Chinese puzzle

This piece appeared in Grant’s Almost Daily Faulty Towers. You can subscribe for free via the main website. I enjoy Grant’s take on the market, but this daily letter is as much as I can get through.

Grant’s called out the craziness of the Global Financial Crisis for several years before it finally broke. I feel that the same applies today: Grant’s is right, but early, therefore wrong in a trading sense. But when this market breaks (and it will be a global recession), China real estate developers will get swept away as by a typhoon.

A real estate division of China Oceanwide Holdings Co. (715 on the Hang Seng) defaulted on a $280 million dollar bond earlier this week, Bloomberg reports. The conglomerate, which was only able to repay roughly half that principal sum using the proceeds of a recent private bond offering, stated in a filing that the rest of the funds are forthcoming in the next three months. A scuttled attempt at $1 billion-plus of U.S. asset sales preceded this week’s development.

Oceanwide has been in trouble for some time. Two years ago, the company abruptly ceased construction on a $1 billion downtown L.A. condominium, hotel and retail complex “due to a recapitalization of the project,” as the Los Angeles Times put it.

The property sector remains in focus for all the wrong reasons, as Chinese developers had already accounted for more than a quarter of the $20 billion in missed bond payments this year as of last week, according to data from Bloomberg.

In response, the authorities look to crack down on financial shenanigans within the all-important property realm. To that end, Caixin reports that regulators are scrutinizing mega-developer China Evergrande (3333 on the Hang Seng) for its ties to lender Shengjing Bank. Per the report, Shengjing holds “large amounts” of Evergrande debt on its books, while Evergrande is Shenjing’s largest shareholder.

The pair have a history. Back in summer 2019, Evergrande shelled out RMB 13.2 billion ($2.1 billion) to raise its stake in Shengjing to 36% from 17%, paying a 40% premium to the bank’s share price. Subsequent reports indicated that the Chinese government “encouraged” the deal to help recapitalize Shengjing.

In response to today’s news, the developer’s dollar-pay 8 3/4% notes due 2025 dropped to 81 from 84, for a 1,429 basis point spread over U.S. Treasurys (traditionally, a pickup in excess of 1,000 basis points indicates borrower distress). Single-B-plus-rated Evergrande sports $117 billion in net debt, equivalent to 8.5 times consensus 2021 Ebitda. The company has pledged to cut its debt load in half by the end of 2023, as it attempts to reach compliance with Beijing’s recently implemented “three red lines” governing property developer balance sheets.

Solvency trouble at Evergrande, which Grant’s predicted in fall 2017 will eventually take its place in history alongside “Bank of United States” and “the Hindenburg,” could reverberate far and wide. Chinese corporate borrowers face a hefty $1.3 trillion in domestic debt maturities over the next 12 months, per data from Bloomberg, with $900 billion of that falling due before year end. That compares to $1 trillion by June 2022 and $600 billion by December 31 for U.S. companies, and $800 billion and $400 billion, respectively, in principal repayments for European corporate borrowers. Chinese firms have already defaulted on more than RMB 100 billion of onshore debt this year, marking the first time that threshold had been crossed before September

For now, Mr. Market continues to whistle past the high-rise. Bloomberg notes that a quartet of Chinese property developers (Yango Group, Greenland Hong Kong Holdings, Times China Holdings and New World Development Company) are marketing dollar bonds today.

Great Tweets

• “Mussolini created the word ‘fascism.’ He defined it as the ‘merging of the state & the corporation.’ He also said a more accurate word would be ‘corporatism.’ That was the definition in Webster’s up until 1987, when a corporation bought Webster’s and changed it.” - Adam McKay
• [Geroge Soros called this #reflexivity when you create economic reality out of stock market hype/crash. #AMC’s bonds due 2026, which were trading at a low of 5 cents in Nov, were up a cent to nearly 99 cents on the dollar Friday after the latest rally in AMC stocks.] (https://twitter.com/Schuldensuehner/status/1398340332765560832?s=20 )
• [Before we get to a low carbon world, oil supply will be choked off far faster than demand will go down (h/t ESG bros and crusaders) and major price spikes are possible, if not likely. Tobacco 2.0. 2/n] (https://twitter.com/Keubiko/status/1398280872131018753?s=20)
• First thing I noticed I had to give up: Fanta. (It’s owned by Coca-Cola) The Nestle products are gonna be tricky, too. I have a sweet tooth. What products are you going to have to boycott?
• NATO chief and Afghan troops coping alone

Oh, no, not more crypto!

