11 March, 2016


If you think things are bad now...

Gillem Tulloch

If you think things are bad now, just wait until the slowdown really begins. China produces 60% of the world's cement but only commands 16% of the world's GDP and 19% of its population. Just think what a simple reversion to mean would mean for supply chains around the world for this and other commodities. Meanwhile, its stock market is the most expensive in the world on 3.5x price to book. Most stock markets fall to below book value every five to seven years in times of a recession. That means there's potentially more than 80% downside for Chinese equities.

Warren Buffett famously said that "it is only when the tide goes out do you discover who's been swimming naked". China's policy makers are desperately trying to stop the tide from going out, with the banking system issuing RMB3.42trn (US$524bn) of net new credit in January - a record high. That equates to Taiwan's entire GDP...in just 31 days. In other words, China's swimming in credit. The banks can probably continue printing money for longer than most of us expect but it is simply making the situation worse with leverage rising across the economy. When the tide finally goes out, they'll be quite a lot of people swimming naked; after all, China's economy is now one of the most over-leveraged in the world.

With China in mind, we've compiled a some of our most relevant past videos in the following post. This includes a 10 minute video with Real Vision plus our China Long & Short report. As a subscriber to our free newsletter, feel free to watch the videos; however, the full reports are only available to our paying institutional subscribers. Please be aware that our services are not available to retail investors. Links to past free newsletters can be found at the end of this post.

Real Vision Interview
Gillem Tulloch (4 February 2015)
In the interview, we try to challenge the commonly held view that the Chinese government is adequately dealing with the threat posed by the indebtedness of its corporate sector. Our view is that they are papering over the cracks by creating vast quantities of cheap money. Real Vision is an on demand platform for finance. Annual subscriptions start from as low as a couple of hundred dollars. For more information, please follow the link to Real Vision TV.

Elephants in the Room
Gillem Tulloch (23 July 2015)
For sure, China’s corporate sector is one of the most over-leveraged in Asia, but India’s is the most over-leveraged BY FAR. That’s rather inconvenient because many seem positive on India. The debt is not confined to just a few sectors or companies, as we keep being told, but is present in most companies, in most sectors and in most quartiles of our sample. Indian companies also have the highest exposure to unhedged foreign debt making its capital structure unstable. This explains the weak currency. We’re not calling for a repeat of the Asian Financial Crisis but growth in both China and India will disappoint for some years to come. That’s doubly inconvenient because these are Asia’s most expensive stock markets – in China’s case BY FAR. Remain UNDERWEIGHT/SHORT. Still, there is some good news from frontier markets and the ASEAN-4.

Tyranny of Numbers
Gillem Tulloch (8 October 2014)
If you think the credit numbers out of China over the past five years have been crazy, just wait for the next five. To maintain GDP growth at the current 7%, China needs to create new credit equivalent to replicating the entire US-listed financial system. By then it will have rehoused 55% of its population over the previous 15 years, will command 65% of the world’s cement production and 59% of its steel. The tyranny of numbers suggests it can’t be done. Within this report, we talk through those numbers and come up with a long/short strategy.

Unpalatable Choices
Gillem Tulloch (16 April 2014)
The magnitude of China’s bubble far surpasses the excesses of Asia’s last crisis in the mid-1990s. But bubbles can only be sustained by injecting ever greater quantities of credit into them which gets harder as time goes by. With an over-leveraged corporate sector, a banking system with lending constraints and interest rates rising, the end could be in sight. China’s policy makers face a stark choice: choke off new credit and cause a relatively short recession, or go for broke in the pursuit of growth. This latter option would buy them time but be accompanied by bailouts, nationalisations and price controls likely ending in a Soviet style failure. The recent clampdown on grey market financing suggests they will pursue the more sensible former option in which case we estimate “only” a 50% downside in the CSI300 index.