Wall Street is convincing itself that China will bounce back relatively quickly around the end of the first quarter, when it expects the coronavirus‘ spread to be contained.
This is banker delusion. China’s economy is growing much more slowly than it was in 2003, when the SARS outbreak hit.
Plus, the financial sector is in much worse shape. It’s loaded with debt, and credit conditions are still deteriorating from bailouts last year. This will all make it much harder to fund struggling businesses and local governments.
This is an opinion column. The thoughts expressed are those of the author.
The coronavirus is still spreading throughout China, but all over Wall Street, a consensus about the virus‘ economic influence is already solidifying.
The thinking goes like this: China will slowly get back to work by the end of the first quarter. Investors will stay fairly steady throughout this period knowing that coronavirus will result only in a temporary knock on corporate profits and general economic activity. Ultimately, like in 2003 when SARS gripped the nation, China will rally to a V-shaped recovery – that is, a quick fall in economy activity followed by a sharp return to normalcy soon after. Markets are overreacting.
This consensus is wrong. And it’s wrong not just because we don’t know if the consensus timeline is even remotely accurate – but also because the Chinese economy, and especially its banking system, is completely different now than it was in 2003.
The country’s economy is growing much more slowly now (GDP growth has recently been about 6%, according to the government, compared with 10% in 2003), and the banking system is far more fragile and laden with debt.
Foto: sourceAutonomous Research
„There’s no reference point at all for what it feels like when China is truly in a recession across the board because they’ve been on a 30-year growth binge,“ Charlene Chu, a senior analyst at Autonomous Research, said. „The world is underplaying what’s going on in China.“
Chu described the coronavirus‘ influence on the economy as a „much deeper shock with a much different context.“ And in the middle of it all, local governments will still be under intense pressure to meet economic targets, and businesses will be under intense pressure not to fire anyone.
Who will think of the banks?
To understand the economic predicament the country finds itself in, you have to remember what was happening in China about a year ago completely aside from the trade conflict with the US. Last winter, you may recall, it seemed the Chinese economy might come apart at the seams, as credit had dried up for the private sector – which is where most of the country’s growth comes from – and consumers dramatically slowed spending.
It is no surprise, then, that the creditworthiness of the Chinese banking system has been trending downward, especially at the lower end.
Foto: sourceAutonomous Research
Because of the coronavirus, this weakened banking system – less than one year out from being on a bit of a brink – will now have to forgive loans for companies large and small and continue financing local governments dealing with the fallout from stagnating economies and the effort to fight the coronavirus. S&P research estimated that if this crisis is prolonged, bad debt in the banking system could increase from 2% at the end of last year to over 6%.
In this environment, some kind of liquidity event could be even more disruptive than it was in the summer.
„Banks will all be more sensitive to their exposure to each other. And they don’t really know each other’s risk,“ Dinny McMahon, the author of „China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans and the End of the Chinese Miracle,“ told Business Insider. „If there was a liquidity event, you might see a flight to safety very quickly, and how the banks define safety may be a bit more severe than it was last year.“
And then, of course, even if the banks could forgive loans and ease credit conditions, that would only do so much. Some businesses simply may not be creditworthy after this economic shock.
„Much of the talk right now is about forcing banks to cut rates, but lower rates won’t solve the problem if firms are insolvent,“ Leland Miller, the founder of the business surveyor China Beige Book, said. „So the issue isn’t cost of capital, it’s whether the underlying firms are ultimately creditworthy. Depending on how long it takes the economy to get back chugging, that number now may be substantially lower than what it was before the outbreak.“
Then there’s the private sector
China’s other financial-system struggle over the past year was ensuring that private-sector companies, mostly small and medium-size enterprises (SMEs), were getting adequate funding. A lot of these companies used to get financing from China’s shadow-banking system, so when authorities cracked down on that in 2017 and 2018, they got squeezed.
Authorities spent last year setting up funding mechanisms for them, but the system still isn’t working to perfection. This is incredibly important. Chinese state media reported that in 2018, the private sector accounted for 50% of tax revenue, 60% of GDP, and 90% of new jobs and new firms.
„I think they know they’re still going to have an issue getting funding to these guys,“ Chu said of the SMEs. „They are looking at the bond market … but they had issues with SMEs and bank problems last summer so that isn’t straightforward.“
Foto: sourceAutonomous Research
Of course, if you’re an SME that has no relationship with a bank, credit relief might not help you much, McMahon told Business Insider.
That is why China announced last week measures to support SMEs that have nothing to do with the banks, including asking local governments to waive taxes and administrative fees.
