We expect the private healthcare service sector to outgrow the public sector in the mid/long term. We have identified three key growth drivers for the sector, including favorable policies towards private healthcare services, accelerated growth in capacity expansion and utilization, as well as rapid growth in  commercial insurance coverage. We expect approximately 8,000 public  hospitals will be privatized over the next 5-10 years due to policy shifts, which  will create substantial growth opportunities for private service providers in the mid/long term. From 2005 to 2013, the CAGR of total beds in private hospitals was 22%, much higher than 7% of the public hospitals in the same period. We also anticipate the utilization rate will improve significantly over the next 5-10 years, from mid-60% to 80-90%. Additionally, the rapid growth of commercial insurance is likely to add another leg of growth for the private healthcare service sector. 
​
We anticipate value creation on two fronts in public hospital reform, including  growth acceleration after privatization and significant margin improvement, driven by change of incentive mechanisms and efficiency improvement  respectively. According to past experience, revenue growth acceleration will be sustained for 3-4 years after takeover while it will take 4-5 years to reach  approximately 10% net margin from breakeven. By our estimates, the order of  ROI generation among four major business models is as follows: OT, IOT  (invest, operate and transfer), equity ownership and greenfield hospitals. We  highlight an approximate 4-5 year payback period for the IOT model and 10 years for the equity method. 

 

The Communist Party understands that in order to hold onto power they need to deliver on improvements in standards of living. Finding work for much of the rural poor in factories and investing heavily in infrastructure fuelled growth for the last two decades and lifted hundreds of millions out of poverty. The current fire year plan has seen a refocus on improving human capital through investment in education, services, social security, sanitation, healthcare and the environment. 

The hukou system of registration segregates rural from urban dwellers. In effect this means that many of the services urban dwellers take for granted are not available to those living in the country. Rolling out services to the hinterland represents a significant growth story for the healthcare sector.  

Phoenix Healthcare IPOed in November, hit a medium-term peak in February and has been ranging between HK$10 and HK$11 since early May. A sustained move above HK$11 would break the progression of lower rally highs and signal a return to demand dominance. 

Fosun Pharmaceutical has been on an aggressive acquisition spree and the share lost upward momentum from March. Is has so far held the majority of its advance and a sustained move below HK$24 would be required to question medium-term scope for continued higher to lateral ranging. 

Tong Ren Tang Technologies hit an accelerated peak a year ago and has been largely rangebound since. The share found support last week at the lower side and a sustained move below HK$11 would be required to question potential for an additional bounce. 

To be fair, allowing Chinese domestic investors to access the Hong Kong stock market may prove to be even more valuable. Given the controls on capital accounts and cross-country listings, Chinese domestic investors are severely underdiversified in their portfolios.

Such underdiversification costs Chinese investors dearly, especially given the exorbitantly high volatility and recent disappointing performance in the Chinese A-share market.

By investing in the Hong Kong market, Chinese investors can not only buy cheaper stocks offered by the same company (for most companies cross-listed between Shanghai and Hong Kong, the H-shares trade at a discount), but also invest in overseas companies that cater to Asian investors and are listed in Hong Kong.

With the direct investment channel between Hong Kong and Shanghai, Chinese investors can use their existing accounts to invest in overseas companies. Such convenience and familiarity will no doubt boost Chinese investors' confidence in investing overseas, which not only helps their portfolio performance but also propels more Chinese capital into the international financial arena.

 

Speculation that the A-H Share spread would disappear due to changes in Chinese regulations sent the Hang Seng to an accelerated peak of 32,000 in 2007. When this speculation came to naught, the Index pulled back sharply before collapsing during the credit crisis. By contrast news that the Chinese are prepared to allow domestic investors relatively unfettered access to the Hong Kong market within the next six months has on this occasion been met with little fanfare. 

Of course the stock market situation is totally different today. In 2007, the A-Share market was surging ahead and investors were speculating that the Hang Seng would participate in a major catch-up move. Today investors need a lot of convincing to consider China particularly when other markets are doing a lot better. The A-H Share premium has fallen to its lowest level since 2006 and may have disappeared altogether by the time the regulatory change comes into being. Whereas in 2007 the Chinese were worried about an overheating stock market, today they are eager to continue to attract investment. Therefore the potential of them following through to allow greater access to their domestic market is probably greater today than it was in 2007. 

But in the last several weeks, the situation appeared to have eased into “dangerous stability,” said an American administration official familiar with the flotillas of Vietnam and China.
A foreign ministry spokesman in Beijing, Hua Chunying, said Tuesday that Mr. Yang would encourage a “frank and thorough exchange of views on matters of common concern to all.”

“We hope Vietnam will focus on the broader picture, come together with China and appropriately deal with the current situation,” she said.

The visit of Mr. Yang, China’s top diplomat, comes as relations between Vietnam and China have been essentially frozen since the arrival of the rig on May 2. Anti-Chinese riots spread through several cities, and looting of factories believed to be Chinese-owned resulted in the deaths of at least four Chinese workers. China evacuated several thousand workers after the riots, leaving some companies in Vietnam, which are dependent on China for supplies and skilled labor, short of employees.

Mr. Yang is expected to meet with Mr. Minh, who is also Vietnam’s foreign minister, but it was not known if he would meet with more leaders, officials said.

Prime Minister Nguyen Tan Dung of Vietnam said that he would consider a legal case against China at the United Nations, in the same way that the Philippines has initiated an arbitration case against China. Beijing roundly criticized Mr. Dung’s suggestion.

 

The annotated map, contained in the above article, of China’s disputes with neighbouring countries over maritime assets illustrates the extent to which it is willing to ruffle feathers as it flexes its economic and increasing military might. The oil rig stationed in waters claimed by Vietnam on May 2nd is probably now a permanent fixture and since China has met with little more than verbal criticism, the dictum that “possession is nine tenths of the law” would appear to be very much in play with regard to these waters. What is to stop China deploying additional oil rigs? China is Vietnam’s largest trading partner and this dependence will likely continue to be used as a none-too-subtle negotiating tool.

Banks were eager to lend to Dezheng Resources and its subsidiaries in recent years. "We all do business with Dezheng companies," one employee of the finance department of a large bank's Qingdao branch said.

Banks are apparently worried that the borrowing total the CBRC arrived at may only be the beginning. "The figure only shows the loans in Qingdao, and banks are examining whether there are other loans to Dezheng Resources and its subsidiaries across the country," an employee of another bank said.

Sources that participated in a June 16 meeting held by the Qingdao branch of the banking regulator said the loans include 4 billion yuan from the Export-Import Bank of China and 2.1 billion yuan from Bank of China. Industrial and Commercial Bank of China, Construction Bank of China, Agricultural Bank of China and China Minsheng Bank each lent 1 billion yuan.

City and Shandong Province banks, such as Rizhao Bank, Qilu Bank and Evergrowing Bank, each lent around 800 million yuan. Some joint stock banks, like China CITIC Bank, Industrial Bank and China Merchants Bank, extended loans of around 600 million yuan.

It is common for companies in China to use commodities as loan collateral. However, sources close to Dezheng Resources say police are investigating whether the company and its owner, Chen Jihong, used duplicate receipts from Qingdao Port Group Co. to get loans from different banks. It is unclear what police were involved.

When this story broke it was bearish of industrial metal prices because one of the arguments that helped support prices was that Chinese demand was still relatively robust. The fact that stockpiles were not as large as previously believed gave the impression the Chinese economy is slowing more than expected. 

