Made in China
The repercussions for Australia are serious. According to one prominent and highly successful fund manager: “No matter how one analyzes the available data, China’s economy has already started to experience a hard landing.”
Some say the short Yuan trade is the single most crowded trade in the world. That could be true, and while it would would mean rather large spikes upwards, it does not mean that being short the Yuan is wrong. As you know our view is that there is a limit, even for China’s vast foreign exchange reserves, to how long they can maintain their currency’s support in the face of significant outflows.
In Kyle Bass we find an investor who looks at what everyone else is looking at but sees what many have not seen. That’s the primary reason why we are always interested in what he has to say even though we don’t subscribe to his investment style of taking very concentrated positions. Nevertheless his profitable bets against US credit default swaps and then against Europe and Greece suggests his thoughts are worth paying attention to.
Last year at the Buttonwood Gathering Kyle Bass echoed Ray Dalio’s concerns, noting; “The next recession will be a hard one because the tools in the toolbox are not there to avert a severe downturn.”
He has since turned his attention to China and believes China’s [FX] reserves are “already below a critical level of minimum reserve adequacy.” In a recent letter explaining his short thesis he added: “In other words, China is CURRENTLY out of the required level of reserves needed to safely operate its financial system.” Bass points out that time has run out for China, its back is completely up against the wall and “the view that China has years of reserves to burn through is misinformed.”
The bulk of his fund, Hayman Capital’s, portfolio is devoted to the yuan short. You can read the full Hayman Capital letter HERE.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
ross waddell
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With China fueling growth around the world, is the real underlying tsunami an ever increasing debt snowball?
Roger Montgomery
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Hi Ross, keep an eye out for the next blog post…
James
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Having put a deposit down for an off the plan apartment in Wollongong back in 2013 I have since watched the property market boom in the city, units like mine selling for 20, 30 even 40% more than I paid for mine. It is about a month from completion and have always had the intention of moving in, but cant help but think that there is a massive bubble in CBD apartments within Australia at the moment. I’m only borrowing about 45% of the purchase price, but now seems like a perfect time to take advantage of the current real estate market by selling at a high price and buying something in a few years; however, I’m not sure whether that is the right thing to do. Anecdotal evidence of the level of Chinese investment within the city’s CBD apartment market definitely doesn’t sit overly well with me due to the potential for a Japanese style crash. If only we had crystal balls…
Roger Montgomery
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Timing markets is notoriously difficult. I am afraid we’re on a hiding to nothing offering you any suggestion. Our observations hopefully help you to assess the risks and opportunities.
LUCAS HAINSWORTH
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Trying to evaluate an economy based on GDP Figures and PMI numbers and growth rates – is the same as trying to figure out the personality of a person by analysing their blood.
Everyone thinks about China because it is the big gorilla in the room – Kyle Bass has been right on two trades so far, Subprime and Europe.
Even if there is a perfect model of the world, you’d need to be infinitely accurate and precise to predict what is going to happen. No one saw that the assassination of some random Archduke in the Balkans by Princip would lead to WW1 and through that WW2.
Let’s put our crystal balls aside and just come back to a bit of reality here.
Every human system that is created to deal with instability breaks. Every item, every tool, every tyre, everything wears out. Our bodies, our cars, our aircraft, our computers, our business models. The point is to understand that there are a few things that are timeless.
People need certain things in their lives, some businesses connect them with what they need, others don’t. You want to own businesses that assist people with the advancement of their material and intellectual lives in a positive manner. You want businesses that help people develop, communicate and advance their point of view.
The Macro stuff is important too, I agree, you didn’t want to be investing in Japan when the bubble went pop. But that’s the thing. You don’t have all eggs in the same place. And anyone who just tombstones the argument that China is going to go boom, or Japan is bust, they’re looking at certain numbers and thinking that the world runs like a machine. The world doesn’t run like a machine, people don’t make decisions always rationally (explain smoking).
It has been shown again and again that policy makers will do anything macro to keep the current world on its current path of progression.
But no one questions the other side of the coin – using stats, China has lifted 500 million people out of poverty and almost eradicated urban poverty. It has democratized technology and increased the worlds material wealth at a faster rate than almost any other time since the industrial revolution. We need to look at what has happened in our economies in the last 60 years and understand that the life that we are living is only possible because of the advances and hard work of those who have had less than us. So to just sit there and say that a multi trillon dollar economy is slowing 30 basis points is to pontificate on small data, neglecting the fact that overall we as a global community are more affluent and wealthy than at any other time, and now the real challenge is to use our economies to eradicate scarcity, which will free us once and for all from our primal greed and envy.