„This isn’t something the banks can necessarily fix, which is new,“ McMahon said. „You’ve got a big part of the economy that’s sort of out there on its own.“
In January, Chinese state media declared China’s victory over all of these issues, saying that it defused „the bomb“ by taking leverage ratios down at banks. The coronavirus could reverse all of that progress, according to S&P Global ratings, and take leverage ratios up to levels unseen in decades. In these circumstances, the government will need to be very careful about how it manages this situation. This is why China’s recovery is going to be a slog, not a snapback.
OTTAWA – Finance Minister Chrystia Freeland says the government is making some changes to mortgage rules to help more Canadians to purchase their first home.
She says the changes will come into force in December and better reflect the housing market.
The price cap for insured mortgages will be boosted for the first time since 2012, moving to $1.5 million from $1 million, to allow more people to qualify for a mortgage with less than a 20 per cent down payment.
The government will also expand its 30-year mortgage amortization to include first-time homebuyers buying any type of home, as well as anybody buying a newly built home.
On Aug. 1 eligibility for the 30-year amortization was changed to include first-time buyers purchasing a newly-built home.
Justice Minister Arif Virani is also releasing drafts for a bill of rights for renters as well as one for homebuyers, both of which the government promised five months ago.
Virani says the government intends to work with provinces to prevent practices like renovictions, where landowners evict tenants and make minimal renovations and then seek higher rents.
The government touts today’s announced measures as the “boldest mortgage reforms in decades,” and it comes after a year of criticism over high housing costs.
The Liberals have been slumping in the polls for months, including among younger adults who say not being able to afford a house is one of their key concerns.
This report by The Canadian Press was first published Sept. 16, 2024.
OTTAWA – Statistics Canada says manufacturing sales rose 1.4 per cent to $71 billion in July, helped by higher sales in the petroleum and coal and chemical product subsectors.
The increase followed a 1.7 per cent decrease in June.
The agency says sales in the petroleum and coal product subsector gained 6.7 per cent to total $8.6 billion in July as most refineries sold more, helped by higher prices and demand.
Chemical product sales rose 5.3 per cent to $5.6 billion in July, boosted by increased sales of pharmaceutical and medicine products.
Sales of wood products fell 4.8 per cent for the month to $2.9 billion, the lowest level since May 2023.
In constant dollar terms, overall manufacturing sales rose 0.9 per cent in July.
This report by The Canadian Press was first published Sept. 16, 2024.
TORONTO – Strength in the base metal and technology sectors helped Canada’s main stock index gain almost 100 points on Friday, while U.S. stock markets climbed to their best week of the year.
“It’s been almost a complete opposite or retracement of what we saw last week,” said Philip Petursson, chief investment strategist at IG Wealth Management.
In New York, the Dow Jones industrial average was up 297.01 points at 41,393.78. The S&P 500 index was up 30.26 points at 5,626.02, while the Nasdaq composite was up 114.30 points at 17,683.98.
The S&P/TSX composite index closed up 93.51 points at 23,568.65.
While last week saw a “healthy” pullback on weaker economic data, this week investors appeared to be buying the dip and hoping the central bank “comes to the rescue,” said Petursson.
Next week, the U.S. Federal Reserve is widely expected to cut its key interest rate for the first time in several years after it significantly hiked it to fight inflation.
But the magnitude of that first cut has been the subject of debate, and the market appears split on whether the cut will be a quarter of a percentage point or a larger half-point reduction.
Petursson thinks it’s clear the smaller cut is coming. Economic data recently hasn’t been great, but it hasn’t been that bad either, he said — and inflation may have come down significantly, but it’s not defeated just yet.
“I think they’re going to be very steady,” he said, with one small cut at each of their three decisions scheduled for the rest of 2024, and more into 2025.
“I don’t think there’s a sense of urgency on the part of the Fed that they have to do something immediately.
A larger cut could also send the wrong message to the markets, added Petursson: that the Fed made a mistake in waiting this long to cut, or that it’s seeing concerning signs in the economy.
It would also be “counter to what they’ve signaled,” he said.
More important than the cut — other than the new tone it sets — will be what Fed chair Jerome Powell has to say, according to Petursson.
“That’s going to be more important than the size of the cut itself,” he said.
In Canada, where the central bank has already cut three times, Petursson expects two more before the year is through.
“Here, the labour situation is worse than what we see in the United States,” he said.
The Canadian dollar traded for 73.61 cents US compared with 73.58 cents US on Thursday.
The October crude oil contract was down 32 cents at US$68.65 per barrel and the October natural gas contract was down five cents at US$2.31 per mmBTU.
The December gold contract was up US$30.10 at US$2,610.70 an ounce and the December copper contract was up four cents US$4.24 a pound.
— With files from The Associated Press
This report by The Canadian Press was first published Sept. 13, 2024.
