The bad news for China is getting worse with every passing day. First it was purely in the financial realm, with both record capital outflows and a crashing housing market leaving the local government-backstopped banks exposed, forcing the PBOC to cut rates not once but twice in 2015, even as sliding wages in China's 4 largest cities confirm the deflationary wave has moved out of the financial arena and has entered the economy proper, something we subsequently confirmed when we showed the latest updated batch of key Chinese charts.
Earlier today we got yet another confirmation of just how truly bad things are for the world's largest (depending on how one counts GDP) economy, when Shanghai Daily reported that fiscal revenue growth slowed in the first two months this year as reduced economic growth dampened tax income and other sources of government revenue.
Fiscal revenue rose 3.2 percent to 2.57 trillion yuan (US$411 million) in the first two months, down from 11.1 percent in the same period a year ago and 2014’s 8.6 percent rise, the Ministry of Finance said on its website yesterday.
Worse, while overall revenue posted a modest increase, personal income tax dropped 7.1% year on year to 164.6 billion yuan. No, not Greece: China.
Adding insult to injury was revenue from tariffs which also declined 5.3 percent after oil, iron ore and commodity prices declined, reducing the value of imports. And confirming that the Chinese housing bubble has burst, Government revenue from land sales dropped 36.2 percent to 455.3 billion yuan due to the sluggish housing sector.
And proving it is not just the Eurozone who is incapable of trimming spending when revenues collapse. China's fiscal expenditure rose 10.5% to 1.89 trillion yuan, up from 6 percent last year. Oh well, when China's economy implodes, it too can blame "austerity."
Yet the story of China's now seemingly imminent hard landing is hardly surprising. What is, is that as all of this is taking place, the Shanghai Composite continues to soar to record highs.
But nlike the late summer and early fall of 2014, when the rise in the Chinese stock market could be attributed to the PBOC's PSL "QE Lite", the relentless buying leg that started in mid-November has stunned most people, as nobody has been able to figure out just who is responsible for all this buying.
But before we reveal the answer, recall what we wrote on November 16 in "China's Shadow Banking Grinds To A Halt As Bad Debt Surges Most In A Decade" when we revealed that one of the most aggressive sources of credit in China - those operating literally in the "shadows" - were not only not creating any incremental credit, but had stopped lending activity altogether!
This is what JPM said then:
The monthly Chinese money and credit figures released this week showed continued contraction in the share of shadow bank intermediation in new credit creation. Figure 6 shows that the share of shadow banks, proxied by the ratio of monthly total social financing over monthly new bank loans, has been on a downward trajectory since the end of 2013, experiencing its fourth episode of slowing since 2010. As of October this year, our smoothed trend in the share of shadow bank intermediation (blue line in Figure 6) stood at its lowest level since 2009. The previous episodes of slowing in shadow bank intermediation during the first halves of 2010, 2011 and 2013 did not see such a sustained pace of contraction. This likely reflects the impact of regulatory tightening on shadow banking activity. With the ratio in Figure 6 approaching 1.0, the picture we are getting is of almost all of new credit creation in China being intermediated via traditional rather than shadow banks currently.
Why do we bring up China's shadow banking system?
Because according to Reuters, it is precisely China's trust firms, with total assets of $2.2 trillion, and who together with Banker Acceptances comprise the bulk of China's shadow banking pipeline, and no longer able (or willing) to lend to China's small companies and individuals due to a spike in regulation, are shifting more cash into frothy capital markets and over-the-counter (OTC) instruments instead of loans.
In other words, instead of using their vast cash hoard of over $2 trillion to re-lend and stimulate China's economy, China's unregulated, shadow banking conduits are now directly buying stocks!
Or as Reuters puts it, "by redirecting money into capital markets and OTC products like asset-backed securities (ABS) and bankers' acceptances, trusts are acting less like lenders and more like hedge funds or lightly regulated mutual funds."
Ironically, or not because this is precisely what is happening in the US and Europe, instead of encouraging lending and economic growth, China's reform which has cracked down on shadow lending, has instead led to yet another surge in risk assets as these same lenders are instead buying risk assets, which in China means almost exclusively stocks, outright.
The details of what is going on in China right under the regulators' noses, and yet completely unobserved until now, are simply stunning.
The shift - a response to a clampdown last year on trust lending to risky real estate and industrial projects - means a significant chunk of shadow banking risk is migrating rather than shrinking.
China trusts take in funds from retail and institutional investors and re-lend or reinvest that money, often in parts of the economy that struggle to obtain bank credit, like mid-sized private enterprises or municipal industrial projects. As of end-2014, total trust assets were 14 trillion yuan, according to China Trust Association data.
Previously, people who bought into opaque wealth management products, many of which were peddled by banks but actually backed by trust assets, found themselves heavily exposed to real estate loans. Trust firms' changing asset mix means these investors may now instead find themselves exposed to high-yield corporate debt (junk bonds), volatile stock funds or risky short-term OTC debt instruments.
While this could help keep the wealth management industry running, and by extension help the trust industry stay afloat, it could delay efforts to properly price risk.
A Reuters analysis of China Trust Association data shows that while loans outstanding grew just 8 percent last year - far below the 62 percent growth in 2013 - growth in obscure asset categories including "tradable financial assets" and "saleable fixed-term investments" was 77 percent and 47 percent, respectively.
It's not just speculation - it's validation.
Sources at two major trust firms, who asked not to be named due to the issue's sensitivity, confirmed they were shifting investment into the capital markets and OTC instruments.
An individual at one of China's top three trusts said that in the past year his firm's investment in shares and bonds grew 30-40 percent and 50 percent, respectively - helping explain where some of the leverage that has driven recent Chinese stock and fixed income market rallies has come from, and raising questions over how sustainable those rallies may be.
He said his trust had begun investing in ABS and bankers' acceptances - tradable claims on a company's future revenues - in January and October 2014, respectively, and would invest more this year.
Issuance of bankers' acceptances, the riskiest form of shadow finance, slowed for most of last year only to rebound late in the year, while ABS issuance has risen rapidly over the past year as China's formal credit markets tightened.
Reuters notes the obvious: "Chinese companies often use bankers' acceptances as a substitute for cash, so an increase in issuances can suggest businesses are under funding stress. Net issuance of bankers' acceptances surged from the fourth quarter of last year, and in January hit the highest level since the first quarter of last year, eclipsing trust loans and company-to-company "entrusted" loans as the largest net source of shadow finance. This could imply that regulators' efforts to squeeze the shadow finance sector have been only partially successful. A spokesperson for the China Banking Regulatory Commission declined to comment when reached by telephone."
To put this in perspective, not even in the late stages of the US stock market just before the Lehman collapse did the US Shadow Banking system directly invest in stocks, and certainly not using funds that validate the Chinese funding crisis.
In fact, the biggest paradox of the Chinese fiasco is that the more the economy slows down, the higher the stock market will soar as the traditional source of funds for a broad segment of the population, trusts and acceptances, are no longer willing to invest in growth but would rather go all in on the last stage of the Ponzi Finance cycle and frontrun other sources of shadow funding.
And since they all know there will not be a happy ending, they can at best hope to be able to sell ahead of everyone else, just before the bottom drops out of the stock market, first in China and then everywhere else.
That said, at least the last mystery of China's soaring stock market has now been exposed, and all that will take for the SHCOMP to suffer a massive correction is for Beijing to decide stocks have risen far enough, and halt all stock investments by the shadow banking intermediaries who no longer serve their quasi-official role.