MorningWord 3/30/15: Gambling in China

by Dan March 30, 2015 9:36 am • Commentary

In late 2014 China made a move to open up its equity markets to outsiders by linking the Shanghai Composite and Hong Kong’s Hang Seng. It saw a fairly slow start, per the WSJ Dec 16th 2014:

Of a net 300 billion yuan ($48.4 billion) that could have flowed into mainland China using the Shanghai-Hong Kong Stock Connect since it launched Nov. 17, just 66.9 billion yuan has been taken up, equivalent to about a fifth of the overall quota allowed in that period, according to exchange data. Even less has flowed from the mainland to Hong Kong—just 8.4 billion yuan, or 3.4% of the 250 billion yuan quota.

Since mid December (following that first disappointing month of flows) the Shanghai Comp is one of the best performing equity indices in the world, up 25%, and up 17% so far in 2015. Some now call Chinese equities a bubble as they are up 100% from the 2013 lows despite declining growth:

Shanghai Comp 10 year chart from Bloomberg
Shanghai Comp 10 year chart from Bloomberg

Which brings me to actual Chinese casinos, in Macau. Recent data out of Macau suggested that gaming revenue in February was down 44% year over year, capping 9 months of steady declines:

Per Wolf Street

Perhaps the crackdown on VIP gambling, and the new smoking regulations in Macau casinos helped push people into Chinese equity trading given the new investment options.

Here is a chart of Chinese brokerage account openings showing the initial surge when the Connect was put in place in late 2014, and the parabolic move, from FTAlphaville:

From MacroBond

For those of you who wonder how the Shanghai Comp could (nearly) double in the past year, while Wynn Resorts,(WYNN) who gets nearly 80% of its sales from Macau, could (nearly) be cut in half should read the FT piece from BNP Paribas’ Richard Iley. (emphasis is the FT’s):

China’s nascent stock market bubble continues to expand with the speculative retail frenzy seemingly reaching a fresh crescendo last week. Data from the China Securities Depository & Clear Corporation reported that a record 1.14 million new A-share trading accounts were opened last week (Chart 1). The inevitable counterpart to the surge in retail activity is the continued surge in margin debt. We estimate that outstanding margin debt increased by a record amount in the five working days to March 25th. The stock of margin debt has already increased by a stunning c.1½% of GDP since the middle of last year and in recent weeks has forging ahead at a c.6% of GDP annualised rate (Chart 2).

As we have previously highlighted, China’s stock market surge of more than 80% since the middle of last year has little to do with macro-fundamentals and almost everything to do with a self-feeding, leverage-fuelled retail buying frenzy (China: Marginal Returns). Economic growth continues to disappoint, especially on a nominal basis and earnings growth, in turn, remains lacklustre. Multiple expansion is therefore driving the gains with P/E ratios for the Shanghai and Shenzhen A-share markets basically doubling since mid-2014.

With A-share P/E ratios still comfortably below previous 2007-2008 ‘bubblicious’ highs, the retail buying frenzy and its margin debt counterpart can in theory continue for some time although the torrid pace of speculative activity suggests a climax may already be relatively close to hand. But the more P/E ratios are levitated by unsustainable leverage, the larger the ultimate correction. The future downside risks to the economy posed by a stock market correction simply add to China’s already long laundry list of macro risks and vulnerabilities. A sharp pull-back in equities would further tighten already uncomfortably restrictive financial conditions and so further weigh on increasingly sluggish GDP growth.

Chinese regulators cracked down on real gambling and subsequently might have caused a rush into other forms of regulated gambling that does not involve travel, and where smoking is legal. Investors should be a tad more suspicious on exactly why Chinese equities are rallying.