China's Surging Interest Bill Underscores Debt Strain (Podcast)

ammunition do they really have? Joining us now? I am so pleased to say, as Victor she associate professor at UC San Diego, a former principle for the Carlisle Group and a former professor at Northwestern Victor, thank you so much for being with us. I want to talk about the composition of China's debt and how much ability they have to lever up further. So let's first talk about where do you see the biggest debt problem in China? Um,

thanks for having me on. So I think the biggest problem, you know, obviously people have talked about the domestic debt, which is you know, around three GDT. That's not good, but domestically, They've got a lot of UH policy tools to deal with that. I think the biggest trouble spot that a lot of investors may not realize is China's

external debt. Among em countries, China is the largest that are by far according to b i S data, and if you include Hong Kong, which of course is a part of China UM, China's external debt now stands around two point five trillion dollars. So that's an enormous amount, even given as three trillion dollars in point exchange reserved. And doesn't about one point two trillion of that have

to be rolled over this year? Yeah? Well, actually, you know, uh, hundreds of billions have to be rolled over every month because a lot of it is is short term loans that Chinese banks have borrowed to finance the foreign exchange needs of Chinese companies and even China's overseas investments such as part of the One Belt, One Road initiative. So

here's here's where I'm wondering. Where the concern comes in is the fear basically that China is restricted in how much it can weaken its currency because if it does so overly then it will have a harder time rolling over these obligations and repaying them. There there are many different potential risks there. There's the evaluation risks because you know, even though a lot of these loans is denominated in dollars, of course the underlying assets that ultimately back a lot

of these loans are women be denominated um. The other concern is that you know, of course the threat of the trade war if it were to shrink China's trade surplus and then meaningful way um because currently obviously the trade surplus has been what China has been using the services dead and if um the trade surplus would the shrink in a meaningful way, then that that would be

a problem for China general e M. Panic. You know, what China has done in the past couple of years is to constantly increase his external debt in order to roll over the existing debt and and to pay for some of the interests even with new loans. And so you know that pipeline were to freeze, that also would

cause a problem for China. I want to pick up on the interest point because this was something that was brought to my attention and I actually reached out to about this, Uh, just how much money China is spending on interest payments? Can you talk a little bit about that. I don't think a lot of people are aware that at this point, given its debtload, a substantial proportion of of of its of the money that it borrows may have to go towards just even repaying interest. Yes, so

domestically China has a has a really big debt problem. Um. You know, when you have debt that is GDP, and when you're interest rate is not zero like the case of Japan and some of the European countries, um, you end up spending a lot of the new credit just to service uh the interest payment, which by my calculation is something like nineteen trillion women b or you know,

roughly three trillion dollars per year. So every month the monetary authorities have to come up with dollars just to service the interests in the economy and it and if it wants the economy to grow from investment on top of that, it would have to provide even more money. So that's why I think investors in China are very savvy. Now. When the PBOC cuts reserve requirement ratio by one, the market actually didn't really react to it, because you know,

it's just part of the course. That's the minimum amount that the monetary authorities need just to roll over its enormous debt pile. Uh, it would have to do a lot more. It would have to deregulate the shadow banking industry, which it just successfully regulated, would basically have to undo

all of that in order to get the economy going. Yet, will the additional money that's necessary to finance either the rollover or indeed new borrowing on the part of China, will that compete for investor dollars who have to also fund US treasury borrowings. Um? So I think, you know, the the domestic and external part are relatively separate, um

and of course increasing them. And I think there's this implicit competition in the sense that Chinese investors increasingly do not want to hold their money in women b because, um, they know that the monetary authorities would just have to keep on printing money to to prevent a crisis, knowing that they would rather hold foreign currencies, and so that creates almost this sort of private demand for the U. S. Treasuries.

