This one really caught me by surprise. It appears that Chinese companies are using bank loans to invest in stocks. In fact, it looks like they are doing it in record amounts. This could explain why the Shanghai Composite Index was the best performing index in the world this year. This also reminds me of the nuttiness in Japan in the late 1980s. If you are too young to remember, the Japanese Nikkei index soared to the 38,900 area at the end of 1989. In case you have not been paying attention the Nikkei closed around 7650 today. So twenty years later it is still down close to 31,000 plus points or a whopping 80 percent--give or take.
You might be thinking what does this have to do with the price of cotton in west Texas. Well, while we are sitting around worrying about the Chinese divesting or buying less Treasury securities we might also think about Japan. At the end of 2008, Japan held $578 billion of treasury securities. China? $696 billion. One big difference though--China's holdings increased by about $219 billion in 2008, while Japanese holdings dropped by about $1.5 billion.
Have you been thinking about where all the money is going to come from to finance our ever increasing Treasury debt? Given any thought to what would happen if we had to pay sharply higher interest rates? I suggest you give this some thought and get back to me.
Leveraging up in China via bank loans, Japan's economy falling off the face of the earth. None of this is bullish for U.S. stocks.
You might want to read the Bloomberg article and give it some thought.
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China Record Loans Diverted to Stocks, Shenyin Says
Chinese companies may be using record bank lending to invest in stocks, fueling a rally that’s made the benchmark Shanghai Composite Index the world’s best performer this year, according to Shenyin & Wanguo Securities Co.
As much as 660 billion yuan ($97 billion) may have been converted by companies into term deposits or used to buy equities, Li Huiyong, Shanghai-based analyst at Shenyin Wanguo, said in a phone interview today, citing money supply figures.
China’s banks lent a record 1.62 trillion yuan in January as part of a government drive to stimulate the world’s third- largest economy, while M2, the broadest measure of money supply, climbed 18.8 percent from a year earlier. The Shanghai Composite has surged 29 percent since the start of 2009, compared with a 10 percent decline in the MSCI World Index.
“Part of the liquidity flowing into the stock market could be from companies using borrowed funds to invest in the stock market instead of working requirements,” said Li.
He arrived at the 660 billion yuan figure by subtracting M1, which includes cash and demand deposits, from M2. The brokerage was voted the best in the country for research by the national pension fund, China’s largest investor.
New loans jumped to twice the record set a year earlier. The biggest proportion of new lending, 39 percent, was through discounted bills, which supply working capital. Medium and long- term corporate loans accounted for 32 percent.
Chasing Returns
Companies are reluctant to increase production amid a slowdown in demand and some may have diverted funds meant for expansion into the stock market to chase higher returns, said Li.
China’s central bank is asking lenders to identify the recipients of last month’s loans to ensure the funding contributes to economic growth, a person with knowledge of the matter said Feb. 13, speaking on condition of anonymity.
Loan growth may continue to surge this month, the Shanghai Securities News reported today, without citing a source.
The government is putting pressure on banks to support its 4 trillion yuan stimulus package, while seeking to avoid a pile- up of bad loans. Default risk represents the biggest threat to Chinese lenders this year, Fitch Ratings has said.
“It’s hard for banks to tell whether the funds are flowing into the real economy or into the stock market,” said Michelle Qi, a Shanghai-based portfolio manager at Bank of Communications Schroder Fund Management, which oversees about $790 million.
“In the short term, there’s a risk that this inflow of funds could push the market too high,” she said.
Stock Valuations
The rally has driven stock valuations 41 percent higher since November, when the Shanghai Composite Index traded at 13.3 times earnings, the lowest since at least November 1997, according to Bloomberg data. The gauge was valued at 48.7 times earnings at its peak in October 2007.
Equity transactions rose last week to the highest in at least three years. The Shanghai and Shenzhen exchanges handled a combined 32 billion shares Feb. 13, the most since Bloomberg started compiling the data in January 2006. An average of 17.3 billion shares have changed hands daily this year, compared with 9.8 billion shares in 2008.
China’s banking regulator is reviewing commercial lenders’ financing of discounted bills after January’s surge prompted concern about excessive risks, the China Business News reported yesterday, citing unidentified people.
Fortune SGAM Fund Management Co.’s Gabriel Gondard said while there may be examples of companies diverting working funds into the stock market, they are likely to be in the minority.
Working Capital
“Corporates are in need of working capital right now,” said Gondard, who helps oversee about $7.2 billion. “There may be exceptions, but it’s not big enough an impact to explain the rally.”
China’s domestic stock market capitalization has increased by $743.1 billion since November, when the government announced its 4 trillion yuan stimulus plan.
The rally has drawn more Chinese investors. About 224,000 accounts were opened to trade equities on the Shanghai and Shenzhen exchanges last week, the fastest pace in almost two months. That’s still about a quarter of the record 1.07 million set up in the week to Sept. 7, 2007.
The gains in the country’s yuan-denominated shares, restricted to its citizens and approved overseas institutions, contrasts with a decline in shares of Chinese companies listed in Hong Kong, where there are no restrictions on overseas investors. The Hang Seng China Enterprise Index of Chinese companies has lost 7.7 percent this year.
‘Superficial Exuberance’
China’s government bonds may rally with the end of the “superficial exuberance” that drove the surge in bank lending over the last two months, Qu Qing, Shenyin Wanguo’s head of bond research said in an interview today.
Some 64 percent of the new loans were made on a short-term basis, rather than for medium- and long-term investment projects, and these are likely to limit a recovery in the economy, Qu said.
Most of the discounted-bill financing was “behavior by companies” to help meet their funding needs, People’s Bank of China Vice Governor Yi Gang said Feb. 14 during a conference in Beijing. “We should respect the market,” he said.
To contact the reporter on this story: Chua Kong Ho in Shanghai at kchua6@bloomberg.net; Zhang Shidong in Shanghai at szhang4@bloomberg.net
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