equivalent of 30% of their bottom line to meet that increased interest expense. Within the cohort of notably leveraged property developers (accounting for roughly one-third of the total group), that same 1% tightening would gobble up 42% of their bottom lines.
Those facts color the efforts of China Evergrande Group (3333 on the Hang Seng), the nation’s largest property developer and Asia’s most prolific high-yield debt issuer, to put itself on the right side of the new regulatory regime. Evergrande announced on last Wednesday’s earnings call that it plans to cut gross debt to RMB 590 billion by June 30 from the current RMB 674 billion, then to RMB 450 billion and RMB 350 billion in 2022 and 2023, respectively. Currently coloring outside each of the three red lines, Evergrande management predicted that they will be in compliance with two of the three directives by Dec. 31, and all three a year after that.
Divestitures from Evergrande’s hodgepodge of side businesses, including a 10% stake in online home and auto sales portal FCB Group for a projected $2.1 billion, are central to the deleveraging strategy. Yet listless recent performance from the conglomerate’s core operations may undermine those goals. Evergrande generated RMB 507 billion in revenue last year, well below the RMB 566 billion analyst consensus. So-called adjusted core profit slipped by 26% to RMB 30 billion, while gross margins fell to 24% from 28% and 36% in 2019 and 2018, respectively.
Indeed, the bond market remains skeptical. B1/single-B-plus rated Evergrande’s senior secured, dollar-pay 8 3/4% notes due 2025 last changed hands at less than 80, equivalent to a 15.52% yield-to-worst and 1,459 basis point spread over U.S. Treasurys.
Evergrande is far from the only developer caught offsides by the recent sea change. Last week, Shanghai and Shenzhen-based Yuzhou Group Holdings Co. Ltd. (1628 on the Hang Seng) disclosed a drop in 2020 earnings to RMB 117 million, 97% below its 2019 bottom line of RMB 3.61 billion, earning a downgrade to B1 from Ba3 at Moody’s Investors Service. The company subsequently told investors that revenues over the first half of 2020 are likely to be restated to as little as RMB 7 billion from the RMB 14 billion reported last August. Management is said to be seeking a waiver on an interest coverage covenant governing a dual currency loan signed last month.
By Yuzhou’s lights, outside forces were responsible for that dramatic reassessment. According to a Wednesday dispatch from Bloomberg, the company attributed that profit and revenue evaporation to auditor Ernst & Young’s “strict” revenue recognition standards, which prevented the company from consolidating certain projects onto its balance sheet.
Sure, blame the umpire.
Wrap
A bit more news flow today:
- strong PMIs from Canada,
- US trade deficit now USD 71.1 B, the biggest on record,
- US consumer credit growth very strong: up $27.58B, highest since 2017,
- Germany records a PSBR of €289.2B, the biggest since re-unification,
- Fed announces that it is unbothered by increases in yields, and unconcerned about fintech stocks pumping.
Markets were generally calm:
- 10Y pretty flat, at 1.67%,
- Commodities pretty flat, food up, copper down,
- Some Ponzi names ($TSLA, $ARKK, $CVNA) down, but generally stocks flattish,
- DXY flat.
$GSX GSX Techedu a reminder to those that think this is cheap - one morning you will wake up to find this as per Luckin Coffee. pic.twitter.com/kRLWjBKGw8
— Vince Stanzione (@Vince_Stanzione) April 7, 2021
Michael Burry Deletes Twitter Account
History doesn't repeat, it Rhymes
— Ragnarök Imminent (@blane9171) April 7, 2021
Dan Ives: Phua Young
Adam Jonas: Henry Blodget
Fred Lambert: Dennis Kneale
ARKInvest: MunderNetNet
And then there is Eroom's law - the observation that drug discovery is becoming slower and more expensive over time pic.twitter.com/HIlpb6Wf02
— srivats sivanandan (@srewats) April 6, 2021
Chart
Thoughts
The explosion of the cost of drug discovery, linked to increasing regulation of drugs is interesting (see Twitter thread above, Eroom’s Law, srivats sivanandan. Normally, people think: sure, what harm can it do to make sure that stuff is safe and properly regulated? Nobody wants a repeat of the Thalidomide scandal. But the brutal fact is that the drug companies welcomed the increased regulation, as it deepened the moat protecting them. Politicians were in favour of it because, well, who doesn’t want to be safe and protected from untested medicines, right? This is just another example what is seen, and what is unseen. All the new treatments that were uneconomic, because not enough patients needed the treatment to cover the costs of tests. All the research that would have been done if pharma research was not directed into producing symptomatic relief for rich world sufferers from chronic conditions.
Bastiat understood all this around the time of the French Revolution, and I’m sure most serious politicians are aware of what they are doing, but they also understand that if they want to be elected, they’ll have to play along, because this is just too difficult to explain, just like pointing out that saving a few thousand jobs in a steelworks is probably going to cost far more jobs in the economy as a whole. Well, maybe one day schools will teach economics as a mainstream subject … maybe.
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