Leland Miller is a leading expert on China’s financial system and a good friend. He and his colleagues publish the China Beige Book, which is actually a whole series of distinct products. They regularly interview (if memory serves correctly) about 2000 large Chinese companies in every sector to get a good idea of what is actually happening in the Chinese economy. There is nothing else like their work, and anybody who is investing large sums or who just does business in China gladly pays the six-figure price to get access to their data and research. Even this quarterly brief that I attach is embargoed, and I am generally not allowed to send it on. Leland made an exception this time (after consulting with his partners), and I thank them for that. You can
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Leland Miller is a leading expert on China’s financial system and a good friend. He and his colleagues publish the China Beige Book, which is actually a whole series of distinct products. They regularly interview (if memory serves correctly) about 2000 large Chinese companies in every sector to get a good idea of what is actually happening in the Chinese economy. There is nothing else like their work, and anybody who is investing large sums or who just does business in China gladly pays the six-figure price to get access to their data and research.
Even this quarterly brief that I attach is embargoed, and I am generally not allowed to send it on. Leland made an exception this time (after consulting with his partners), and I thank them for that. You can learn more about China Beige Book here: chinabeigebook.com/
Below I’m going to paste the email intro that Leland sent me, which has some qualifiers and insights about the quarterly brief you’re going to read. I should note that in our recent conversations Leland was more upbeat about China than he has been in several years. That is not to say he’ll be that way next year, but the facts on the ground right now are all pretty good. Now, here’s Leland:
As promised, here is our Early Look Brief from last quarter. Per the usual, it was released ten days before the end of the quarter, which makes it the earliest look in the world at the current quarter’s data.
A lot of this now seems consensus – as all good assessments should in hindsight – but if you recall at the time (mid-to-late June) there was growing sentiment that (1) the economy had already peaked for 2017 and was now starting to slow; (2) deleveraging was having a major effect on corporates; and (3) the commodities sector had likely peaked in Q1 and was now in slowdown mode as well. Our data undercut all of these.
Moreover, the steel and especially aluminum rallies which we wrote about at length back then are still going strong. (We took a lot of heat for those calls initially, because the consensus at the time was that April’s volatility, coupled with the deleveraging campaign, meant commodities had seen their inflection point months earlier.)
One other thing to note: we’re the only firm in the world able to track ‘changes in net capacity’ across coal, aluminum, steel and copper in China. This is important, because all our recent metals bullishness notwithstanding, we think markets have badly misunderstood the supply side picture for all of those sub-sectors, and continue to do so. Our data show quite convincingly that Beijing is *not* cutting overall capacity the way most analysts think they are... and this realization is likely to cause commodities investors some serious pain in 2018.
Happy to discuss any particular points, overall or related to commodities.
Shane and I are leaving Beaver Creek this morning to go in to Denver for a few days. Then we’ll head back to Dallas on Sunday. We are staying at the Park Hyatt, which I have to say is a fabulous resort hotel with an incredible spa. If you’re a skier, you can ski right out to the slopes; but it’s summer now and I’ve been intent on just relaxing a bit. Hard to believe that September is almost here. You have a great week.
Your thinking about my fellow Texans in South Texas analyst,
John Mauldin, Editor
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By Leland Miller and the staff at China Beige Book
So far, 2017 has played out as a best-case scenario for China’s economy. The remarkable absence of both domestic (more foolish financial policies) and foreign (Trump tariffs) shocks has created the stable environment corporates need to outperform most expectations, including ours.
This fortuitous run continued for at least one more quarter. China Beige Book’s new Q2 results show an economy that improved again, compared to both last quarter and a year ago, with retail and services each bouncing back from underwhelming Q1 performances. Manufacturing’s rally has now surpassed the one-year mark. Commodities surprised to the upside, despite significant price volatility in April. All this outmatched a slowdown in property and enabled hiring to improve almost across the board.
Three developments are worth extra emphasis. Any worries the leadership had about the labor market prior to the Party Congress have likely evaporated, with hiring improving on an already solid Q1 – both nationally and in all the major sectors. Claims of fading Chinese manufacturing turn out to have been premature, and new orders say at least another quarter of solid expansion is coming. And, while it’s only one quarter, it was all accomplished despite the initial signs of deleveraging – interest rates spiked and borrowing edged down. Facing the challenge of a very poor start to 2016, the Party has turned the economy back in the right direction, with time to spare.
Even in Beijing, though, there is no free lunch. Companies across the economy understand that 2017 needs to be a strong year economically and are storing problems away for the future. Literally – inventories hit their highest levels in the history of CBB data, both nationally and in every sector. The same companies who report solid results on most indicators also continue to show cash flow in the red – corporate health has not yet responded to better growth. And property continues to make investors nervous. As we predicted last quarter, the sector as a whole weakened noticeably despite a major turnaround in residential construction.
The credit market is also a source of heartburn. Firms did not report higher borrowing costs in Q1, but they certainly did so in Q2. Either firms expect the spike to be temporary or they are bearing up under the strain temporarily for political reasons. Either way, China has not yet even begun to face the pain from deleveraging, so the commitment to do so remains very much in question. It remains true that either rates have to come plunging back down, as the NDRC recently called for, or the present level of corporate activity is headed for a cliff. Today’s feast may have been bought with tomorrow’s lunch money. But for now, we toast the solid quarter.