As a result, of course, the Chinese government has done a lot to prevent domestic money from flowing overseas to overseas assets. They've been relatively successful. Um. And so right now that you know that, we were not seeing a massive capital flight, but the temptation is there. Uh and the moment that the regulators um looseness grips, so to speak. UM, I think a lot of money would want to flow

out of China. Victor. I want to talk a little bit about something that you mentioned that just servicing non financial debt in China totaled about three trillion dollars. You said that basically, Uh, that was roughly twenty two of the gross domestic product of China. So this is a significant headwing to economic growth at this point. Is that correct? Yes, Um, it is a significant headwind. UM. And and we've seen that, we've seen you know, so China actually did not de

leverage uh. It's it's a financial system in the past year, despite the rhetorics, UM, it just slowed down the rate of growth of credit UM from you sort of mid teens to around ten percent. Uh. And that already in itself caused a drastic slowdown of growth. UM. You know,

actual deleveraging would immediately cause a financial crisis. So going forward, if it wanted growth to resume at at a at a real rate of you know, six percent, seven percent, which are the policy objectives still, then it would have to pump a lot more money into the economy, and that, of course will challenge people's confidence in the Roman b I want to thank you very much for spending time

with us. A Vic She is the associate professor at the University California, San Diego, joining us from La Joya speaking about the need for China to service it's dollar denominated debt and the amount of debt that it will have to roll over this year. Big banks are pushing back against the big equity exchanges. Basically, they want to have their cake and eat it too. They want cheaper exchanges, they want them faster, so they're going to create their own.

Joining us now to talk about that, Chris and Ag executive editor focusing on equities for Bloomberg. So, Chris, what exactly is this that a group of banks, Dine founders including Morgan, Stanley, Ubs, Citadel, Virtue and others, were they hoping to create here? Um, I think if you've got to look at the US stock market structures. That's kind of constantly evolving sort of Darwinian competitive arena, and there's been there's been four or five waves of that over

the last twenty years. This is the latest sort of you know, monopoly busting effort among in that in that cycle. It's not exactly you know, a bunch of rag tag up starts. You're dealing with the biggest financial institutions in the country banding together, um to get some kind of in road foothold in the not not really do opoly.

There's about there's about three companies to control most of the the stock exchanges at the moment, and now there's going to be there's gonna be four, and this is going to be sort of mutually held thing by again all of the biggest all of the biggest players in the in the stock trading ecosystem, including interestingly the big market makers which are really the power players in that in that system, Virtue and UH Citadel, which are responsible for or some ungodly number of trades in the in

the U S stock market. Chris, what did these banks and brokerage firms object to when it comes to price? Um, it's not I have to say not altogether queer frankly, I mean they in some ways, A lot of these a lot of these players are sort of they're sort of the pantheon of villains and a lot of market structure arguments, certainly Citadel and Virtue or not companies that have enormous amounts of peers cried for them, um uh,

sort of straightforwardly one of the big cost centers. One of the only things that anyone can make any money doing in the stock market right now is selling data on trades. This incredibly you know, this not enormous data that is generated by the actual customers is then sold back to those very customers. But at the same time, don't these exchanges pay rebates to the brokers that send them order flo that's right, and Virtue and Citadel or

presumably big collectors of those. So it's not entirely clear what huge advantage they're hoping hoping to leverage out of the existing should create for themselves by doing this. This is not a hugely profitable business anymore. It's very low margin, very extremely high volume. That's sort of been the direction of market structure revolution over the last twenty years that spreads on trades have gone ever ever slimmer, and the amount of trades that happen by virtue of basically high

frequency traders computerized traders has gone way up. So what they lack in profits they make up for in volume. So, Chris, I wonder if there's a broader takeaway here about market structures, since people are accusing the changes in market structure that have moved trading towards a more electronic, faster, uh, you know, less lucrative for the exchanges and others kind of model, and that this is the reason why things are bouncing

around because there aren't humans in between. You buying that? Um, I'm not sure that that. I totally buy that. I feel like volatility we shall always have. I do think that may be relevant to this, to the what's going on here today, Like a lot of stuff that goes on in market structure, if you look at it closely, is a kind of big pr game, um and and a serious one because uh, the regulatory sites for every once in a while trained on high frequency trating. It's

