Can't be a little bit.....

The law of inflation is that whatever goes up will go up some more - and that is the concern in China right now, at both the macro and the micro level. It is also why, the equity market’s super gain in October (+12%) is a little less super than July 2009’s 15.6%. Indeed, some CPI estimates for October range as high as 4.0%, after 3.6% in September. This is also underlined by the widening premium investors demand to hold 10 year bonds. The difference between yields on benchmark debt due in 2012 and that maturing in 2020 rose seven basis points in October to 129 after reaching a five month high of 131 this week. Interest rates swaps also firmed (at the one year level by 17 basis points to 2.36% this month).

The Yuan may yet help out with inflation and, after a mixed week, Forwards rose and point to a 3.6% appreciation over 12 months from the spot rate of 6.6782. Meantime, Westpac says this is too low and plumps for a 5% rise by the end of this year, while Citigroup believes the Yuan will reach 6.0 to the US dollar by the end of 2012. As far as the PBOC is concerned, advisor Li Daokui says China can accommodate a 3 to 5% gain in the value of the Yuan in nominal terms; he also references historic experiences by way of support.

Nor were developers in favour as October equity trading drew to a close and their sub-index within the Shanghai Composite fell 2.2% this morning. China’s banking regulator asked lenders to guard against risks from property loans and the China Securities Journal reported banks had cut discounts on mortgage rates.

As regular readers will know, I am never knowingly pessimistic. I am, thus, grateful to Hartford Financial (with $352 billion under management) which said today that US investors should invest overseas as a hedge against higher taxes after November’s congressional elections and increase their allocations in Chinese and Singaporean stocks. “China is attractive because of strong local consumer demand. In addition business investment also remains strong. Good consumption along with good business investment will bode well for the economy and the market”.

“Production is the only answer to inflation” - Chester Bowles

Shanghai Composite:
Today: -0.46% to 2,978.84 at close
(best since 16 April)
This week: +0.1%
October: +12.2%
Since 5 July: +26.0%
YTD: -9.1%

Hang Seng:
Today: -0.49 to 23,096.32 at close
This week: -1.8%
October: +3.3%
YTD: +5.6%

Oil futures: $81.39
Gold futures: $1338.70
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.3842

HEADLINES

MONEY

• Stocks fall on inflation concern, thereby reducing best monthly gain in more than a year
• Yuan Forwards rise by the most in a week
• Yuan may reach 6.0 against the US dollar by the end of 2012, says Citigroup
• Bonds suggest PBOC’s inflation fight is intensifying, says China Credit
• ChiNext’s first anniversary is not an auspicious one with just a 7% gain in value plus and concern is rising over risk of mass selling when ‘lock-ups’ end

DOMESTIC

• Wen hoped for a good meeting with Japan’s PM Kan

HONG KONG

• HKMA activates swap agreement with China after this year’s quota for Yuan-conversion for trade settlement is exhausted in October

Correction not a ceiling

When the Yuan appreciates it seems that share prices in China rise - and vice versa. Today, for example, is the fifth out of the last six when the Shanghai Composite has fallen - having briefly visited the sunny uplit lands of 3,000 last Thursday and Friday. And, is it a coincidence that the Yuan is at its weakest level today since 30 September? Perhaps my eschewing of a career as an equity trader was a smart move after all. In any event China’s toymakers will be pleased and at a trade fair in Guangzhou this week, currency was the number one issue; and as one manufacturer said: “if the Yuan rises to six to the dollar we’re doomed”.

Okay, some of this weakness in the Yuan is driven by a stronger dollar; and there seem to be more and more of them according to Commerce Minister Chen Deming who said that the US Fed’s “uncontrolled” issuance of dollars is adding to inflation risks in China. Similarly, commodity prices are also priced in dollars which provides further exacerbation. But despite what Chen said were “difficulties” for Chinese firms he believes the Nation will see stable growth in exports and a “relatively big jump” in imports next year, 2011.

The State Council or ‘Cabinet’ is also in robust mood following its Q4 economic meeting. It said that while it is not all plane sailing, the economy is “moving in the expected direction”, growth is steady and relatively fast and momentum “further cemented”. However, it remains hawkish on food costs and property prices. Today it was also reported, in the Securities Times, that China may levy a 0.6% property tax on the value of all new homes other than first ones and work on trails may commence before year end.