According to China Electric Power Promotion Council (CEPPC) report, Fuqing Nuclear unit 1 completed its last round of security checks in mid-April before loading fuel and is currently on schedule to be commissioned from August 2014. However, after Datang’s Ningde nuclear recorded c.Rmb100m loss in 1Q14 due to a 90-day overhaul, investors become a bit concerned whether Fuqing’s profit contribution is likely to be compromised by the undertaking of regular maintenance. While we understand that a new nuclear unit would need to perform a major overhaul for fuel re-load in its second year of operation, the time period is normally shorter. Hence, we do not think the longer-than expected maintenance period for Ningde is a common situation to be assumed for other nuclear projects.

Average utilization still over 7,300 hours despite maintenance In Figure 1, we summarize the utilization hour record of China’s operating nuclear units with GII or GII+ technology. Result shows that, excluding Tianwan unit 1, which incurred some technical issues during the first three years, average utilization in the second year is still above 7,300 hours, quickly climbing to above 7,700 hours in the third year.

 

A link to the full report is posted in the Subscriber's Area.

Over the last decade China has aggressively invested in procuring the energy resources required to fuel economic expansion. Building nuclear power capacity has been a major component of that strategy and these new reactors are now being commissioned. Considering how extensive the pipeline is for additional reactors, this represents a growth story from the perspective of utilities. 

The investment bank CLSA recently conducted a survey of 609 projects nationwide. By physically visiting the sites by day and night, watching the lights go on, noting decorations and talking to guards, they calculated an estimate of 15% vacancy rate in apartments built since 2000. That implies about 10 million empty units nationally, considerably less than feared (one report had suggested implausibly that 64 million homes lay empty). Still, 15% is high, more than Las Vegas and considerably more than the US at 10% overall.

Adding construction already underway, CLSA say China's vacancy rate will hit 20% and could go even higher unless developers immediately curb new starts. Vacancy is heavier in small cities, already nudging 20%. The ghost cities are altogether worse.

And

Indeed, officials are saying demand may be peaking, and that's what the market today worries about. CLSA, which is not known as especially bearish, thinks small cities may need to collapse construction by a shocking 60% over the next few years. These cities consume 70% of materials used in all residential construction, which accounts for half of all steel use. Do the maths: that's a 20% impact on steel demand.

The above quotes from CLSA offer some valuable perspective on just how large China’s excess supply problem in the property market is. As developers cut prices, sentiment towards the sector is unlikely to be as bullish as it has been over the last few years and most pressure is likely to be felt outside the small group of Tier 1 cities. The performance of the cement and steel sectors should also offer some insight for how well this well publicised issue has been discounted by investors. 

At a meeting yesterday, we were discussing the outlook for China and I mentioned how low valuations are on the country’s banks. The rejoinder to that argument was that why should anyone consider an investment in Bank of China when one could buy Goldman Sachs for an Estimated P/E of 10.12, dividend yield of 1.37% and a five-year average dividend growth rate of over 6%. This raises an important consideration in the perception and calculation of value.   

Despite this, sensitivity to popular feeling is clearly strong. Many people worry about a crisis in Wealth Management Products (WMPs), which amount to RMB10 trillion in assets (almost AUD 2 trillion). China has a very high savings rate but savers do not have a lot of attractive options. Official deposit rates are controlled at a low level (below inflation), it is not possible to invest significant amounts abroad, the stockmarket has been a poor performer despite fantastic GDP growth and corporate governance can be suspect, and the property market boasts some bubble characteristics and the government makes it hard to own property other than one’s principal residence.

Apparently couples sometimes get divorced so that they can buy two properties! The paucity of investment options has pushed savers into a hunt for “safe” yield, in a similar trend to what has happened elsewhere for somewhat different reasons, and that has lead them to WMPs. Issued but not underwritten by banks, the WMPs have channelled money to poor credits including developers, entrepreneurs and local government schemes. Even the governor of the People’s Bank of China referred to the WMPs as a Ponzi scheme given the actual returns on investments do not match the returns promised to investors. They may yet cause a crisis but for now people believe WMPs are guaranteed by the issuing banks. The government forced a sponsoring bank of a failed WMP, that was not actually legally liable, to repay savers’ investments in full after a protest outside the bank and a storm on social media.

 

A link to the full report is posted in the Subscriber's Area.

The pressures on the Chinese financial system have been remarked on extensively in the media. The equal pressure on those who seek to preserve their wealth through investments is less publicised. China’s government might be the world’s largest creditor but China’s population are the world’s largest savers. 

China’s stocks rose, with a gauge of mainland shares traded in Hong Kong climbing the most in a week, as speculation that state-linked investors are buying equities overshadowed concern that the economy is slowing.

And  
 
 “The stock market is approaching the level which the government can’t tolerate,” said Cai Feng, a strategist at Guoyuan Securities Co. in Shanghai. “The level of 2,000 is more crucial. The government will use tactics including policies, public opinion and funds. In terms of injection of funds, it will increase holdings of big state-owned companies and buy index ETFs.”

 

The Chinese administration is leaning on the property sector and has so far refused to relent on its tightening policy. This has put pressure on the banking sector because no one knows just how large the problem with bad loans is likely to be. As a result, even though China has some of the most attractive valuations of any stock market, investors have been slow to commit funds. A catalyst is required to reignite investor appetite. 

 

Bad news is that major policy relaxation is unlikely in the near term 
In the 2008/11 downturns, we saw policy relaxations by the government. For 2014, given the central government’s adamant stance on economic reform and still-solid sales performance for end-user properties, we believe any significant adjustments to property market policies by the central government are unlikely and that the key adjustment should be pricing by developers (instead of economic reform, which is positive for the Chinese economy for the medium term). With our 2014E negative cash flows for the listed developers (mainly on aggressive land purchases in 2013), rising net gearing and inventory levels, developers should start cutting prices more meaningfully in the next two/three months. A key risk is that some developers may make incorrect market judgments on pricing, which could exacerbate the risks of financial distress.
 
Home upgrades no longer included in the PBOC’s support list 
Recently, the PBOC has reiterated financing support only to first-time  homebuyers, but financing to upgraders (which used to be part of the government’s support list) and developers has not been mentioned at all. The government has also further tightened rules on trust and non-standard loans to developers, cracked down on zero-downpayment plans offered by some developers, and accelerated the establishment of realty registration (which is a step towards the introduction of property taxes). All this highlights that the overall property policy environment should not see much change for the rest of 2014. While we could see some minor policy fine-tuning by selected local governments, significant policy relaxation by local and central governments is unlikely unless there are significant price declines in the individual cities that pose major threats to the banking system, employment and the economy. 

 

The full report is posted in the Subscriber's Area.

Markets are based on fundamentals but price is often driven by the mood of the crowd. When developers begin to cut prices, buyers who have been desperate to purchase race in but the more mature investor quickly learns to delay purchases in the hope of getting an even better bargain. Meanwhile those who hold inventory stop buying and begin to think about selling. As the process matures, if developers begin to see sales dip at a 10% discount, they are incentivised to increase the discount to 15% and so on. Confidence begets confidence as long as prices rise but weakness is preyed upon as prices decline.

To develop a multi-layer capital market with proper structure, complete function and effective regulation by 2020, the Guideline highlighted the development of direct financing, which includes three major areas of bond market, equity market and private equity.

On bond market, the Guideline aimed to a) develop a scheme of local government bond issuance; 2) enrich bond products suitable for various investors; 3) develop bond types for SMEs; 4) connect different bond exchanges and 5) improve issuance procedure, rating mechanism as well as 6) promote asset securitization. To develop a multi-layered equity market and cultivate a healthy private equity market are other two major areas in promoting the direct-financing.

In A share stock market, the approval-based stock issuance system will be replaced by a registration-based one, and such move will be accompanied by the new IPOs governing rules published by the Securities Association of China the same day of the Guideline. Regulators will crackdown insider trading, enhance information disclosure, improve delisting regime, and support pension funds investments into capital markets by preferential tax policies.

