Korean Banks Signal China Troubles

Growth for growth’s sake is pretty much over. This reflects the need to retool investment strategies to exploit what progress actually means in a world of slowing population growth, debt retrenchment, and environmental problems. Altogether this means that the cult of GDP is dying. This means trades should be based on the balance sheet strength, not on earnings growth much less multiple expansion.

The best-class Korean bank, Shinhan, is seeing its equity get pummeled. All Korean banks are getting pummeled. Not only underperforming my model—which is a pretty good one—it has been on a slide for months now.

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What gives?

It is a red alert on the China front. While China runs a huge trade surplus with the West, China runs a huge trade deficit position with most Asian countries. Emerging Asia exports raw and intermediate goods to China, and China applies the final phase of production before shipping manufactured goods overseas. Developed Asian countries like Japan and Korea export massive amounts of machinery to Chinese businesses and consumer goods to Chinese households.

Asia was in a virtuous feed-back cycle for decades. We called it “the Rise of China”. Then China, India, and a set of other Asian countries are ever more closely interconnected in a sort of inter-Asian domestic market. There is an impressive litany of free trade agreements in place for over a decade across Asia: Japan-Singapore, China-Singapore, South Korea-Singapore, India-Singapore, India-Japan, India-South Korea, Australia and New Zealand with just about every Asian country including China, same with the ASEAN countries. There is an epic agreement being worked out between China, Japan, and South Korea.

These agreements mean more than anything deep and lasting integration of nations into supra-national blocks. This extraordinary trade model in Asia—buoyant intra-regional trade, leveraged on the comparative advantages of various Asian countries—is predicated on: product specialization based on comparative advantage and a low cost of transport. Asia, not North America and Europe, already makes up a significant part of the global economy. Globalization has actually made it the engine of the global economy, increasingly independent, and progressive.

I think we have seen the highs for a while. The rise of China meant that the global economic center of gravity is shifting to the East. Now China is done with infrastructure. The West inevitably must continue balance sheet repair, which means less appetite for consumer goods, hitting Asian exports. The United States and Germany have come a long way on this front, but other countries not so much. So growth markets will be hard to find.

The solution to the problem of weak growth is moving up the capital structure. But Korean bank debt is a freaky little puzzle to me. Have a look at three years’ worth of capitalization-weighted Korean Bank debt yields. Forget talking about the volatility. This debt acts like it has an identity crisis, or rather has a risk-on/risk-off switch.

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We are seeing in Korean bank bond yields down accompanying the equity sell-off. The most reasonable data-driven trigger I have been able to find for this local currency 2s10s on Korean sovereign debt. Shinhan bank, like all banks, is sensitive to curve flattening. This makes perfect sense given that a flatter curve means weaker bank margins. This looks like a reasonable trend to ride—conditioned on a Chinese soft-landing. In the event of a full-on economic collapse in China, be advised to unwind.

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Right or wrong, it is stories, not abstract presentations of data and relationship between data, that get the traction.

So here’s a plausible story: Growth for growth’s sake is pretty much over. This reflects the need to retool investment strategies to exploit what progress actually means in a world of slowing population growth, debt retrenchment, and environmental problems. Altogether this means that the cult of GDP is dying. This means trades should be based on the balance sheet strength, not on earnings growth much less multiple expansion.

So think bonds. Longer-term, Asian stocks will recover; just not convinced that we are seeing good valuations though. This is not just book-talking.

GDP may be losing it importance as a metric, but globalization is not dying, far from it. In North America and Europe you may hear yammering about its demise. Globalization in the West is cast as a job-stealer: It is absolutely not. Globalization in the Asian press is viewed as an opportunity-maker: it absolutely is. This is because there is no culture on the planet that can collectively tighten their belts, pay down, and live on lessened means like China’s.

Globalization of trade will look more like regionalization of trade. The center of gravity of the global economy will continue to shift to Asia. There must also be a shift to domestic demand. Export-driven growth cannot be a permanent strategy. Demand will not only generate more growth, but will also reduce global imbalances.

In the long-run, this Asian version of globalization this will be positive for Asia.


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