Premier Wen is also in the spotlight and was seemingly attacked in an editorial in the People’s Daily. It disputed criticism that political reform is lagging behind economic growth, in what analysts said may be an attack on his calls for greater openness. Similarly, Professor Huang Jing (of the National University of Singapore) said that this was an “anti-reform statement”.

As I mentioned, trading day-to-day is not my forte but, as October wends its way to a close, the very positive big picture remains. And, I was particularly heartened by both HSBC, which sees a further 15% rise in equities (even with another 50 basis points on interest rates this year) and CICC, which said the recent decline in China’s stocks is “a correction rather than a ceiling”.

Shanghai Composite:
Today: -0.15% to 2,992.58 at close
(best since 16 April)
This week: +0.6%
October: +12.7%
Since 5 July: +26.6%
YTD: -8.7%

Hang Seng:
Today: +0.20 to 23,210.96 at close
This week: -1.3%
YTD: +6.1%

Oil futures: $82.04
Gold futures: $1325.00
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.3809

HEADLINES

MONEY

• Yuan falls to weakest level in October
• “Uncontrolled” printing of US dollars by the Fed poses threat of higher inflation in China
• Loans may exceed the Government’s target this year, says State Researcher
• PBOC sells three month bills at 1.77% yield
• Three year bills at 2.85% - the first rise in a year

ECONOMY

• Cabinet focuses on and food and property economic momentum is maintained
• Yuan appreciation is tough on toy makers

REAL ESTATE

• Property tax may be struck at 0.6% of value (for all but first homes), says Securities Times

DOMESTIC

• Wen may be the focus People's Daily leading article

HONG KONG

• Rally of China share in Hong Kong is intact, says CICC

Arms and legs

Paul the Octopus, who predicted, correctly, every result for the German soccer team at this year’s World Cup - and the winner of the final - has died in Oberhausen. The two and a half year old cephalopod became an international media sensation during the tournament in South Africa as he picked the winners by choosing between two mussel-filled containers sporting the flags of each team. Maybe, it is something about having eight arms that makes predicting the future easier. In any event, asking a devilfish (as they are also known) for help underlines our desperation to know what is going to happen.

For my part, I find Merrill Lynch an altogether more palatable alternative and they have raised their Q4 GDP estimate for China from 9.0 to 9.3% (and for the full year from 10.1 to 10.3%). This also comes on the same day that the 1,181 public companies reported a 48% rise in net income for the first nine months of 2010 (albeit cash went the other way). Similarly, the Shanghai Composite leads 89 other benchmark indices for October (+13%) and YCMNet says the rally still “has legs”. Meantime, the Government, with one eye on the inflation rate, has, this week, also raised gasoline and diesel prices by 3%.

In real estate, too, there was good news as those clever people at Citigroup said the measures to control property speculation will have only a temporary effect on demand “given excessive liquidity in the Country, the Government’s dependence on real estate for revenues and the lack of investment alternatives. In our view, policy should not be paid too much attention”. In addition, new loans to the real estate sector rose 32.9% in the first nine months from a year ago to Yuan 1.72 trillion, according to the PBOC.

Finally, the Yuan weakened by the most in 22 months (-0.25% to 6.6795) following Vice Commerce Minister, Zhong Shan’s comments that this year’s trade surplus will be “definitely” smaller than in 2009. Comments from Professor Wang Yong, a PBOC researcher, also had an impact when he said that China should resist pressure from the US and Europe to let the currency appreciate. That said, Yuan Forwards are still looking to 2.6% appreciation (although this is down 100 basis point from last week). In addition, China’s largest shipbuilder listed in Singapore, Yangzijiang, is currency hedging the Yuan at 3% appreciation per year in expectation that it will rise, but that the Government will prevent gains above that pace. An ASEAN meeting takes place in Hanoi tomorrow and Friday and the Yuan is expected to be front and centre in discussions.

