The weeklong Lunar New Year holiday starts in China on February 8. This isn’t do or die for Macao casinos but it would sure be nice to see traffic to the Macao properties of Las Vegas Sands (LVS), Wynn Resorts (WYNN) and most especially MGM Resorts International (MGM), since I own those shares in my Jubak Picks portfolio, pick up during this holiday. What I’d particularly like to see is a pick up in VIP and other big stakes gambling because that would indicate that wealthier Chinese have decided that going to Macao isn’t going to put them on the radar screens of Chinese anti-corruption investigators. A high roller trip to Macao has been a black mark almost as large as the purchase of a Rolex or anything from Louis Vuitton.
We won’t know the details on the make up of traffic to Macao until the holiday is over but pre-holiday traffic has been up over last year. Total visitors to Macao climbed 5% from the pre-holiday week in 2015 and the number of visitors to Macao from mainland China was ahead by 11% from the pre-holiday week in 2015.
We’re looking ahead to the Year of the Monkey so we should be prepared for tricks (and for being pelted with rotten fruit.) A Year of the Monkey can come in one of five varieties. 2016 is a Year of the Fire Monkey who is ambitious and adventurous, but also irritable.
China’s central bank moved to stabilize the country’s stock markets after stocks fell 7% in Shanghai yesterday and triggered a market shutdown. Today the Shanghai Composite Index fell 0.26% and the Shenzhen index was lower by 1.86%.
What’s funny–in an “Oh No” instead of a “Ha, Ha” kind of way–is that the strong intervention by the People’s Bank didn’t actually produce a rally to recoup any of yesterday’s losses. It looks like Chinese investors have decided that troubles in China’s financial markets and economy aren’t susceptible to a quick fix.
The People’s Bank injected 130 billion yuan ($19.9 billion) into the financial system on Tuesday, the most since September. That was enough to take the overnight repurchase rate, a measure of the availability of funds to banks, down one basis point to 2.01% in Shanghai. That rate had climbed to 2.12% on December 31, the highestl since last April. Government regulators also said that they are rethinking lifting the ban on sales by big shareholders who own more than 5% of a company’s shares. That ban, imposed to help stabilize the market in last summer’s sell off, was set to expire on Friday, January 8. The expected expiration of that ban is thought to have contributed to yesterday’s sell off.
In addition, acting through China’s commercial banks, the People’s Bank moved to support the yuan. The onshore yuan, yuan that trade inside Mainland China, rose 0.18% Tuesday after dropping 0.62% on Monday. The People’s Bank is looking to stem rising cash outflows from China on worries about a falling yuan and a slowing Chinese economy, Bloomberg estimates that $367 billion left the country in the three months that ended in November.
Tuesday’s moves won’t stem the outflow of yuan or fix a slowing economic growth rate in China. And intervening to support China’s stock markets won’t help reduce the huge price gap between Shanghai and Shenzhen and the world’s other major stock markets. The median price to earnings ratio in Shanghai is near 65, Bloomberg calculates. India, the world’s next most expensive major market trades near 25. The U.S, U.K., and German markets all trade with median price to earnings ratios of 20 or less. Shares of Chinese companies that are listed in both Shanghai and Hong Kong sell for 38% higher prices in Shanghai–which has more to do with the dominance of optimistic individual investors (80% of trading) in Shanghai and the relative lack of international investors in those markets than it does with any fundamental strength in Shanghai versus Hong Kong.
With China’s growth rate slowing and the yuan in a downtrend, there’s no way for Shanghai and Shenzhen to sustain the current level of premium pricing. The People’s Bank can intervene to prevent panic selling but the only way to actually end that PE gap is for Mainland Chinese stocks to fall further until the economy can find its feet and growth can stabilize. That return to rising growth isn’t projected by economists to happen in 2016 or 2017.
As January goes, so goes the year, the saying goes.
Let’s hope not for 2016.