The State Council also said it will foster the market for private equity funds and venture capital funds. Going forward, the placement of private equity won’t be subjected to administrative approval and funds of private equity and venture capital will be encouraged to support SMEs and newly emerging industries.

Developing the capital markets is a major policy goal for the Chinese administration as it seeks to allow the market a greater role in setting prices for financial products. The loophole through which Alipay can offer deposit rates multiples those of the major banks represents an example of how much the regulatory environment still has to evolve. 

The seeds of conflict are evident. On his recent visit to Asia, President Obama made clear how the tensions between Japan and China over the Senkaku Islands (Diaoyu Islands to Beijing) could draw in the United States. His declaration that the Japan-administered rocks in the East China Sea “fall within the scope of Article 5 of the U.S.-Japan Treaty of Mutual Cooperation and Security” incensed China, which claims the islands. Mind your own business and get over the Cold War was the essence of the Chinese message to Washington.

Vietnam and China also have maritime conflicts that have flared in recent days as a result of a Chinese decision to place an oil rig in the South China Sea. Chinese ships escorting the rig rammed and fired water cannons at Vietnamese vessels attempting to stop the move in potentially oil- and gas-rich waters claimed by Hanoi.

The U.S. response in support of Vietnam, its erstwhile enemy turned pivot-to-Asia partner, was firm: “China’s decision to introduce an oil rig accompanied by numerous government vessels for the first time in waters disputed with Vietnam is provocative and raises tensions,” Jen Psaki, a State Department spokeswoman, said in a statement. “This unilateral action appears to be part of a broader pattern of Chinese behavior to advance its claims over disputed territory in a manner that undermines peace and stability in the region.”

In a piece last week I argued that outsiders looking at the West’s response to Russia’s actions in Ukraine could only conclude that possible targets elsewhere might be softer than they might once have thought. China’s actions in the South China Sea have been ramped up recently and the timing is hardly a coincidence.

Phat Dragon brought forward the timing of the enactment of growth stabilisation policies from midyear to ‘immediate’ not long after the NPC. Policy needs be loosened to a degree because without a replenishment of the investment pipeline, the growth pulse will slow to the point where domestic demand growth will fall below 7% in Q3. Chinese policymakers have little room to move nowadays, with domestic demand growth sub 7% viewed as unpalatable from the point of view of job creation and anything exceeding 8% likely to be inflationary.

This change of tack by domestic policymakers will combine with an improvement in global economic conditions to lift the economy in late 2014, ensuring that it enters 2015 will some positive momentum.

Phat Dragon anticipates that the world economy will be significantly firmer in 2015, which will assist China as it attempts to grow in a less credit-intensive fashion. While RRR cuts remain possible, Phat Dragon argues that it must be obvious that OMO could not achieve the same ends before the PBoC would choose that avenue for boosting liquidity. The most likely time for a RRR cut is probably post deposit rate reform, which now has a definite “within two years” timeframe attached to it. (Note that “in the near future” meant 11 months in the case of the wider CNY band, and deposit insurance/guarantee system is likely to be built first).

Regarding China’s balance sheet challenges, the financial system will remain a source of bearish news flow. While Phat Dragon feels that the ultimate risks relating to Chinese debt are generally exaggerated (it still has a current account surplus after all, and is the world’s second largest international creditor) there seems little doubt in Phat Dragon’s mind that bearish views on the growth-credit nexus will be remunerative in the first half of this year.

 

The full report is posted in the Subscriber's Area.

The moderation of China’s investment led growth rate necessitates that the manufacturing and exports pick up some of the slack if a more serious deterioration is to be avoided. Allowing the Yuan to weaken would appear to be a central strut in achieving this goal. 

Easing the reserve requirements imposed on banks represent a blunt but effective instrument in controlling how liquidity flows into the capital markets. However since the government has no control subsequently over who this additional money would be lent to, we can regard it as a last resort from a policy perspective. 

China’s economy remains within what can only be described as a policy transition phase. Many investors remain on the side lines as they watch for signs of a bullish catalyst not least from the banking sector which remains rangebound above the 2013 lows. 

We undertook two proprietary studies, on 2,400 Chinese corporate bond issuers and 13,000 collective trust products, and identified credit risks worth Rmb237bn for these two markets, with listed banks exposed to 37% of these risks. Despite setting aside excess provisions of Rmb819bn, their valuation prices in NPLs of Rmb2.8tr. We expect the sentiment on Chinese banks to reverse after the end of the repayment peaks of the corporate bonds and trust products this May/June, when the market realizes that the actual default rates are materially lower than expected and a gradual rise in default rate is the usual path towards correct pricing of credit and an efficient capital allocation.

Quantifying the expected default rate of the corporate bond market 
Our proprietary study on 2,400 Chinese corporate bond issuers, with a combined issuance of 5,500 bonds, identifies 88 issuers facing suspension risks due to P&L losses in 2012 and 1H13 with 74 of them being SOEs that are unlikely to default. This leaves 14 privately owned entities (POEs) as higher risk bond issuers, in addition to the 8 POEs downgraded and on the negative watch list, with a combined issuance of Rmb28.6bn, or 39bps of the total outstanding corporate bonds, which reached Rmb7.4tr in February 2014. Around 65% of these loss-making issuers are involved in the overcapacity sector, namely steel (34%), mining (20%), metal (9%) and solar (2%), in terms of issuance size.

 

A link to the full report is posted in the Subscriber's Area.

Chinese banks have among the lowest P/Es and highest yields in the world. The reason they continue to trade at such attractive valuations is because investors do not feel sufficiently informed with regard to their non performing loans to commit capital. This reports offers a number of insights into the schedule of potential defaults which helps improve our knowledge of the situation. If you are interested in China, this report is well worth reading. 

In recent weeks, investors have been treated to a litany of bad news from China: disappointing Jan-Feb economic data, the first ever default in the domestic bond market and another default in the trust sector. With slowing money supply and credit growth, fears of a ‘hard landing’ or systemic crisis have been re-ignited. We remain of the view that such concerns are exaggerated. The increasing profile given to credit events reflects, we think, a desire to educate depositors about risk more than a genuine increase in risk. 

Nevertheless, the weaker economic data cannot be ignored and we have revised down our forecast for 2014 GDP growth to 7.8% from 8.6% previously and our CPI inflation forecast to 2.2% from 3.7% previously. This represents a mild pickup in growth in 2014 in both real and nominal terms relative to 2013, albeit less dramatic than we previously expected.

We estimate that the Jan-Feb data are consistent with GDP growth slowing to about 7.4%yoy in Q1 from 7.7% in Q4. With growth slowing towards the bottom of the government’s 7%-8% comfort zone, this weakening momentum is likely to elicit a policy response. The decline in interbank rates in recent weeks may be the initial monetary component of this stimulus. Recent approvals of RMB142bn in government investment for five railway projects may be the beginning of the fiscal component. We think the government may also seek to accelerate growth-enhancing reforms, especially liberalization of private investment.

But we expect any stimulus to be very modest. The slowdown is largely the outcome of the government’s efforts to rebalance the economy’s structure and senior policymakers have frequently noted that rebalancing is likely to depress activity in the near term. What they will seek to do is to support growth to prevent an increase in financial risks and to ensure adequate employment growth. Aggressive monetary stimulus could, to be sure, boost growth rapidly, but at the cost of the rebalancing agenda. So the reform agenda constrains the policy response in some ways but also shapes the response towards accelerated liberalization in a bid to support growth through means other than traditional stimulus.