“Talent without discipline is like an octopus on roller skates. There’s plenty of movement, but you never know if it’s going to be forward, backwards, or sideways” - H. Jackson Brown Jr

Shanghai Composite:
Today: -1.46% at 2,997.45 at close
(best since 16 April)
This week: +0.7%
October: +12.9%
Since 5 July: +26.8%
YTD: -8.6%

Hang Seng:
Today: -1.85 at 23,164.58 at close
This week: -1.5%
YTD: +5.9%

Oil futures: $81.79
Gold futures: $1333.30
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.3819

HEADLINES

YUAN & MARKETS

• Yuan falls most in almost two years
• Yangzijiang Shipbuilding Holdings hedges for 3% annual appreciation of the Yuan
• PBOC Professor defends Yuan
• Shanghai Composite is best global index in the month of October with 13% gain

ECONOMY

• Merrill Lynch raises Q4 GDP forecast form 9.0 to 9.3%
• Nine month profit of listed Chinese companies rises 48% to Yuan 198 billion, but net cash flow falls
• China hikes fuel prices to help cool the economy
• China ranks itself as the World's 17th most competitive economy, which is a gain of 56 places since 1990

REAL ESTATE

• Developers share prices surge on Citigroup comments that property controls will have only a temporary effect
• Nine month new loans to the real estate sector advance 33% to Yuan 1.72 trillion
• Chongqing may introduce a property tax on both second and large first homes
• Singapore and China top league table of house price rise, says Knight Frank

INTERNATIONAL

• ASEAN meeting in Hanoi likely to focus on Yuan
• Rice price is likely to extend rally as flooding and storms damage Asian harvest

BONDS

• Finance Ministry sells 10 year bonds at 3.67% yield
• One year bills at 2.2913% yield and first rise since 8 June
• Bank bonds lead declines after surprise interest rate rise

DOMESTIC

• Transport gridlock drives price of coal to a four month high
• Thousands of students are reported to have marched on Japanese consulate in Chongqing

HONG KONG

• Hong Kong luxury home prices exceed 1997’s peak

IRON & STEEL

• ArcelorMittal shares fall on demand outlook and selling prices
• EU imposes 22.3% five year tariff on Chinese car wheels

31

“31” means working very hard i.e. 24+7 = 31. Such wisdom comes from Jake Harper who is the “half” in the sharp US sitcom “Two-and-a-half-men”. Tim Geithner is a fan too, he tells me, but his abbreviation for hard work is “G20” and, specifically, the finance ministers' unit which concluded its travails on Saturday in South Korea (ahead of the Grand Prix).

Here, they all agreed (save for Japan) to avoid competitive devaluations as a means of boosting exports (okay, it is not a sharp toothed initiative but will, nonetheless, ease indigestion). The IMF was also there and - “in its biggest reform ever” - agreed to increase the role of emerging markets through the fact that Europe has surrendered two seats on the executive board and 6% of the vote moving their way. However, the G20 did not adopt Geithner’s plan to set numerical targets (of circa 4%) for current account surpluses or deficits but did say it would work to reduce excessive imbalances; and it has also initiated the development of a “financial safety net” to stop nascent financial crises.

Still hawkish, but polite, on the Yuan, Geithner made an unscheduled visit to Qingdao yesterday to speak with Vice Premier Wang; which is unambiguously a good thing. This morning, too, Yuan Forwards have regained their poise and are pointing to a further 3.4% appreciation. Don’t expect a surge but such movement dramatically reduces tension and, hopefully, eases domestic inflation (hot money flows aside). It is also a building block in domestic demand creation. The latter is a major objective of the Country’s new five year plan (on which the ink is drying) and the Shanghai Composite reflected investor anticipation of it today, especially in consumer and technology companies, as it waltzed through 3,000 once more to a new six month high.

Credit Suisse (which is looking for 3,600 in Shanghai) and CICC are bullish too, albeit developers remain under the cosh of, perhaps, an even earlier trial of a property tax (and despite eastern China’s CJ Land looking set to raise $618 million in a Hong Kong IPO).

Finally, and also on a positive note, yields on China’s corporate bonds are falling at a record pace relative to Government debt as regulators allow insurance companies to boost their holdings of the securities. The premium investors demand to hold 10 year notes issued by companies rated AAA, instead of sovereign debt, has reduced by 49 basis points this year to 89 basis points, as of last week – which is the biggest annual drop in Chinabond data going back to 2006.