Roger Montgomery
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True Lucas but China’s hitherto fixed asset-led growth changed the face of our economy, as well as the salaries being paid for jobs at KFC in the Pilbara, causing individuals to pack up, move their families, overpay for a house on which they have now lost 80% and still owe a fortune. The global community may indeed be wealthier in aggregate but try telling that to the individual described above. It is also useful Lucas to remember that the slowdown we are witnessing is more than “30 basis points” and could have serious consequences for asset prices and those that have recently borrowed to buy property. It may or may not have a dramatic impact on the returns for investors in Montgomery Funds but that doesn’t mean we should eschew our duty to the broader community to at least discuss what we are concerned for them about.
Carlos
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Roger,
if you don’t invest based on macroeconomics and there is no correlation between the economy and stockmarket performance, what is the point of worrying about China and the opening statement that the repercussions for Australia are serious ?
Roger Montgomery
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Carlos, Simply because many investors have asked what we think and we respect that. Importantly, we aren’t worrying at all. We wrote this last year, it may prove helpful:
“Consider the US IPO of Coca-Cola in 1919 at $40 per share. “A year later the stock was trading at $19.50 – the result of rising sugar prices and a perpetual contract Coca-Cola had with its bottlers to supply syrup for $1 per gallon. What would have happened if your grandparents or great-grandparents purchased a single share in 1919 at $40 and held on through the subsequent decline to $19.50 in 1920, – then on through the great crash of 1929, the subsequent depression of the 1930s, World War II, a baby boom, dozens of other wars and skirmishes, an oil crisis, assassinations, the fall of the Berlin Wall, yuppies, innumerable recessions, booms, busts and scandals, as well as a war in Vietnam, two in Iraq and a global financial crisis? If they kept this share in the family and reinvested all their dividends, they would on 8 January 2010 have 126,321 shares and their investment would have a market value of $6,966,603.15.”
“That’s what I wrote in my book Value.able, published in 2010. Since then however the dividends have kept on flowing – there have been another 14 in fact – and there was a two-for-one split on 13 August 2012, as well.
“By March of 2015, after 14 further dividends and the two-for-one split, and since 8 January 2010, the value of that single Coca-Cola share in 1919 is $11.7 million.”
Joe
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Sorry, by ‘Chinese banks’ I mean Chinese central bank prop up commercial banks…
Joe
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So the key question around China is this. How much of it’s debt is external, and how much is internal?
Kyle Bass believes that China will experience a massive spike in non-performing loans. If the majority of these loans are internal (re; loans by Chinese banks denominated in yuan), then surely the Chinese banks can simply print money to prop up commercial banks?
If a large proportion of debt is external (i.e. denominated in USD), then China has a serious problem.
Either way the yuan will devalue. If the former is true (majority of debt internal), I don’t see how a weaker yuan is a massive issue. Yes, imports will become more expensive for Chinese, but given that everything is manufactured there anyway Chinese consumers can simply shift consumption habits internally. In fact, if anything this situation will create a bigger headache for the Fed, as an appreciating USD (relative to the yuan), perhaps this will make it even harder for them to raise rates?…
Roger Montgomery
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We understand 10% of the 3.3 trillion is in USD.
Guy Davis
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We are lucky so many giants in the value community are so generous with their insights, including of course the Montgomery blog. Bass is dead right that the financial community on the whole has been all too quick to believe the official GDP numbers and downplay many of the risks that have also been articulated extensively by Jim Chanos. The herd won’t be able to say they weren’t warned!
Luke Joseph
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What is the team’s view on the likelihood of a hard landing in China?
If you view it as likely, would the cash levels in the funds begin to exceed 25-30%?
Roger Montgomery
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Hi Luke, The answer to that depends on the fund you are looking at. The Montgomery Fund has a soft limit of 30 per cent cash. The Montgomery [private] Fund’s target is much higher.
Carlos
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If repercussions for Australia are serious, shouldn’t your funds be in maximum cash?
Roger Montgomery
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No Carlos, We don’t invest based on macro economics. There is no correlation between the economy and stock market performance in any year.
Richard Endersbee
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Hi Roger, do you foresee negative rates in Australia as a possibility? (greater than 50% chance in 3-5 yrs)
Roger Montgomery
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We don’t make any such predictions. They are ultimately of little use. Even if you did know where rates would be in 3 to 5 years, you still wouldn’t be sure of making money doing anything other than what we do, which is to own pieces of businesses with desirable economics and prospects. So that’s what we will keep doing.
garry howlett
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Hi Roger, as this plays out would you be inclined to lean towards the $AUD still depreciating from current levels against the $USD? Even though the U.S future interest rate rises may be delayed.
I also note Montgomery also sees what many others don’t, you guys called this 4 to 5 years ago. Should have saved many readers here at the blog a lot of money.
many thanks
Roger Montgomery
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Thanks for the encouraging words Garry. Picking currencies is obvious at extremes. Shorting the Aussie Peso at $1.10 or $1.05 was easy and something some of us actually did in volume. Today it’s much less clear.
Boris Bedniy
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I think AUD is going to trade sideways and then gradually go down into 60s zone, may be 10% from current level but upside is limited. The whole AU economy transformation need low AUD.
Roger Montgomery
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If only we could be that accurate Boris!