We think Q1 is likely to be the trough for growth this cycle, then, in part because we see a policy response aimed at providing a little stimulus. More important, though, we expect the external sector to re-emerge for the first time in four years as a source of growth in the economy. Exports grew at an annualized rate of about 17% over the last six months of 2013 and we expect that as US activity recovers from its winter chill the apparent pause in Chinese export momentum so far this year will be replaced by renewed growth. We look for net exports to contribute about 0.6ppts to GDP growth this year, a forecast that we view as conservative.

 

A link to the full report can be found in the Subscr iber's Area.

Two clear results of the People’s Congress have been a willingness to allow systemically unimportant companies declare bankruptcy and to allow the Yuan to weaken. In many respects these two policies are intertwined. If the administration is to cut off funding to failing entities it will need the manufacturing sector to return to being a central performer in the country’s growth engine. A weaker currency would certainly help in that objective.  
 

The regulatory action ends a probe that began in January, when China's State Administration for Industry & Commerce began investigating the company following media reports.

"We continue to believe in the potential of China's large and growing market," said Dan Chard, Nu Skin's president of global sales and operations, in a statement. "We remain committed to working cooperatively with the Chinese government to ensure the healthy, long-term growth of our business."

Nu Skin was fined $524,00 for illegally conducting direct sales. The company was fined an additional $16,000 for product claims that Chinese regulators said did not have enough evidence. Six Nu Skin sales employees were fined a combined $241,000 for "unauthorized promotional activities."

Over the last few years, companies employing a direct selling strategy have come under scrutiny from both short sellers and regulatory authorities. Peer group and door-to-door selling strategies are employed because they succeed in tapping into retail markets without having to spend fortunes on leases and shop fittings. Unfortunately, this leaves companies open to the accusation that they are engaged in pyramid selling which has had outsized effects on their shares.

The Bloomberg-JPMorgan Asia Dollar Index fell to a six- month low after the U.S. central bank reduced its monthly bond- buying program yesterday by another $10 billion to $55 billion.

The purchases could end in the second half of this year and borrowing costs may be increased around six months later, said Fed Chair Janet Yellen. China’s yuan sank to a one-year low after the nation’s central bank weakened the currency’s reference rate by 0.18 percent, matching a March 10 cut that was the biggest since July 2012.

“Yellen’s comment seem more hawkish than expected,” said Samson Tu, a Taipei-based fund manager at Uni-President Assets Management Corp. “It may take one or two days for the message to be digested before emerging-market currencies can stabilize, and Asian currencies are facing the additional pressure of the weakening yuan.”

 

The most consistent trends in the currency markets develop when the strongest currencies are paired against the weakest. Over the last year, the slow recovery of expectations for the US Dollar have changed the dynamics of the currency markets particularly as previous stalwarts, the Yuan and the Yen, have moved towards being among the weakest. 

 

Among the key listed Chinese developers that have yet to announce their FY13 results but will be reporting by the end of March, based on the actual 2012 dividends and our forecasted 2013 dividends, we expect high 2013 dividend yields for R&F, Greentown, Agile and Evergrande. Specifically, at the current share price, R&F is trading at a 2012A dividend yield of 7.8% and 2013E dividend yield of 9.1%. Greentown is trading at a 2012A dividend yield of 7.3% and 2013E dividend yield of 8%. Evergrande is trading at a 2012A dividend of 5.3% and 2013E dividend yield of 7.3% while Agile is trading at a 2012A dividend yield of 8.4% and 2013E dividend yield of 8.7%.

Looking at the information on the short interests on Chinese developers, which are estimates based on DataExplorers and the DB Global Prime Finance team, we found that the size of the cumulative short positions on the China property names, including the high-quality state-owned developers like COLI and CR Land, has recently risen quite sharply. For example, the short interests/positions on COLI have increased 9% month-on-month, and based on our estimates, it would take about 8 days to cover the outstanding short positions. As another example, the short interests/positions on CR Land have increased 37% month-on-month, and based on our estimates, it would take about 11 days to cover the outstanding short positions.

 

The issues China has with overcapacity in the materials sector, a rising tide of defaults in the corporate sector and overbuilding particularly in 2nd and 3rd tier cities are well understood. Considering just how low valuations are, it is reasonable to assume that a good share of the bad news is already in the price. 

However, one of the most compelling arguments for remaining on the side-line remains that we just do not know how large the problem is with bad loans and therefore cannot make a judgement on whether attractive valuations can be trusted. The current devaluation of the Yuan suggests efforts are underway to try and enhance the economy’s competitiveness.
 

Total debt of publicly traded non-financial companies in China and Hong Kong has surged to $1.98 trillion from $607 billion at the end of 2007. Some 63 companies have a debt-to- equity ratio exceeding 400 percent, compared to the average of 73 percent. In latest filings, 351 have negative ratios of earnings before interest, taxes, depreciation and amortization to interest expenses, while 409 have coverage of less than 1.

Renewable energy, materials, household appliances and software companies dominate the rankings.

Premier Li Keqiang is trying to balance efforts to avoid sharper slowdowns in economic growth with steps to rein in debt.

Expansion in gross domestic product is set to cool to a more than two-decade low of 7.5 percent this year from 7.7 percent in 2013, according to the median estimate in a Bloomberg survey.

 

$630 billion in Chinese corporate debt will need to be paid off or refinanced this year and we have just seen the first onshore default. It is a reasonable expectation that more will follow. Until now, investment vehicles have been supported by government largesse and investors have been made whole in the event of trouble. That is simply unsustainable, not least because the debt market is now so large that to continue on that trajectory would eventually bankrupt the country. 

As for the “tigers,” since about a year ago 19 ministerial and provincial-level senior leaders have been arrested, including four members (two full members and two alternate members) of the newly formed 18th Central Committee.51 Many of the arrested leaders have had ties to the country’s most formidable special interest groups like the oil industry, including Jiang Jiemin, the minister who oversaw all major state-owned enterprises (SOEs) under the State-owned Assets Supervision and Administration Commission (SASAC). In addition, 30 executives of SOEs—including 20 CEOs—were arrested in 2013, representing various industries such as energy, transportation, telecommunications, finance, steel, and mining.

Some critics may be cynical about the methods employed in the anti-corruption campaign, which relies more on the CCP’s traditional campaign mechanisms rather than the legal system. Zi Zhongyun, a distinguished scholar and former English interpreter for Mao Zedong and Zhou Enlai, recently wrote that the current anti-corruption campaign could not effectively prevent corruption—not only because there are far too many corrupt officials in the country, but also because such a campaign might lead to power abuse and undermine the role of the legal system and emerging civil society.53 While Zi and likeminded critics have valid concerns, one may reasonably argue that this criticism is unfair on the grounds that one simply cannot expect to establish a legal system in China in a short period of time. The fact is that, as Zi herself recognizes in her article, the campaign has already transformed the behavior of Chinese officials. Also, in the defense of Wang Qishan, Wang himself stated explicitly that the anti-corruption campaign should mainly deal with symptoms (....) now in order to gain the necessary time to find a way to cure the disease (....) in the future.

It should be noted that the Third Plenum resolution did hold out promise for legal reforms, especially greater judicial independence. Under the current system local judges and secretaries of local discipline inspection commissions answer to local party chiefs, who exert political pressure on their decisions. Under the rule of Bo Xilai, for example, Chongqing city’s high court almost completely followed Bo’s orders. Abuse of power and police brutality became rampant in the city. The proposed vertical control of local courts by the national judiciary (and also the vertical control of local discipline commissions by the CCDI) should be seen as an encouraging policy move to prevent power abuse and strengthen the rule of law.

 

The Party Congress currently underway is taking place amid the aftermath of terror attacks and high expectations for reform. This report is a useful primer for how the political establishment is structured and who is in charge of what. 
 

The Kunming attack came just days before the opening meetings of the Chinese People's Political Consultative Conference today and the National People's Congress on Wednesday.