“There is no season when such pleasant and sunny spots may be lighted on and produce so pleasant an effect on the feelings, as now in October” - Nathaniel Hawthorne

Shanghai Composite:
Today: +2.57% at 3,051.42 at close
(best since 16 April)
Last week: +0.1%
October: +14.9%
Since 5 July: +29.1%
YTD: -6.9%

Hang Seng:
Today: +0.47 at 23,627.91 at close
Last week: -1.0%
YTD: +8.0%

Oil futures: $82.80
Gold futures: $1345.60
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.4038

HEADLINES

G20, YUAN etc

• Yuan Forwards predict a further 3.4% appreciation
• G20 pledges to avoid devaluations to boost exports
• Geithner expects China to “continue to move” on the Yuan; as he hold unscheduled talks in China with Vice Premier Wang
• G20 split over Geithner's plan to set current account targets
• Geithner says US has special responsibility to support dollar
• IMF Reform in favour of emerging markets

SHARES & BONDS

• China stock index targets are raised by Credit Suisse; including 3,600 on Shanghai Composite
• China's “secular” trend is bullish for consumer shares, according to CICC
• BRIC stocks may double, says SocGen
• Corporate debt yields drop at record rate relative to Government debt

REAL ESTATE

• Developers decline on reports of trial property tax
• China Vanke sees Q3 net income rise 6%
• CJ Land plans $618 million IPO in Hong Kong

DOMESTIC

• China meets target of 70 million visitors to World Expo in Shanghai as nears its conclusion

HONG KONG

• Private home completions hit four yearAir pollution hits “very high” level of 11,100
• Air pollution hits "very high" levels of 109 in CBD

Coffee morning

Did you know that Arabica coffee rose to a 13 year high (of $2.0315 per pound or 454 grams) in New York yesterday? Not many people do. Did you also know that annual coffee consumption per capita in China is 22 grams whereas in Japan it is 3.3 kilos? But, China’s consumption is growing at 20% per annum, reckons Starbucks.

This serves to underline two of the dynamics percolating in China right now: a large number of key commodities, including coffee, are rising in price (which is very important for the inflation rate and profit margins); and the consumer has imbibed his early morning java and is wide-awake.

On the former, one example is Maanshan Steel, the Nation’s number two, which saw its Q3 profits all but disappear, with high iron ore prices working to seriously erode margins. Similarly, producer prices for September, which were out yesterday, showed a 4.3% rise. This was higher than expected and “is a pipeline to the CPI”, says Nomura (which also expects interest rates to rise 1% next year). Countering this, though, is the Chinese consumer and his retail sales, as we know, rose 18.8% in September. Similarly, consumption accounted for more than a third (34.4%) of economic growth in the first nine months of 2010. Goldman’s says “domestic demand is here to stay” and is under-pinned by a strong level of nominal wage growth. “These are even more important than the currency”.

Of the two, above, inflation held sway over the market today as stocks fell for a second day, with a weather eye on interest rates and a Bloomberg survey where the consensus was for an 0.5% rise next year (in two bites). In any event, West China Securities said “the market needs a breather after a big rally starting in the month”.

As the G-20 finance chiefs meeting continues today in South Korea, the Yuan looks like finishing the week lower for the first time since early September (down 0.25% to 6.6580 in morning trade). This suggests China will remain resilient to any dramatic Yuan appreciation pressure, albeit Yuan Forwards reflect bets the currency will strengthen 3.1% in a year’s time to 6.45 (albeit some estimates are as low as 6.20).

Finally on real estate, the IMF is pragmatic saying that while there may be a property bubble in some of the larger cities, “the threat of a housing price bust and consequent financial instability is not immediate”. Similarly, Ping An Insurance, the Nation’s second largest insurer, is diversifying into commercial property (specifically offices, hotels and service apartments), private equity and increasing its holdings in stocks to boost investment performance after its worst year since 2005.

