It’s no secret that things are getting tougher for China’s manufacturing sector as the country embarks on a difficult transition from an investment-driven economy to a model led by services and consumption. Domestic demand for metals has fallen [6] as “idle cranes, empty construction sites, and abandoned buildings” (to quote Bloomberg) betray a sharp economic deceleration. Export growth has slowed, rail freight has collapsed to what look like depression levels, and industrial production remains in the doldrums and will need to fall far further if China is serious about getting its pollution problem under control.
Meanwhile, Chinese equities have staged one of the most impressive rallies in recent memory as housewives, security guards, banana vendors, and, more recently, farmers [7], flock to the SHCOMP and the Shenzhen exchange where, using record margin debt, the semi-literate hordes have driven multiples into the stratosphere and created an environment where umbrella manufacturers [8] post 2,000% gains.
[9]
Given the above, and given the fact that credit is increasingly hard to come by for in the manufacturing sector with China’s largest banks reporting rising NPLs thanks in large part to souring loans to the industrial sector, one could hardly blame the industrialists for wanting to get in on the equity mania. And because nothing surprises us when it comes to China’s stock market miracle, we can’t say we were completely shocked to learn that some manufacturers are laying off everyone and trading stocks from the shop floor while they wait for the economy to recover. WSJ has more [10]:
Chinese companies are turning to an unlikely source for profits in the soft economy: the country’s red-hot stock markets.
Take Dong Jun, who earlier this year shut down his factory making lighting equipment and electrical wiring and let go some 100 workers. The 50-year-old comes to the plant in the eastern city of Yancheng almost daily, but spends his time trading stocks on behalf of his company, Yanwu Keda Electric Co.
“Manufacturing is a very hard business these days,” said Mr. Dong, chairman of the company. “I want to make some money from the stock market and use the profits to restart my manufacturing business later, when the economy turns for the better.”
Chinese companies are finding stock investing an attractive option as the wider economy struggles with tepid demand, excess industrial capacity, persistently high borrowing costs and other troubles. Their interest poses a challenge for policy makers, who want to nurture markets companies can tap for investment capital, rather than creating a venue for speculation.
You read that correctly, Dong Jun fired everyone and now goes to his lighting equipment plant everyday to trade stocks. And make no mistake, Dong isn’t alone. In fact, according to the Journal, 97% of profit growth in the manufacturing sector is being generated by stock trading:
According to the latest official data, profits earned by Chinese manufacturers rose 2.6% from a year earlier in April, a turnaround from a drop of 0.4% in the previous month. Yet nearly all of that increase—97%—came from securities investment income, data from the National Bureau of Statistics show. Excluding the investment income, China’s industrial profits were up 0.09%.
Meanwhile, over the course of 2014, the value of stocks, bonds and other tradable securities owned by listed Chinese companies rose by 946 billion yuan ($152.4 billion), a 60% increase, according to an analysis by Mr. Zhu.
So Chinese corporates are using their balance sheets to fund stock purchases which is something that US companies are also doing at a record pace but in China, companies aren't just buying their own stocks, they're buying anything and everything and they're doing it on margin:
The trend is starting to worry Chinese regulators, who have been trying to make sure that banks and the stock markets ultimately channel money into parts of the economy that create jobs. Even more problematic, according to some officials, is that the rush by companies to tap the market for easy gains now—sometimes using borrowed money to purchase stocks—could leave some scrambling for capital if the market turns.
China Railway Construction Corp. is among the companies that have put more of their funds at work in the stock market. According to its regulatory filings, the state-owned contractor since late last year has bought shares in companies including a liquor maker in Shanxi province, in the north, a retailer in central China, and a property developer near Beijing.
Better still, some companies are buying shares in Chinese banks — the same Chinese banks which, because lending to manufacturers has lower margins and has become more risky in the downturn, are helping brokers expand margin financing.
Bank stocks have proved attractive for China State Construction International Holdings Ltd., the listed arm of state-owned China State Construction Engineering Corp. It has increased its stakes in Bank of Communications Co., a large state-controlled firm, and Huaxia Bank Co., a regional lender, whose shares have been on the rise in recent months, according to data provider Wind Info. The company hasn’t released its first-quarter results. Officials at the firm didn’t respond to a request for comment.
Chinese banks, meanwhile, have been funneling funds to brokerages, helping them to expand their margin-financing businesses, a more lucrative practice than making plain corporate loans, according to banking executives and analysts.
China CITIC Bank Corp. is the most aggressive in lending to brokerages to help them finance their margin-financing businesses, according to an analysis by Reorient Group, a Hong Kong-based investment bank. Loans made to brokerages for that purpose totaled nearly 913 billion yuan in the first quarter, up 92% from a year earlier, the firm’s study shows. “Banks are happy to channel liquidity to brokerages as a way to participate in the stock rally,” said Steve Wang, head of China research at Reorient.
Essentially, banks are funding the purchase of their own stock by lending money via margin financing to the very same manufacturing sector which can't service its bank debt.
So we can add coporations to the list of Chinese stock speculators buying on margin. This means that if (or perhaps more appropriately "when") China's equity bubble does finally burst, corporate defaults (which are already on the rise [11] and would likely occur far more often if the PBoC didn't pressure lenders into rolling over bad debt) will accelerate meaningfully amid cascading margin calls and frantic attempts to raise capital.
Bondholders beware. You were warned.