Last October, three people died carrying out what Beijing described as a terrorist suicide attack in Tiananmen Square that killed two others and left dozens injured.

Officials blamed the East Turkestan Islamic Movement for the incident, which occurred 10 days before a crucial Communist Party meeting.

"Terrorists are using all means to create widespread social panic … across China," said Pan Zhiping, an expert on terrorism at Xinjiang Social Science Academy. "The timing of the Kunming attack implies the terrorists want to create the biggest impact possible.

"Security is tight in Beijing and Xinjiang and in their surrounding provinces, but Kunming, a city thousands of kilometres away … is less defended. Nobody could have predicted an attack would be staged there."

Events unfolding in Ukraine have stolen headlines, but the mass murder that shook China over the weekend represents an escalation of the terror campaign that many associate with Xinjiang separatists.

The Communist Party’s claim to legitimacy rests on its ability to deliver social stability and improving standards of living. It is reasonable to expect that anyone who wishes to damage the Party would look on the weekend before the opening of the annual congress as an opportune moment to act.

“Compared with a few days ago, chances for a reversal only from a technical point of view look to be smaller,” said Minoru Shioiri, a Tokyo-based manager in the credit and foreign- exchange trading division at Mitsubishi UFJ Morgan Stanley Securities Co. “The move has a lot to do with the onshore fixing. So, rather than a technical story, it’s a question over whether there is any change in the central bank’s stance over the yuan.”

UBS AG said yesterday recent depreciation may suggest the People’s Bank of China is shifting away from allowing a steady pace of gains and this may lead to a reversal of “hot money” inflows.

Investors should buy the offshore yuan at 6.12 per dollar as introducing more volatility into the markets is part of the process to liberalize China’s capital account, said Jonathan Cavenagh, a Singapore-based strategist at Westpac Banking Corp.

“Where I would definitely reset my view is a move above 6.15 per dollar,” said Cavenagh. “That would potentially be a game changer because that’s where you potentially start to move to regions where some of the structured products in offshore yuan start to get stopped out. The move into the 6.15 to 6.20 range is something where I probably have to reconsider my view in a fairly meaningful way.”

 

Introducing greater volatility into the currency markets may be part of the PBoC’s plan to adjust its reliance on foreign capital flows and to cool the expansion of the shadow banking system but it is unlikely to be welcomed by China’s neighbours who are likely to feel a ripple effect. Considering just how large the shadow banking sector has become, it would be rash to expect the Yuan to continue to appreciate as it has done over the last decade since it is no longer in China’s interests to the have the strongest currency in the world. 

 

Shortly before Lu's appointment, the central bank named Ma Jun, chief China economist at Deutsche Bank AG, as its chief economist, a document seen by Caixin shows. Ma, 50, is considered one of the most bullish economists among analysts in China.

Sources close to the situation said the two appointments were surprising in that the central bank often fills those positions by promoting insiders. Efforts have continued throughout recent years to bring in talents with more diversified backgrounds, but they were not always successful.

In 2009, for example, some central bankers wanted to invite Ha Jimin, then chief economist of investment bank China International Capital Corp., to head the bank's second department of monetary policy. The proposal fell through because of opposition, the sources say.

An attempt to make Goldman Sachs' ex-employee Fred Hu a deputy governor for the bank also failed, the sources said.

It remains an open question whether Lu's leadership can make the research bureau play a more significant role in deciding monetary policies, analysts say.

Compared with economists in Western central banks and international economic institutions such as the World Bank, research fellows in China's central bank have been largely reduced to a role of assisting their coworkers with policymaking, sources with knowledge of the situation say.

In practice, the research bureau can act on its own initiative and choose research topics, but it often needs to work on projects dictated by other departments, the sources say.

 

Over the years subscribers have kindly forwarded a significant number of reports by Jun Ma, while we was at Deutsche Bank, which can be found in the archive. He was generally cautious of China from 2010 but adopted a more optimistic approach over the last year as valuations improved and the previous lows were approached. 

China’s Long March Capital Ltd., which partners with Citic Group Corp., is considering buying South African platinum assets after their value was depressed by strikes, the company’s Managing Partner Clement Kwong said.

The company is now reviewing a decision to hold off on purchasing South African platinum assets because of the labor issues, Kwong said in a Feb. 19 interview in Johannesburg. Long March last year partnered with Citic unit Baiyin Non-Ferrous Metal Group Co. Ltd. and China-Africa Development Fund to complete their buy-out of Perth-based Gold One International Ltd. and indirectly acquired a stake in Westonaria, South Africa-based Sibanye Gold Ltd..

“If the industry survives and makes a profit then that would be a good signal to look at investing,” said Kwong, who founded Long March Capital with a partner in 2008. “This last round has repriced these assets down so I think it would be as cheap as it gets.”

 

China has been highly successful in acquiring mining assets at bargain basement prices by following a buy low approach which should be the envy of boardrooms across the mining sector. 

The recent expression of interest in platinum assets highlights the fact that China is now the world’s largest car market and suggests it may also be interested in lead and other industrial metal assets. 

 

According to yesterday’s [Ed. Tuesday] “Comment of the Day”, “Some bear markets...are occurring in developing countries where governance and politics appear temporarily out of control...Brazil is an example”.   

The noted economist, Frank Shostak, says, “In countries such as Turkey and Argentina a tighter stance by central banks has set in motion an economic bust.
  
Sam Kee Chong in the Malaysia Chronicle recently concluded that, “Indonesia might be heading for the perfect storm...and that the other countries, in the region are vulnerable. 

The above are examples of many analysts alerting us to the emerging markets danger which other economists warn could be the “black swan” that inflicts widespread damage to financial markets in 2014.  It will not be a black swan event as far as FT Money is concerned but your views regarding the severity of the threat, or its imminence, would be appreciated.  

 

Thank you for these informative links and please also see David’s leader on Tuesday, including the last paragraph of his response. In short we can probably expect more volatility in terms of total return from emerging markets than has been the case over the last decade. 

As previous delegates at The Chart Seminar will be aware, we try not to introduce teaching examples of our own but rely on active participation from those present to generate suggestions for instruments of interest to them for us to work with. The Singapore venue for The Chart Seminar last week was notable because the vast majority of delegates were involved in private banking, with the result that in the first day the only examples requested were for currencies. 

This is perhaps not so surprising since the most notable event that has occurred in the region this year has been the pressure experienced by emerging market currencies and the knock=on effect this has had on the region’s stock markets. As a result investors are asking the question whether the bull markets that have prevailed since 2008 are still in force. 
 

New local-currency lending was 1.32 trillion yuan, the highest level since 2010. M2, the broadest measure of money supply, increased 13.2 percent from a year earlier last month, according to the central bank. That matched the median economist estimate and compared with 13.6 percent in December.

Record new credit will help the economy to maintain momentum while underscoring challenges for officials trying to limit the risk of financial turbulence from defaults and bad loans.

Uncertainty as to how China is likely to tackle its credit bubble remains a considerable headwind to sentiment improving from the perspective of many foreign investors. However, as we have seen in the cases of the USA and Europe, an issue with credit expansion can go on for much longer than many people expect once it has been identified. 

The nature of China’s credit system is that demand for credit tends to be highest in January so we will not know to what extent credit growth is sustainable until after the first quarter. The administration apparently wishes to tackle the situation but it is taking a long-term perspective; suggesting the muddle through approach taken to date is likely to continue. We will probably have more visibility on this issue once the party Congress concludes next month. 
 

“I remember from one of your recent audios you pointed to the fact that despite the relative lackluster performance of China’s main stock indices there are sectors that are performing well. I came across this presentation that addresses the same: be careful with general index-linked funds & ETFs and look for specific sectors, e.g. healthcare, insurance, railways.”