“No one can understand the truth until he drinks of coffee’s frothy goodness” - Sheik Abd-al-Kadir

Shanghai Composite:
Today: -0.29% at 2,975.04 at close
This week: +0.1%
October: +12.0%
Since 5 July: +25.9%
YTD: -9.2%

Hang Seng:
Today: nc at 23,517.54 at close
This week: -1.0%
YTD: +7.5%

Oil futures: $81.03
Gold futures: $1325.30
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.3936

Headlines

• Yuan is set for its first weekly drop since the begiining of September: -0.25% to 6.580
• Interest rate increase of 0.5% are likely in 2011, says survey
• China will continue to resist massive Yuan appreciation due to a fear of becoming the Nation becoming ‘another Japan post-the Plaza Accord of 1985’
• IMF (1) sees “property bubble” in major cities, like Shanghai, but not nationwide
• IMF (2) “the threat of a housing price bust and consequent financial instability is not immediate”
• Mizuho Asia says that it is buying China's consumer and health care shares, in particular
• Urban unemployment rate was 4.1% at end-September

Normal resumed

Antonyms of surprise include ‘expected’ and ‘predicted’ with both applicable to today’s GDP and inflation data; unlike Tuesday’s bombshell on interest rates. China’s economy grew 9.6% in Q3, which is the smallest gain in a year (and within 0.1% of the median 9.5% estimate). Meantime, inflation accelerated to 3.6% in September to the fastest pace in 23 months (which was exactly in line with forecasts). Shares fell below 3,000 and off a six month high. Life is normal again.

Worries persist over even higher borrowing costs, but maybe Tuesday was a smart-bombshell and will do the job on its own. Support for this comes from the interest-rate-swap market where the one-year rate (2.36% and up 18bp yesterday) remains below the one year deposit rate of 2.5%. Similarly, Asahi Life says that “China has used various tools and it seems to have worked. Instead of raising rates aggressively, China is likely to see the impact and then adjust all those measures to manage their economy. They only tighten to a point where they can achieve their growth target”. It is also the case that within the overall inflation rate, food is reported to be up 8% and High Frequency Economics said it knows of no interest rate rise which will reduce food prices.

Predictably, too, developers’ share prices have fallen further than the market. However, the Statistics Bureau said that property price increases in China, as seen in the first quarter, have been effectively curbed. Investment demand and speculative investment are also cooling.

In the first three quarters of the year, GDP grew at 10.6% and, within that, investment accounted for 58.8%, consumption 34.4% and exports 6.8%. This is the sort of arithmetic I like and it is economically sound. The World Bank has cut its forecast for China from 8.7 to 8.5%, while the State Information Centre says that the Nation is adjusting its economic model with “potential” growth moderating to around 9% (from 11% in the past five and 10% in the past three decades). This is all very okay to be getting on with, especially with one eye on the composition (see above).

Elsewhere, as Yuan Forwards advanced for the first time in three days and point to further appreciation of 3.7%, who has heard the words “currency war” this week?

“What we anticipate seldom occurs, what we least expected generally happens” - Disraeli.

Shanghai Composite:
Today: -0.68% at 2,983.53 at close
This week: +0.4%
October: +12.4%
Since 5 July: +26.2%
YTD: -9.0%

Hang Seng:
Today: +0.37% at 23,644.53 at close
This week: -0.5%
YTD: +8.1%

Oil futures: $83.39
Gold futures: $1343.80
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.4025

Headlines

ECONOMY

• Economic growth cools but inflation doesn’t as GDP rises 9.6% in Q3; and inflation is 3.6% in September (while producer prices are at 4.3%)
• Urban fixed asset investment 24.5 % in the first nine months
• Retail sales rose 18.8% in September
  Investment takes lion’s share of output at 58.8%; consumption is at 34.4%; and exports are 3.7%

YUAN & RATES

• Yuan Forwards advance for first time in three days and point to further currency appreciation of 3.7%
• Interest-rate-swaps point to no further rate rises: one year rate of 2.36% vs deposits at 2.5%
• Rate rise may take “hot air” out of stocks, says Aberdeen Asset Management; and share prices remain attractively valued for the longer term
• China increases three month bill yield for first time since June: +0.2 to 1.7726%
• Finance Ministry to sell Yuan 28 Billion of 10 year bonds at end of October
• Banks pay 30% less on Yuan debt in Hong Kong

