I have a rally in China to sell you

I have a rally in China to sell you

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China Rally

The Chinese economy and markets are suffering from the double burden of the zero Covid policy and a slow-moving real estate crisis triggered by official efforts to limit speculation and leverage in real estate. November brought official hints that the government might want to lighten both of these burdens. From the FT, last Friday:

China has eased coronavirus quarantine requirements for close contacts and international travelers, in the first marginal relaxation of Xi Jinping’s zero-Covid strategy since the policy was reaffirmed at the Communist Party Congress last month.

The State Council, China’s cabinet, reduced mandatory quarantine for close contacts of positive Covid-19 cases and overseas arrivals from seven days to five, while maintaining an additional three days of home isolation …

And yesterday :

China’s central bank will extend the year-end deadline for lenders to cap their ratio of loans to the real estate sector, one of the strongest measures Beijing has ever taken to relieve the pressure of the credit crunch that is rocking the sector. Chinese real estate.

. . . lenders now have an as-yet-undetermined deadline to cap the ratio of their outstanding home loans to total loans with big banks at 40%, and their outstanding mortgages to total loans at 32.5% .

Speculation about these moves was circulating even before the news arrived. Stock markets bought both the rumor and the fact:

Some sellside analysts were also enthusiastic, particularly on the real estate side. Here are some quotes from a Caixin story titled “Chinese Regulators Roll Out Property Rescue for Embattled Developers”:

“China’s housing bailout is finally here,” Societe Generale Group economists Yao Wei and Michelle Lam wrote in a note on Monday. “If implemented, the plan should significantly increase the chances for housing activity – both construction and sales – to find a bottom and start to recover soon”…

The measures represent “the most crucial pivot since Beijing dramatically tightened funding for the real estate sector,” economists at Nomura Holdings Inc. wrote in a note on Monday. They “demonstrate that Beijing is willing to undo most of its financial tightening measures, including the three red lines and two red lines introduced in late 2020,” they wrote.

The enthusiasm, both on the Covid side and on the property side, seems unwarranted.

Of course, there is a trade, and perhaps a good one, in the timing of any given gradual easing of regulations. But the structural issues that drive these regulations remain unchanged. From an extremely simple point of view, the problem on the medical side is that the Chinese Covid vaccines are not as good as the mRNA vaccines used in many other countries. On the real estate side, the problem is that the Chinese economy in general and the finances of Chinese households in particular depend enormously on real estate investment, an investment that no longer generates a barely acceptable level of return.

We therefore share the view of Andrew Batson and Ernan Cui of Gavekal Research, who wrote this on the relaxation of Covid rules:

The government’s preferred strategy is likely to continue to refine current techniques for eradicating local outbreaks while striving to develop better vaccines and treatments nationwide. Public health officials appear to envision the end goal as a combination of improved pharmaceuticals and other measures that will minimize both infections and deaths. This ideal is far from being realized: under current conditions, there would be millions of deaths among China’s vulnerable elderly population if the spread of the virus were not controlled.

It is unclear when better vaccines will become widely available in China. Meanwhile, as Batson pointed out in a note yesterday, the number of cases in China is actually rising quite rapidly. Even if national regulations ease slightly, local authorities will need to tighten restrictions to bring these numbers down. A boost to the economy from the easing of the zero-Covid policy seems a long way off.

The situation in real estate is less deadly but even less conducive to quick fixes. The only vaccine against bad real estate investing is financial pain. Falling asset prices, write-downs of balance sheets, reallocation of workers and capital to new sectors – all of this takes time, as the United States discovered in the years after 2008. The idea that the sector Chinese real estate will soon “bottom out and start to recover” sounds frankly bizarre.

Amazon joins cost cutters

Even mighty Amazon can’t escape the wave of tech layoffs:

Amazon plans to lay off about 10,000 people in corporate and tech jobs starting this week, people with knowledge of the matter said, in what would be the largest job cuts in the company’s history.

The cuts will focus on Amazon’s device organization, including voice assistant Alexa, as well as its retail and human resources division, said the people, who spoke on condition of anonymity. because they were not allowed to speak publicly.

Job cuts are inevitably compared to Meta’s last week, although the scale differs. Amazon is cutting 3% of its workforce, mostly in unprofitable divisions. In contrast, Meta lost 13% of its entire staff, but was careful to limit the cuts to its unprofitable Metaverse unit. Markets, after smiling at Meta’s layoff announcement last week, seemed less pleased with Amazon. The stock fell 2%. (That’s likely because the cost cuts were already priced in. The stock rose 12% last week after news of a cost revision.)

Until recently, Amazon has enjoyed breathtaking growth, reporting revenue growth of 19% since 2017. Investors slapped a meaty multiple on the stock, nearly 90 times earnings. But as we’ve noted before, this multiple is a bit misleading because the company has never placed a high priority on earnings, and its investors have played with that. The assumption has always been that at some point in the future, Amazon could dramatically increase its margins, if it wanted to or if investors demanded it. The big question is whether, now that the stock has returned all of its pandemic-era gains, that moment is coming.

Amazon’s web services business is highly profitable. The question is about retail. Amazon’s combined domestic and international retail arms have posted five consecutive quarters of operating losses. Sales went well. The real problem will be familiar to you: costs. Over the past few years, Amazon’s expenses have steadily increased as a proportion of revenue, a trend that has accelerated during the pandemic:

Line chart of Amazon cost categories as % of revenue showing getting expensive

Management pays attention to this. Here’s Amazon’s CFO on the company’s October earnings call (Andy Jassy, ​​like Jeff Bezos before him, doesn’t talk to hoi polloi investors):

Let’s go first to our [retail segments] we have generated more than $1 billion in operating cost improvements through better leverage of our fixed cost base and continued productivity improvements in our fulfillment and transportation networks. This represents a solid improvement in productivity quarter over quarter, but not as much as we had expected . . . We recognize that there are still many opportunities to continue to improve productivity and reduce costs across all of our networks . ..

We are working very hard to ensure that today’s profitability is not the new norm.

Amazon is looking to cut where it’s most inflated. Its Alexa unit is posting an annual operating loss of $5 billion, the Wall Street Journal reported. Halving would roughly cover Amazon’s losses in North American retail over the past year.

Although the company’s revenue continues to grow, in a recession, that’s not a sure thing. Advertising tends to lead the cycle and Google’s revenue has slowed while Meta’s is declining. If revenue growth stagnates or stalls, investor complaints will mount, as they have at Meta. Amazon still has time to prove that it can make a good profit. But the markets will eventually get tired of waiting. (Ethan Wu)

A good read

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