Thank you for this interesting report from LGT Bank. Here is a section:

Policies are designed to favour the private sector and make the public sector more efficient

In the long term, private enterprises should outperform SOEs.

Most China equity indices are SOE-heavy. Recommend investing in specific reform beneficiaries rather than index-linked ETFs

Banks, property developers and basic resources companies represent by the far the most liquid and largest companies in China and therefore occupy large weightings in various indices. One of the reasons they are so large is because they were among the greatest beneficiaries of China’s initial focus on infrastructure development and export led growth.

Industrial & Commercial Bank of China Ltd. is rejecting calls to bail out a troubled 3 billion-yuan ($495 million) trust product, a bank official with knowledge of the matter said, stoking concern that the nation’s first default on such high-yield investments may be looming.

ICBC, which distributed the product sold by a trust company to raise funds for Shanxi Zhenfu Energy Group, won't assume primary responsibility after the coal miner collapsed, according to the executive, who asked not be identified while negotiations continue. China's largest bank may be forced to repay investors, most of whom were Beijing-based ICBC's own private banking clients, Guangzhou Daily reported yesterday.

A default on the investment product, which comes due Jan. 31, may shake investors' faith in the implicit guarantees offered by trust companies to lure funds from wealthy people.

Assets managed by China’s 67 trusts soared 60 percent to $1.67 trillion in the 12 months ended September even as policy makers sought to curb money flow outside the formal banking system.

“Nobody wants this default to become a trigger for a financial crisis,” Xue Huiru, a Shanghai-based analyst at SWS Research Co., said of China Credit Trust's product. “Breaking the implicit guarantee may help the long-term development of China's financial system, but the short-term pain would be too much for the economy to take.”

While the Chinese banks maintain listings on both the mainland and Hong Kong, they remain organs of the Chinese administration. Therefore their actions can be interpreted as reflecting the motivations of those in power. The fact that on the one hand the administration has been attempting to clamp down on lending to the property market, while on the other the banking sector has been making abundant use of trusts to increase lending, reflects just the type of contradiction that is inherent in a one party system where politicians are personally enriched by holding sway over the actions of state owned organisations.

First, IPPs are the cheapest power stocks in the world and the cheapest in their 10-year trading history. Second, there will be a potential tariff hike for gas-fired plants. Third, IPPs have scope to raise dividend payout. Fourth, asset injection will return in 2014. After a mediocre share performance despite a strong earnings recovery in 2013, it is time to catch up. We have Buys on all five IPPs with Huadian/Huaneng as top picks given their 1) more attractive valuation, 2) stronger asset injection potential, and 3) more upside from gas plant tariff hike. 

IPPs are significantly undervalued
Following a mediocre performance in 2013 despite 60-156% EPS growth, IPPs are trading at the lowest PE multiples and highest dividend yield over the past ten years. Across the global power utility stocks, China IPPs have the highest average dividend yield and the lowest average PE. Among the China utilities sector, the China IPPs are trading at 6.3x FY14E P/E and 0.9x FY14E P/B vs. Gas at 20.6x FY14E P/E and 2.8x FY14E P/B, Water at 26.9x FY14E P/E and 3.4x FY14E P/B and Wind at 16.2x FY14E P/E and 1.5x FY14E P/B. 

Tariff hike for gas-fired plants; dividend payout to rise
We expect a tariff hike for gas-fired plants to address the gas price hike and supply shortage, which will be particularly positive to Huaneng, Datang and Huadian. With better cashflow and reduced capex, IPPs are likely to raise payouts, such as Huadian and CR Power with payout ratio of 32/33% in 2013. Moreover, IPPs are on the fast track to de-leveraging.

Asset injection is the key theme in 2014
As we have argued, China IPPs uniquely positioned with significant assets at the parentco level that are scheduled to be put into listco over the next few years. For example, at end-2013, Huaneng Group had 137GW vs. Huaneng Power¡¯s 67GW; Huadian Group had 100GW vs. Huadian Power?¡¥s 37GW. In 2013, asset injection was done on a small scale by CR Power and CPI. We expect more scalable injection in 2014 after profitability improves in 2013.

The report quoted above is posted in the Subscriber's Area.

While the mainland¡¯s stock market remains under pressure, the fact that China¡¯s valuations are among the lowest of any major economy suggests that some judicious bargain hunting is likely to be rewarded. As with many of the large cap state owned enterprises, the utility sector has been going through a tough time as it deals with increased regulation and less government support. However if this process of deleveraging is close to ending, there is potential for a rerating of the sector. 
 

China took the step as computer games have proliferated well beyond consoles to smartphones and the Internet, so people who want to play games already can in many cases. China had announced last year that the ban would be lifted within the Shanghai free-trade zone, which opened in September.

“The way they are ending the ban gives them a controlled way to let in global leaders to partner with domestic companies,” said Mark Natkin, managing director of Marbridge Consulting Ltd., a market research firm in Beijing. Companies should wait for the release of the rules, which may take another six months, before starting production and hardware sales, he said.

While Tencent Holdings has been among the greatest beneficiaries of China’s appetite for online gaming, the console market has been almost entirely neglected with most people relying on bootlegged versions of hardware to gain access to games. The lifting of the ban on consoles represents a growth opportunity for manufacturers of hardware and associated software titles. A comparison might be Apple’s success in gaining access to the Chinese market and the result this has had on its sales.

China's purchasing managers index for the non-manufacturing sector fell to 54.6 in December, the lowest since August and down from 56 a month earlier, data released today by the National Bureau of Statistics and the China Federation of Logistics and Purchasing showed. A figure above 50 indicates expansion.
"Money managers took profits off the table,"Chris Weston, chief market strategist at IG Ltd. in Melbourne, said by e-mail. "There will be weakness in global cyclicals today in Asia. It's hard to really pinpoint any bright spots."

The China data added to signs of a slowdown in the world's second-largest economy. An official gauge for factory output released Jan. 1 fell more than economists projected to a four-month low. A separate report published yesterday by HSBC Holdings Plc and Markit Economics showed its PMI of Chinese manufacturing slipped to 50.5 from 50.8 in November, matching the median estimate in a Bloomberg survey of economists.

While China's intention to foster a market oriented economy and consider the environment more prominently in planning decisions is to be welcomed, the ramifications for some of the stock market's largest sectors such as banking, materials and building is somewhat uncertain. 

The FTSE/Xinhua A600 Banks Index had been ranging mostly above the 200-day MA following a reversionary move, but broke down three weeks ago and has now returned to retest the July lows. It will need to continue to find support 8000 to check the downward bias and suggest a return to demand dominance. 
 

Xi Jinping, delivering his first New Year’s address as China’s president, said the country must press ahead with reforms in 2014 to improve livelihoods and make the country “rich and strong.”

“I firmly believe that new glories will be awaiting the Chinese people,” Xi said in a speech broadcast on state radio yesterday.

China enters 2014 facing slowing economic growth, rising environmental concerns and higher tensions with Japan over a territorial dispute that has damaged a $366 billion trade relationship. Tackling those challenges will be up to Xi, who as head of the Communist Party, military and state has amassed the greatest individual sway over his nation since former paramount leader Deng Xiaoping.

“In 2014 we will make new strides along the path of reform,” Xi said.

A key task will be overseeing the broadest economic reforms since the 1990s which were spelled out at the Communist Party Central Committee’s Third Plenum in November. Shifts include loosening the one-child policy, increasing property rights for farmers and encouraging private investment in more industries.

The world’s second largest economy is clearly undergoing an important transformation process.  An investment decision to buy or sell Chinese stocks is a bet on Xi Jinping, who now has more power than any leader since the shrewd and highly effective Deng Xiaoping.

