MorningWord 3/3/13: Bubble-Spotting, China Edition – $FXI

by Dan March 4, 2013 9:07 am • Commentary

MorningWord 3/4/13:  Just when you thought some of the market ills from 2011/2012 were behind us, then wham, right in the kisser. First Europe last week, and now fears of a slowdown in China (again).  The Shanghai Composite and the Hang Seng nearly hit the lows for 2013 last night (down 3.65% & 1.5% and both basically flat for 2013) on the back of a series of weak economic data coupled with the nation’s attempt at cooling off an overheated housing market.  China has clearly been off the radar of many investors in the U.S. for the last couple months, but it was just a few months ago that many western market participants were more focussed on 2,000 on the downside in Shanghai, rather than 14,165 in the Dow Jones.  Since the Shanghai’s false breakdown in December, the index had more than a 25% rally of the lows.  After failing to get near what looks like significant resistance at 2500, this puppy could be range bound for some time.

5yr Shanghai Comp from Bloomberg
5yr Shanghai Comp from Bloomberg


On the heels of China’s tightening measures, and soon after Asian markets opened, CBS’s 60 Minutes ran a piece on China’s real estate bubble that got a lot of love in the financial Twittersphere in real time.  If you haven’t seen it, you should:

For many market participants, this is not a new story, famed short seller Jim Chanos has been warning of a property bubble ready to burst for at least 3 years; 2010-here, 2011-here & 2012-here, and websites like Business Insider have also been writing about these ghosts towns (here).

Why should U.S. investors worry about the potential for China’s real estate bubble burst and what would most certainly amount to a credit crisis of epic proportion?  For the same reason that international investors should have feared back in 2007/08 about the U.S. real estate bubble burst and the subsequent reverberations across almost all businesses, causing a financial crisis that spread from Wall Street to Main Street, and then quickly overseas.  Some of the actions by Chinese banking officials to cool down the real estate market in the last year or  so and to rein in their massive shadow banking industry, appear reminiscent to the last ditch efforts by U.S. regulators to contain the uncontainable impending subprime credit crisis here.

Ironically, it was demand from China in 2009 that helped the world economy shake off the global recession caused by our crisis, and after years of very strong growth in China, U.S. multinationals in 2012 saw a drop in revenues, earning and operating profits (chart below from, as the country struggles with decelerating GDP that is expected to be flat year over year at 7.4% in 2013, a far cry from some of the 12-23% prints just a few years ago.

US Companies  Profits Continue To Fall In China As GDP Growth Slows

So the easy answer, and to oversimplify it and state the obvious, is that U.S. investors should keep a close eye on investment bubbles while they inflate and eventually deflate because many of our investments in U.S. companies rely a great deal on China for growth, either for manufacturing to sell outside of China or to penetrate and gain market share in a country that has a massive emerging middle class greater than the entire U.S. population.  Maybe 2013 will not be to dis-similar to 2011/2012 with macro risks abound causing volatility in U.S. equities.

Enis:  I have no doubt that the Chinese property bubble is of historic proportions, and its bursting would cause massive economic consequences in all asset classes around the world (and major social consequences in China).  But this bubble has been known for years now, so developing a trading thesis around it is in large part about timing.

My main takeaway from the 60 Minutes piece was not the actual story (which I had already heard and seen many times), but the simple fact that the Chinese government allowed a prominent American program such access to the developments and to the people involved.  The new Chinese administration actually seems resolved to curb property speculation, and using the foreign media to discourage more speculation is just another tool.  The risk going forward is that the Chinese government succeeds too well, and their soft landing becomes a very hard landing indeed.




MorningWord 3/1/13:  Last night CRM reported eps (.51 vs .40 consensus, but .08 of the beat comes from an r&d tax credit) and revenues ($835m vs $831m consensus) that beat expectations, and guided Fy 2014 to inline with consensus.  By all accounts the quarter looked good on most metrics from op margins that came in 1% higher than expectations, and strong bookings that included a very healthy large order closing rate in Q4.  Yesterday afternoon, prior to the results I placed a low risk, potentially high reward bearish trade in Apr expiration, that would benefit from a move in line or greater than the implied 8% move, but, it was not solely predicated on the move happening today.

Most readers know I often look to be a tad contrarian in these situations, and CRM is not the sort of stock that would make it on my Buy list given its current growth profile and valuation. So I would tend to look for structures that offer a good risk reward in front of potential inflection points, and that was the plan with yesterday’s trade (from yesterday’s trade post):

Trying to pick tops is difficult business, but trying to spot inflection points is another thing all together.  On tonight’s call, if results show fiscal 2014 consensus estimates to be a tad optimistic, the stock will likely be re-rated, similar to the revelation that AAPL investors had in the last 5 months that the company was facing deceleration in earnings and margins.  The difference btwn CRM is that the stock is priced as if they will continue to grow sales and earnings at 20% plus a year for the next ten years.

So what did last nights call actually show? As stated above, it showed what I would call their ability to hold on to their first mover advantage for now.  The guidance that they gave for the current quarter was actually a tad light to expectations, and the full year guidance bulls will argue will prove to be conservative.

Wall Street analysts are overwhelmingly positive on the stock with 35 Buys, 3 Holds and 4 Sells, things feel about as good as it gets from a sentiment standpoint.

The stock is up ~4.3% in the pre-market and I have a sneaking suspicion that the quarter and guidance wasn’t the sort of masterpiece that will drive incremental buyers a few % from all time highs, and if I were part of the 10% short interest I might not exactly being scrambling to cover.  Earlier in the week another high valuation, semi-controversial stock, PCLN had a large implied move that it under-performed on its own strong quarter, and has since spent the next 2 trading days filling in the earnings gap, maybe its wishful thinking, but if I saw this sort of price action in CRM today, the stock could set up as a decent press on the short side.

So here is the MAIN ERROR IN MY CRM TRADE,  (as I said I wasn’t trying to pick a top merely an inflection point, but in hindsight),  I SHOULD HAVE JUST WAITED TILL AFTER THE RESULTS WERE OUT AND PLACE MY TRADE WHETHER THE STOCK WAS UP OR DOWN 4%.

I was risking less than 1% of the underlying to catch the inflection over the next month and a half, but now I am stuck with a position where the strikes may be to far out of the money, I will need to dig myself out of a hole.