Overnight the Shanghai Composite Index fell 7% before new circuit breakers halted trading on the exchange. As markets opened around the world, other indexes followed Shanghai’s lead–without matching all the volatility seen in Shanghai. The German DAX was down 4.28% as of noon New York time and the French CAC 40 was lower by 2.43%. In New York Dow Jones Industrial Average was lower by 2.47% and the Standard & Poor’s 500 was down 2.25%.
The downward trend reflects a bout of negative news overnight. Saudi Arabia cut diplomatic ties with Iran and expelled all that country’s diplomats after a crowd stormed the Saudi embassy in Tehran protesting the execution of Shiite cleric Sheikh Nimr al-Nimr as part of a mass execution in Saudi Arabia. In China the manufacturing sector fell for a 10th straight month as the Caixin Purchasing Managers Index fell to 48.2. German inflation for December came in at just 0.2% following a 0.3% increase in November (and expectations for a 0.4% increase by economists.) That heightened worries that the European Central Bank’s program of quantitative easing, designed to raise inflation and economic growth, wasn’t working.
That news is enough to move global markets lower–except for the oil market where as of 10 a.m. in New York U.S. benchmark West Texas Intermediate was up 2.11% and the Brent benchmark was ahead 3% on fears that tensions in the Middle East would disrupt oil production.
But the huge drop in Shanghai needed a push from peculiarly Chinese factors. Today was the first day for new circuit breakers in Shanghai and, apparently, the automatic pause in trading designed to calm markets has acted to increase volatility. The pause created by the first circuit breaker resulted in an increase in selling once trading resumed because Chinese traders feared they would be prevented from selling by a second circuit breaker. In effect everyone ran for the door in fear that the second “calming” device was about to go off. China’s markets have also been on edge on what seems to be well-founded speculation that on Friday the government would rescind a ban on selling by shareholders owning more than 5% of a company’s stock. The ban was put in place to tame fears during the summer sell off in Shanghai. I’ve no idea whether today’s plunge will have any effect on the timing for lifting the ban. (Not unlikely though.)
The fact that the circuit-breaker induced panic selling and the selling on the lifting of the ban on big holders selling are both China-central means, I think, that other global markets are likely to react to new such as the rise in tensions in the Middle East and the slowdown in China’s manufacturing sector by moving lower but not with the kind of panic selling we’ve seen in Shanghai.
Welcome to 2016.
Certainly the headline is important: In November China’s foreign-exchange reserves declined to the lowest level since February 2013 as the People’s Bank of China sold dollars to prop up the renminbi/yuan ahead of the International Monetary Fund’s decision on adding China’s currency to the very exclusive club of global reserve currencies along with the dollar, the yen, the euro and the pound.
But the commentary on that headline is more likely to move financial markets in the short term: In order to maintain adequate liquidity, while reducing its currency interventions, the People’s Bank will cut bank reserve requirement ratios four to five times in 2016, according to an email response from Standard Chartered Bank to questions from Bloomberg.
China’s currency reserves dropped by $87.2 billion to just $3.44 trillion at the end of November, the People’s Bank reported today, December 7. That brings the reduction for 2015 to $405 billion, as far as outside analysts can tell. The bank also uses the forward futures market to support the renminbi/yuan and that may or may not be reflected in these numbers. (The IMF approved adding the renminbi/yuan to the fund’s Special Drawing Rights basket in a change that will take effect on October 1, 2016. That decision is likely to spur buying of the Chinese currency by central banks and other institutions that track the IMF’s currency portfolio in their own holdings.)
While the pressure to buy renminbi/yuan and sell dollars ahead of the IMF decision is now over, cash outflows from China are likely to continue into 2016 as individual Chinese test the limits of new rules on moving money out of the country and as Chinese investors and individuals look for higher returns in the United States after the Federal Reserve starts raising interest rates. Bloomberg reported today that Macquarie Securities is projecting that China’s reserves could drop to $3 trillion by the end of 2016.