 This item continues in the Subscriber’s Area.  

More than 150 additional Chinese and Hong Kong listed shares were added to the Chart Library over the holiday. I clicked through the list today using the View All Charts function in the International Equity Library and a number are worthy of comment. 

"Tightening financial conditions pose a risk to growth at a time when the economy is already weaker," Greg Gibbs, a currency strategist at Royal Bank of Scotland Group Plc in Singapore, wrote in a note yesterday. "The market is well aware of potential stresses in the Chinese financial sector and, if there are weak points, tightening financial conditions are more likely to weed these out."

China's non-financial companies have a record 2.6 trillion yuan of interest and principal repayments to make next year, and the official China Securities Journal said in a Nov. 26 editorial that higher interest costs may cause a "partial debt crisis to explode."

 

Among Asia recovery candidates both Japan and India have been notable for their outperformance. However, despite a low P/E for the overall market China remains an underperformer. The more disciplined approach adopted by the PBOC and its new found respect for market set rates has had a particular impact on the banking sector. 
 

Policy tailwinds. We expect China waste and water names to continue to outperform backed by favorable government policies towards environmental protection. We see China’s waste-to-energy (WTE) market continuing to expand in line with the government objective to lift the WTE-to-total treatment ratio from 20% in 2010 to 35% in 2015F. China’s wastewater treatment (WWT) market is likely to experience a gradual slowdown in new capacity additions as the WWT ratio continues to rise over the medium term; however, tariff hikes should mitigate the effect on earnings.

“Market has yet to factor in potential growth from new markets such as hazardous waste treatment (HWT) and water renovation projects. We believe HWT will become a new important income stream for China’s waste operators given increasing demand for third-party waste treatment and the higher returns it brings (levered IRR: 15-20%) compared with WTE (levered IRR: 10-15%). As China is still behind in its water renovation plans, we expect more investment in this area in the medium term; good news for WWT operators.

“Volume growth from new project wins, collection points growth, and M&A opportunities. We expect waste/waste water volume growth from project wins in both existing and new geographical areas, a rising number of waste/waste water collection points, and large-scale M&A. Watch for established SOE players with strong political connections, experienced management teams, solid“

Catalysts and risks. Near-term catalysts include (1) more lucrative waste/water project wins, (2) faster-than-expected penetration into new business segments, (3) additional supportive policies, and (4) large-scale value-accretive M&A. Downside risks to our view include (1) slower-than-expected new capacity expansion, (2) on-grid tariff, waste tipping fee, and water tariff cuts, and (3) rising interest rates.
 

The changing priorities of the Chinese administration from an outright focus on growth to a more nuanced, human capital, centred approach has obvious benefits for the environmental sector. Water treatment has been a particular beneficiary since China has substantial issues with providing ample water for its growing needs and related shares have rallied impressively. 

"I was very interested in your views as to China being quite cheap - or at least compared with some well known indices!

"I would be interested in your views of how to enter this market. Many funds and collectives seem to have high annual and initial costs, frequently above 2 or 3 % pa.

"I have been a subscriber for 10 years next month- you and Eoin have become distant but fond (and doubtlessly well off) relatives!"

Thank you for your email and both Eoin and I are honoured to be thought of as 'distant but fond relatives'.

Vice President Joe Biden will press Chinese leaders on their intentions in creating a new air-defense zone, as Defense Secretary Chuck Hagel assured Japan of U.S. support and continued military operations in the region.

Biden will use meetings with leaders in Beijing next week partly to express U.S. concern aboutChina's behavior toward its neighbors and seek an explanation of the air zone it claimed over disputed areas of the East China Sea, according to an administration official who briefed reporters today on condition of anonymity to discuss the vice president's plans.

China's establishment of an air zone that includes islands claimed by both Japan and China "is a potentially destabilizing unilateral action designed to change the status quo in the region, and raises the risk of misunderstanding and miscalculation," Hagel said in a call today to Japanese Defense Minister Itsunori Onodera, according to an e-mailed statement by Pentagon spokesman Carl Woog.

The U.S. sent two unarmed B-52 bombers through the disputed zone this week without the advance notice that China has demanded and without incident. South Korea's military sent a plane through the area yesterday on a regular patrol flight, according to NHK, Japan's public broadcasting organization, which cited military sources it didn't name.

ANA Holdings Inc. (9202) and Japan Airlines Co., Japan's largest carriers, ran flights that landed today through the zone without advance notice, the companies said. Peach Aviation Ltd., a low-fare affiliate of ANA, also flew through the area without coordinating with the Chinese.

China's bullying manoeuvre is creating a Keynesian military stimulus in Asia but I do not think it has many allies in this adventure. Worse still for China, it will now have to endure Joe Biden's grins.

Germany's DAX Index has risen for nine consecutive weeks and eleven out of the last thirteen weeks. It is also more overextended relative to its 200-day moving average than at any time since this bull market commenced with a weekly upside key reversal in March 2009. The next downward dynamic (see examples following previous overextensions to the upside) will indicate the onset of a corrective phase.

The US Dollar declined for much of the decade from 2000 as the USA dealt with twin busts and money policy that deliberately targeted a weak currency as a policy objective. The relative attraction of other currency markets was therefore burnished. Investors became accustomed to an environment where currency market and capital market appreciation contributed to total return.

Asia is on the cusp of a full-blown arms race. The escalating clash between China and almost all its neighbours in the Pacific has reached a threshold. All other economic issues at this point are becoming secondary.

Beijing's implicit threat to shoot down any aircraft that fails to adhere to its new air control zone in the East China Sea is a watershed moment for the world. The issue cannot easily be finessed. Other countries either comply, or they don't comply. Somebody has to back down.

The gravity of the latest dispute should by now be obvious even to those who don't pay attention the Pacific Rim, the most dangerous geostrategic fault line in the world.

Japan's foreign minister, Fumio Kishida, accused China of "profoundly dangerous acts that unilaterally change the status quo".

The US defence secretary Chuck Hagel called it "a destabilising attempt to alter the status quo in the region" and warned that the US would defy the order. The Pentagon has since stated that US pilots will not switch on their transponders to comply, and will defend themselves if attacked. Think about this for a moment.

Mr Hagel asserted categorically that Washington will stand behind its alliance with Japan, the anchor of American security in Asia. "The United States reaffirms its long-standing policy that Article V of the US Japan Mutual Defense Treaty applies to the Senkaku Islands," he said.

Whether China fully believes this another matter, of course. The Senkaku islands offer a perfect opportunity for Beijing to test the resolve of the Obama Administration since it is far from clear to the war-weary American people why they should risk conflict in Asia over these uninhabited rocks near Taiwan, and since it also far from clear whether President Obama's Asian Pivot is much more than a rhetorical flourish.

Besides, Beijing has just watched the US throw its long-time ally Saudi Arabia under a bus over Iran. It has watched Moscow score an alleged victory over Washington in Syria. You and I may think it is an error to infer too much US weakness from these incidents, but that is irrelevant. Beijing seems to be drawing its own conclusions.

Even if the immediate crisis can be defused, we are clearly sliding into a new Cold War. While it is dangerous, it could have paradoxical and powerful side effects. Rearmament lifted the world economy out of slump in the late 1930s, working as a form of concerted Keynesian fiscal stimulus. It could do so again.

The world could certainly use a Keynesian stimulus, although most of us hoped that would be infrastructure redevelopment. However, China has already done that, although perhaps not to everyone's tastes.

I have been concerned for some time about what Ambrose Evans-Pritchard discusses in this excellent article. China is definitely the aggressor in the East China Sea. Its World War II resentment of Japan, while understandable, can also be politically expedient. Moreover, China will not welcome the economic revival and rearmament of its old enemy. China is also testing President Obama. Additionally, due to its disastrous one child policy, China has a growing social issue with over 30 million excess males, who may be regarded as an expendable asset.

