“And the little screaming fact that sounds through all history: repression works only to strengthen and knit the repressed.” ― The Grapes of Wrath by John Steinbeck
China’s Priorities
From the Wall Street Journal (emphasis added):
In the trenches of China’s debt-addled economy, the government has made a startling decision: Let companies fail.
That has left creditors angry, debtors fighting to save their businesses and judges on a mission to promote the benefits of bankruptcy.
After years of pumping out financial support to keep the economy humming and workers happy, China has embarked on a debt reckoning. Beijing is building a bankruptcy system to take on a significant pickup in corporate defaults.
The country now has more than 90 U.S.-style specialized bankruptcy courts to help sort through a morass of corporate debt that, until recently, would have been swallowed by state banks and other creditors.
It is a sign that Beijing is worried about the number of failing companies and trying to find a fix. The system is helping, many lawyers, foreign investors and lenders say, as it takes some pressure off local governments that lack the resources for so many bailouts.
[…]
China introduced formal bankruptcy laws in 2007. But courts routinely rejected applications from struggling businesses and their creditors because of concerns over potential social unrest and large-scale layoffs.
Many insolvent companies chugged along with state subsidies and loans from state-owned banks. Some simply walked away from their debts, leaving creditors hanging.
[…]
It is part of a shift from what Judge Ye described as policy-mandated bankruptcy—the government largely decides which companies fail or survive—to a “market-oriented bankruptcy” process that lets market forces decide who are the winners and losers.
While some cultural blowback is to be expected, this is a positive development. If China is going to transition from an investment-led to a more balanced economy, malinvestment needs to be discouraged. Market-oriented bankruptcy proceedings replacing government-led bailouts is a welcome step in the right direction.
Household, or private, consumption accounted for less than 40 per cent of China’s GDP in 2018, the thirteenth consecutive year in which private consumption has accounted for less than 40 per cent of GDP. Such persistently low-levels of private consumption, as a share of GDP, are unprecedented in recorded economic history. Given the magnitude of and the prolonged period over which the Chinese consumer has been repressed, China’s leadership is unlikely to be able to encourage households into increasing spending merely by tweaking policy. Difficult policy decisions will need to be made and stuck with. Discouraging and allowing markets to punish corporate malinvestment is once such decision.
Malinvestment is a direct consequence of over-investment. Over-investment requires an abundance of domestic savings or the ability to attract high-levels of foreign direct investment.
Foreign private investors require some form of protection when investing in jurisdictions where the political risk-premium is high. The protection for investing in China was provided by its burgeoning pile of net foreign assets.
In the chart below, in the top panel the magenta line is the level of foreign exchange reserves held by China and the bars in bottom panel represent the cumulative foreign direct investment into the Mainland since 1995. The two series have been in almost perfect lockstep.
The rest-of-the-world is becoming increasingly unable and unwilling to absorb China’s trade surpluses. Thereby inhibiting further increases in Chinese foreign exchange reserves and by extension the flow of foreign capital into the Mainland.
Lower appetite for Chinese trade surpluses implies lower demand for Chinese exports. Lower Chinese exports in turn means the investment needs of Chinese corporates are reduced.
From the Financial Times:
China’s listed manufacturers are increasingly putting their money into financial assets such as stocks and bonds rather than investing in their own businesses, as the potential returns from capital expenditure wane.
To curb speculation and malinvestment, there needs to be an increase consumption in China. Consumption will only increase once the powers that be put to an end to their policies of financial repression. That is, an end to artificially low interest rates that penalise depositors for the benefit of large corporates, excessive levels of direct and indirect subsidies to state-owned enterprises and an undervalued currency. Additionaly, the burden of creating social safety nets needs to be removed from households and placed it on the state.
China does not need 6 per cent plus of GDP growth, it needs private consumption growth of 3 to 4 per cent above the rate of GDP growth for the next decade, or possibly even longer. The People’s Bank of China this week rolling over its one-year medium-term lending facility at 3.25 per cent, 5 basis point below the previous rate of 3.3 per cent, and setting the direction of monetary policy toward easing, suggests GDP growth not household consumption growth remains the priority for Chinese policymakers.
Industrial Strength
This has been a difficult year for American manufacturers, marked by trade war related changes and an almost synchronised global economic slowdown. Output, investment and employment are all down at US manufacturing companies and surveys revealed manufacturers to be less than optimistic on near-term prospects.
With that in mind, consider the below chart of the Industrial Select SPDR ETF $ XLI.
Industrial stocks are breaking out to all-time highs and that too on improving relative strength (second panel above).
The following constituents of the ETF appear to the most interesting from the long-side.
Fastenal $FAST
Fastenal resells industrial, safety, and construction supplies such as such as screws, threaded rods, and nuts and offers services including inventory management, manufacturing, and tool repair.
Rollins Inc. $ROL
Rollins Inc. provides essential pest control services and protection against termite damage, rodents and insects.
Pentair $PNR
Pentair sells comprehensive range of smart, sustainable water treatment solutions to homes, business and industry globally.
Alaska Air $ALK
Owner and operator of two US based airlines: Alaska Airlines and Horizon Air.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.