Goldilocks Still Skipping Along.
For the economy, this may be as good as it gets for a while, but right now it’s pretty good. Policy support, no foreign shocks, no one wanting to rock the boat ahead of the Party Congress. The economy a year ago was much weaker than commonly thought, so merely on-year gains wouldn’t be impressive. But the economy a quarter ago was fairly active and this quarter is more so, on multiple dimensions. Revenue growth accelerated (though see inventories). Sales price gains eased fears of deflation harming growth. Most important, hiring strengthened again. This might be politically influenced, and thus temporary, but it already constitutes a political success. Moreover, with the labor force shrinking, a drop-off from the current hiring pace wouldn’t be a concern. On the whole, the second quarter is a very nice baseline for Beijing to be working from.
Why Rebalance When You Can Have Both?
The second quarter saw minimal progress in moving away from manufacturing toward services leadership in the economy. This was an excellent failure, however, since services performed well and manufacturing almost as well. Manufacturing tapered but extended its powerful rally since the first half of 2016. Revenue, hiring, and new orders were all higher on-quarter and sharply higher on-year. Still, services outperformed manufacturing in revenue and profits. Hiring in services has been uneven, but Q2 was solid.
Commodities Surprises to the Upside.
Defying early signs of a slowdown, our biggest Q2 surprise was another robust performance in commodities. Make no mistake, the warning signs look like Times Square: the second quarter saw huge across-the-board jumps in inventory, sliding sales price growth in three of four sub-sectors, and rising input costs. Yet, more firms again saw rising sales prices than input cost hikes, sales volumes accelerated, and cash flow moved from red to black, bolstering balance sheets.
Away from Markets’ Gaze, Aluminum Shines.
Commodities’ unsung hero: aluminum. CBB data show aluminum firms wildly outperforming the current market narrative, seeing broad Q2 gains in revenues, profits, volumes, output, and new orders, as well as cash flow, which jumped into the black for the first time in our survey’s history. The why is less clear than the what, but one obvious possibility is aluminum is the latest recipient of some of China’s excess liquidity. The #moneyball may have struck again.
Property Slows Off its Q1 Peak.
As we forecast last quarter, the property sector weakened, growth slowing in three of five sub-sectors. Transportation construction drove the deterioration with commercial realty and construction piling on. The extent of the pain may have been masked by better results on the residential side. Overall revenues and profits plunged in Tier 1 cities, with the slowdown concentrated primarily in the Beijing and Shanghai regions. Hiring stagnated, while cash flow worsened across the board. It is the credit picture, however, that looks most daunting. Borrowing completely cratered outside of residential construction, as rejections jumped and shadow banks suddenly refused (or were ordered not) to backstop the sector. Reflecting this disfavor, the relatively few property firms that were able to issue bonds this quarter paid through the nose – the highest yields ever seen in the CBB survey.
Inventory Levels Notch All-Time High.
The single most worrisome development is the level of inventories, which hit an all-time CBB high nationwide in the second quarter. The three sectors tracked– manufacturing, retail, and commodities – also each saw all-time highs. Inventories can stay elevated in China’s mixed economy for far longer than market economies, but they still represent either more waste and debt or a painful hangover that will drag down future growth.
No Fun in Shanghai.
Two high-profile regions marked a comeback after several quarters of lackluster performance. Guangdong turned in the strongest revenue and profit result while Beijing posted the largest on-quarter improvement in each. Shanghai missed the dragon boat, turning in the lowest growth figures nationwide. Inland provinces at least matched Q1, with the Center in particular reporting faster revenue growth. Even with its stellar results, though, Guangdong probably isn’t celebrating too loudly: companies in the region are China’s most sophisticated in terms of accounting practices and they report the country’s worst deterioration in cash flow.
The Right Kind of Inflation.
Unlike cash flow, the inflation picture has tilted away from stress toward health. The main reason is retail, which had the largest gains of any major sector in revenue, profits, and hiring. The hiring contributed to the strength economy-wide that pushed up wage payments by firms. In light of stated goals of reducing inequality and boosting consumption, this is a clearly positive development. Another element of good inflation is directly connected to retail: sales price increases continued in Q2, a sharp contrast to the weakness in 2014-15. Retail results show people are still buying despite rising prices. Higher input costs are harder to explain but were concentrated mostly in property. Input cost inflation was mild in retail and services and nearly invisible in manufacturing.
Borrowers Comforted by “Party Congress Put.”
China’s attempt at deleveraging has been discussed to no end, but its implications are not well understood. In Q1, corporate reporting to CBB showed credit tightening was limited to interbank markets. In Q2, it hit firms: bond yields and rates at shadow banks touched the highest levels in the history of our survey, and bank rates their highest since 2014. So why did borrowing not collapse, denting the broader economy? One reason is what we call the “Party Congress Put.” While borrowing did see a mild drop for the third straight quarter, companies’ six-month revenue expectations remain robust in every sector save property. Companies assume deleveraging is transient, likely because they are skeptical the Party will allow economic pain in 2017. It will not be until 2018 when we find out whether deleveraging is genuine – because it won’t be until 2018 that it will actually hurt.