TRADE

• Krugman says trade war is looming
• Geithner’s comments may signal peace, says BNY Mellon
• China pledges to maintain rare earth supplies; and may increase exports in 2011

DOMESTIC

• Shanghai may build new vacation resort near the new Disney theme park where work has commenced
• Cold wave of weather moves across China and may harm energy, transport and farming

IRON & STEEL

• Steel output in China drops 5.9%, year-on-year, in September on energy restraints; and is minus 7.2% versus August
• Steel prices have risen 10% since July

Shanghai surprises

While avoiding the literality of the title, if you left work early in Shanghai on Tuesday you would have missed a trick or two. First off, the Shanghai Composite jumped 60-odd points in the last hour of trading to close above 3,000 for the first time in six months. Then, even later, interest rates went up for the first time since December 2007; effective from today.

The latter move was a genuine shocker, especially as PBOC Governor Zhou Xiaochuan had said, as recently as 8 October, that bank reserve requirements and bill sales were sufficient tools to control inflation. Similarly, 13 from 19 economists in a Bloomberg survey last month forecast that lending rates would stay unchanged this year. However, policy makers most probably acted ahead of what are expected to be feisty inflation data tomorrow: the median September CPI estimate is 3.6% but some estimates range as high as 4.0% (August was 3.5%). They authorities must have also anticipated the surge in industrial production of +16.3% in the first nine months of the year (and data were promulgated today); albeit they ignored the probable easing in Q3 GDP growth from double digits to 9.5% (figures are out tomorrow).

The collective noun for surprises could be ‘party’ and it continued today with, first, the Yuan falling by the most in four months (-0.3% as measured by the daily reference rate); and then the stock market did not tank - and sustained the 3,000 level. The logic here is that the first interest rate increase in nearly three years will help tame inflation and prevent asset bubbles. Certainly Goldmans, JPMorgan and UBS (who said the rate hike was a “speed bump”) are all bullish, albeit Deutsche is more circumspect. There is also a risk that hot money may flow into China and stoke inflation. But, as Credit Suisse said capital controls can deal with the former; and capital flows are the “lesser evil” when compared with inflation anyway.

Strangely, the Hang Seng did not join in and shares closed almost 1% down, with property stocks the hardest hit of the Index’s four industry groups.

Finally, I am also indebted to Reuters who pointed out that the increase in one year interest rates of 25 basis points was the first time in modern history that Beijing adjusted deposit and lending levels by a number that was not a multiple of nine. In the past, the PBOC typically raised rates by 27 basis points. “The reason is that on the abacus, adding multiples of nine was much easier than adding multiples of 10. So the modern PBOC inherited that special character from the old days” observed Ken Peng at Citigroup.

There is another big day tomorrow; and remember as both Kung Fu and Oscar Wilde said: “expect the unexpected”

Shanghai Composite:
Today: +0.07% at 3,003.95 at close
(best since 21 April 2010)
This week: +1.1%
October: +13.1%
Since 5 July: +27.1%
YTD: -8.3%

Hang Seng:
Today: -0.87% at 23,556.50 at close
This week: -0.9%
YTD: +7.7%

Oil futures: $80.12
Gold futures: $1340.20
(new ‘immediate delivery’ high of $1387.35 on 14 October)
Euro/$ spot: 1.3795

Headlines

• China raises interest rates as higher inflation anticipated
• Industrial output rises 16.3% in first three-quarters of 2010
• Yuan falls most in four months after surprise interest rate rise (-0.3% at reference rate)
• Rate move may attract capital and fuel inflation
• Five year bond sale yield at 15 basis points higher (to 2.91%) - after interest rate rise
• IMF says China could raise rates further
• Abacus superceded, says Reuters as increases divisible by nine are abandoned
• Buy Chinese shares after interest-rate-induced dip, says Goldmans; most others agree
• Ikea plans to add $300 million to its investment in China
• State-owned companies see their nine month profit rises 46% to Yuan 1.4 trillion ($211 billion), year-on-year
• Lending to small and medium-sized firms is rising sharply; +19% in H1
• The development push is West to benefit from lower wages; and the Yangtze gets even busier