About half the financial news media space is occupied by stories about crypto currencies. It’s a fascinating topic, for sure. When I first heard about bitcoin in a podcast in April 2011, I was hooked on the subject. I actually had used public key encryption, and was familiar with how public key cryptography works, at least from a user’s perspective. I published my own gpg public key way back in 2000. I have no idea how the general public think about “crypto” now. As I have said from time to time, the value of bitcoin is a pure measure of sentiment, and there is still a lot of positive sentiment. People assume that now Goldman Sachs are putting out research notes about “crypto” being a new asset class, there must be something to this thing. After all, most people don’t really understand how Netflix makes any money (it doesn’t) but still wishes it owned shares in it (they go up. And up. …)

Well, as you can tell, crypto falls firmly into the “a worthless asset trading at a premium price” category, but as with most things it this category, until the broader market becomes unambiguously bearish, it’s best to sit and wait.

The FT is clearly a sceptic. The article points out. The title is “Goldman’s not giving up hope on Bitcoin” with a subtitle Where there’s a prime brokerage opportunity, there’s a way. And if there’s a whale, there’s a will.

PBoC executing stealth FX purchases to prevent CNY from rising to its natural level?

This piece about how the CNY is being artificially held down by its central bank. The amazing thing is that the work is made available to all without charge. I don’t know much about Ex-Ante Data but I’ve subscribed to their Substack and look forward to reading more research from them.

My instinct is that resources, including currency, will flow to East Asia, and to China in particular, over the next decade. The growth in population, and productive capacity is irreversible, in my view (which is conditioned by hearing too much guidance from Gavekal Research, I fear).

Anyway, it’s always nice to have one’s priors confirmed, and this is an example for me. However, FX is a tricky asset, as it is subject to heavy manipulation by political actors who can quite happily do things which are hugely destructive to their economies to thwart the actions of ‘speculators’ who simply are trying to improve price discovery. Soros broke the Bank of England, but you never hear of the times he tried to out-stare a central bank somewhere and blinked first. I can’t believe he got to be as rich as he is without having good risk management in place.

Fusion power: no longer twenty years to achieving commercial viability?

This press release from AERE suggests that we are getting closer than ever to making nuclear fusion economically viable.

My first job was with UKAEA, and I visited Culham, which was very close to the site where I worked, Harwell. It was a standing joke that governments had infinite patience to continue funding fusion research decades after the point where the originators had promised that the technology would be an economic source of power. At that point, the fact that it produced no carbon emissions was not even a factor.

The message then, as now, is that getting fusion to work commercially is “merely” an engineering problem. The physics is settled. Fusion works, and has been used to produce the most devastating weapon the planet has ever seen: the “H Bomb.” I sometimes feel that this is exactly the same attitude that prevails in discussion about carbon capture and storage, but I’ll stop there.

Anyway, maybe we are near to a breakthrough. Nuclear fusion would truly be a game changer. Apart from cheap, carbon-free energy, it has the huge advantage that there is no nuclear waste, to speak of, which has always been the Achilles’ Heel of nuclear fission. Although I think we’re nearly all much too afraid of radioactivity, it must be said that the idea of releasing Pu radioisotopes to circulating in the world’s oceans for the next few hundred thousand years is not a nice legacy to leave for future generations.

Wrap

It’s the last trading day before the long weekend. Nothing moved. This service will resume after Memorial Day/Whit Monday.