We should keep an eye on this situation because if it ever did go horribly wrong, the world's three biggest economies would be involved.

China's growth moderation is on course. The latest IMF forecast suggests that China's GDP growth will fall to 7.3% in 2014 from an estimated 7.6% in 2013. Reducing inequality and gentrification are on top of the government's agenda. We believe this should be accomplished by implementing broad reforms such as financial market liberalisation, effective land management, free labour mobility, broadening of social security net coverage and establishing a well-defined property rights / compensation system on natural resources. In our view, headline GDP rates only matter when it comes to national power as what counts day to day are living standards, i.e. GDP per capita.

One of the reasons democracies tend to persist is because of the institutions normally associated with this form of government. Among these are individual property rights, minority shareholder protections, an independent judiciary, free press and unambiguous law enforcement. Without aspiring to such a framework it is hard to imagine how democracies could persist beyond the short to medium term.

Yang Cuiyan, a 41-year-old housekeeper from Anhui province, is one reason China is poised to topple India as the world's top consumer of gold even as investors desert the metal.

"I don't know anything about the stock market and I don't have enough money to buy property, so I figured gold is the safest choice," she said. "I can put it on when I go back home to show everyone that I'm doing well."

Yang, who made the 650-mile (1,000-kilometer) journey to the capital from her rural home to visit relatives and shop, is one of the legions of middle-aged Chinese women, respectfully referred to as aunties, who bought coins and jewelry this year, bringing support to a market shunned by many professional investors who began doubting the metal as a store of value.

Bullion consumption in the world's second-largest economy will surge 29 percent to a record 1,000 metric tons in 2013, according to the median of 13 estimates from analysts, traders and gold producers in China surveyed by Bloomberg News. Demand that may ease 2.4 percent in 2014 from this peak still points to purchases greater than any other nation and more than the U.S., Europe and the Middle East combined.

China's demand for jewelry, bars and coins rose 30 percent to 996.3 tons in the 12 months to September, while usage in India gained 24 percent to 977.6 tons, according to the London-based World Gold Council. India was No. 1 for calendar 2012.

Gold remains in an overall downward trend; Goldman Sachs it talking it lower and western investors and traders are still drifting away from the Total Known ETF Holdings of Gold. However, it is also oversold in the short term and near prior support from the late June low.

Probably the biggest of those fish is that giant part of the world economy known as Asia. The chart below shows the anticipated growth in numbers of the middle class throughout the world over the next two decades. The solid green circle is the current middle class population (or as at 2009 to be precise); the wider blue-fringed circle represents the forecast size of this population in 20 years' time. The OECD definition of middle class is those households with daily per capita expenditures of between $10 and $100 in purchasing power parity terms.

Note that in the US and Europe, the size of the middle class is barely expected to change over the next two decades. Central and South America, and the Middle East and North Africa, are forecast to grow a little. But one area stands out: the emerging middle class in Asia is forecast to explode, from roughly 500 million to some 3 billion people.

In equity investing, the combination of a compelling secular growth story and compellingly attractive valuations is a very rare thing, the sort of investment opportunity that one might only see once or twice in a generation, if that. But it exists, here in Asia, today. Once again, however, we have to abandon conventional financial thinking in order to exploit it.

This is a very good issue of Tim Prices' letter and I commend it to you.

“The mega reform package approved by the 3rd Plenum, which includes 60 measures, is by far the most profound in a decade, if not decades, in terms of scope, depth, and impact. Its aggressiveness even exceeded our very bullish expectation. Emphasizing that the market would play a decisive role in allocating resources, this plan will guide China's second-half journey towards a market-based economy, significantly lift China's growth potential, and help reduce macro risks.

We believe that deregulation which will permit private companies to enter most industries other than those related to national security is the most important reform within the package. Our estimate shows that relative to the reform scenario, deregulation will boost the average annual real output growth of the private sector by 3ppts per year in the coming decade.

The measures to liberalize interest rates and the capital account, granting greater market access to foreign investors, granting farmers the titles of land use rights, as well as resource pricing reform will enhance the efficiency of resources allocation, and speed up the development the service sector. The development of the municipal bond market will help remove a major overhang on banks NPLs. The transfer of SOE shares to the pension fund and raising the SOE dividend payout ratio will help improve pension and fiscal sustainability in the longer run. The two-child policy will help raise long-term growth potential.

What can only be described as a lukewarm response to the initial announcement of policy ambitions following the plenary session of China's parliament turned to enthusiasm on Friday as some of the more ambitious objectives were revealed. These are now being hailed as the most extensive reforms in decades and are likely to prove a catalyst for investor interest in the stock market.

Two of the most important moves relate to the banking sector and the one child policy.

Call it policy presentation with Chinese characteristics. After the meeting of its leadership last week, China's Communist Party issued a muddled communique that aroused no great excitement. Then, on the weekend, well ahead of the usual schedule for such announcements, the party released a longer follow-up statement worth getting excited about.

It's radical stuff -- in principle, if not (yet) in policy. Maybe China's new president, Xi Jinping, aspires to be another Deng Xiaoping after all.

The "Decision on Major Issues Concerning Comprehensively Deepening Reforms" was nothing if not wide-ranging. Tucked inside it were the biggest headlines, so far as many foreign observers are concerned: China's notorious one-child policy is to be softened, and the system of arbitrary confinement to "re-education" in labor camps, a tool of political repression, is to be ended.

Most of the statement, though, is devoted to a comprehensive list of economic and financial reforms. This emphasis is deliberate: "The reform of the economic system is the focus of all the efforts to deepen the all-round reform." Many of the proposals echo the long-standing recommendations of pro-market advocates at home and abroad.

The statement calls for China's financial sector to be liberalized. There will be new private banks, as well as further moves toward exchange-rate flexibility, market-determined interest rates and capital-account convertibility. The blueprint calls for price reforms in water, energy, transportation and telecommunications. Farmers will be given new property rights, including the right of succession and the ability to sell shares in their land or use it as collateral. The system of household registration, which controls workers' movement from countryside to city, will be eased (though curbs on migration to the biggest cities will remain).

Bloomberg's second paragraph above summarises the reaction of numerous China watchers. Many of us hoped for another Deng Xiaoping when Xi Jinping was first appointed. He had more power than his immediate predecessors but the new President obviously did not have Deng's political stature. Consequently he had to negotiate his way and has successfully done so, judging from this abridged 60-point document.

China’s leaders are under pressure to revamp the nation’s finances as swelling local-government debt highlights the risk of a buildup of bad loans and state businesses’ access to bank funding crowds out small firms. Today’s document didn’t discuss specific issues such as regional borrowing, interest rates or the one-child policy, while referring generally to giving farmers more property rights.

“It’s going in the right direction is the most you can say,” said Louis Kuijs, chief China economist at Royal Bank of Scotland Group Plc in Hong Kong. “Even though some of the phrasing is new, the ideas are not so new.”

The communique, published by the official Xinhua News Agency, reiterated the role of state ownership while saying development of the non-public sector will be “encouraged.”

That emphasis “probably precludes drastic state-owned enterprise-related reforms,” said Kuijs, who previously worked for the World Bank in China.
 

The announcement following the weekend’s policy summit has underwhelmed markets. This is particularly noteworthy because high level officials had taken such pains to hype the reform agenda ahead of the meeting. What is perhaps most important is that while a greater role for markets has been advocated, nothing specific has been mentioned about reform of the state owned enterprises (SEO) sector. These companies remain the personal fiefdoms of individual party cadres and represent a barrier to greater competition and efficiency. (Also see Comment of the Day on October 29th).