A slip in the renminbi/yuan would likely be welcomed by the People’s Bank and China’s economic leadership since a lower renminbi/yuan against the dollar would provide a boost to China’s exports and to a flagging economic growth rate. In offshore trading the yuan fell 0.32% to 6.3671 to the dollar today in Hong Kong.
But a few international investment houses, such as Goldman Sachs, are predicting that the “normal” decline in the renminbi/yuan won’t be enough and that China will force an actual devaluation of its currency. A devaluation of the sort that China pursued this summer would send shock waves through the currencies and economies of other Asian exporters.
Of course, it is frequently hard to tell what policy China is pursuing in the financial markets until well after the fact. Which will make it hard to interpret the greater volatility in the renminbi/yuan that is likely to accompany the reduction in currency interventions promised by the People’s Bank as part of discussions about the IMF’s decision letting China into the currency club. Is that volatility simply a reflection of a less aggressive People’s Bank or a sign that China is pursuing a stealth-devaluation of its currency?
You can expect any slippage in the renminbi/yuan against the dollar to bring that question to the fore—at least until the markets decide they understand the new rules at the People’s Bank. (Whenever that might be.)
Yesterday I posted that Monsanto’s (MON) ugly earnings report provided important guidance for navigating earnings season. Wall Street analysts are projecting a 6.9% drop in third quarter earnings but that decline won’t be spread evenly across all market sectors. Energy stocks will, of course, see a big drop in earnings but, according to Standard & Poor’s, sectors such as telecommunications, technology, consumer discretionary, and health care will see growth of 10% or better.
Now we get a further bit of navigational advice from Yum! Brands (YUM). On Tuesday, after the market close, Yum! Brands reported earnings of $1 a share, 7 cents lower than Wall Street estimates, and revenue of $3.43 billion instead of the projected $3.67 billion.
But what is important for navigating this quarter’s earnings season was the market reaction to this miss.
Companies miss earnings projections by 7 cents or about 6.5% all the time. It’s never good news.
But seldom do stocks get taken out and shot for a 6.5% miss.
And that’d exactly what the market did to Yum! Brands. The shares closed at $83.42 on Tuesday before the earnings report and then plunged Wednesday after the open to $68.09 as of 10 a.m. New York time. That’s a drop of 18.5%.
Now there’s no doubt that Yum! Brands disappointed pretty much across the board. Same store sales in China, which accounts for about one-third of Yum’s operating profit, grew by just 2% instead of the projected 9%.
But Yum! Brands real offense was disappointing the market in some of the places where the market is most susceptible to fear.
Financial markets are worried about slowing growth in China? Yum’s results raised the possibility that growth in China had slowed so much that the company’s revenue would never completely bounce back from the food-safety scandals that had devastated sales. With growth in China slowing, what if Yum’s food safety scandals had destroyed the brand with Chinese consumers? Forever!
The other fear that hit Yum like a cold burger patty in the face was worry that growth in the fast food sector was over Forever! McDonald’s (MCD) revenue line has been essentially flat for four years. The sector is battling perceptions that its customers have moved on to better quality food and are looking for something other than gray burgers and overly salty chicken. What if the sector is never coming back?
Never is a long time and it’s a good bet that the fears about the future of Yum sales in China and about the death of the fast food sector are somewhat overblown. That’s what happens in a panic.
But the larger point for investors during this earnings season is that the markets are littered with land mines that are just ready to blow up on any company that steps on one. China growth slowdown is obviously one such land mine and Yum! Brands won’t be the last company to trip that mine this quarter. Falling commodity prices make up another mine—I’d look out, especially, for oil, copper and iron ore. The strong dollar is a third—look for exporters that live up to fears that a strong dollar will decimate sales. I’m sure there are others—falling prices in the drug sector as a result of political and regulatory scrutiny, for example. I’m sure you can make up your own list of land mines and the companies most likely to step on them.