I doubt this was the reason. But you had Stephen nuch in three weeks ago talking about how high frequency traders were responsible for all of the Volatili. They make fairly easy targets. And one thing you get every now and then is someone coming in saying sort of I'm going to baptize the world and fire. I'm gonna simplify everything and put out home homey sounding press release like the one that went out this morning, saying look, we're

gonna come in and simplify everything. That's going to be cheaper, you know, simple order types. You had a couple of years ago with the Michael Lewis exchange of I E X, the one profiled, and uh, flash boys, that this happens. And this is a consideration where setting yourself up is kind of a hero of market structure, however questionable what ultimately is can be a worthwhile thing when regulators start to get their dander up about stuff that may be

part of what's going on here. I mean, I don't know, you know, I certainly it wouldn't be stated as one of the goals of the thing, but it might be nice to have, oh, we're coming in trying to save everyone to point to in a couple months when Minuchin starts setting up hearings and things like that. I don't I don't know which occurs to me, it's not out of the question that that's part of the motive here, doesn't the security is an exchange commission really regulate how

much the exchanges can charge for their data? There's yeah, and the exchange has recently lost uh uh some kind of regulatory hearing where their their fees were sent back to them for more explanation. Basically with the you know, the expectation that they're probably gonna end up being cut. At the same time, keeping exchanges, keeping the companies that uh that are the sites of all trading in this country is not totally bankrupt motive in and of itself.

It helps to have relatively profitable venues where you can go and get your trade done in half a second. It's not a completely bankrupt motive for the work for you know, for capitalism, basically to have these things existing so you know what of things to balance. Thanks very

much for being with us. Chris nig is Executive editor for editor for Equities for Bloomberg, speaking about brokers forming a new stock market to take on the New York Stock Exchange, the NASTAC and the cbo E on Friday, p G and E. This is the utility that supplies electricity and power to most of northern California, said that it is quote working diligently to assess the company's potential liabilities as a result of the wildfires and the options

for addressing those liabilities, while those liabilities may lead to bankruptcy filing and bankruptcy protection. Here to tell us more, Kick Conoledge he is our senior Industrials and utilities analysts for Bloomberg Intelligence Kit. Is this part of the negotiation that goes on between the utility and lawmakers or is there a serious issue here that PGNI could seek bankruptcy protection because it needs it right? Well, I think him

there that it's both. Really, I think you can with utilities, you can't separate, uh, the the financial condition from the political condition that they are always dependent on what the regulators and the legislators do. And of course that has come to a critical situation in California, especially for Penny and Northern California, because of all the wildfire. So you

have twenty five billion estimated or thirty billion. I saw today somebody saying in liabilities for wildfire's potentially over the next X number of years to be paid out. Somebody's got to pay that, that would I mean, the whole market cap of PG and E is only eleven billion or ten billion now, so, uh, something's got to give. So a bankruptcy filing as reported would would not I think shock anybody, but whether it's needed at this point

is in question. So if its market cap is a ten or a little bit above a billion dollars, just give you a sense. It's total debt is more than twice that at about twenty two billion dollars, and its bonds have been plunging. I just have to wonder what are the recoveries going to be like if they do decide to declare bankruptcy or file for bankruptcy. Because this is a company that is an investment grade credit rating,

right it is. Uh, it doesn't happen that much that utility goes bankrupt, So we don't really know what would happen in that situation. But uh, but interestingly, the one that did go bankrupt, and oh one I believe it was was p G and E. And I think the you can go back and look at that, and the recoveries were good for bondholders. I believe it was all

fully recovered. And you know, it's a while ago, so I don't hold me to every detail, but I think it was all fully recovered, and eventually the stock got back to a point where it was higher than it was before they went into bankruptcy. So but that took four or five years. So it's a an extremely complex, UH working out type of situation where of course everybody wants to get paid, and the bond holders and the stockholders and the UH trial lawyers and and the regulators

and so on. So it's it at least it will take a long time to figure out who's owed what. UH. But the bottom line is California. I think that the cooler heads know that it only makes sense to have an investment grade utility to run the polls and wires and electrons in northern California. The shares of pgen E are down a little bit more than today. What would a bankruptcy filing do that would be positive for pg

n E. UH. What what it would do is it would UH put the question of how you adjust the debt to the amount of equity UH into a bankruptcy court so that you would be relieved of the concern that a sudden influx of demand for payment would immediately tip over the company and lead to a liquidity crisis. So you know, as with any bankruptcy, that's the kind

of situation. But overall the utility bankruptcy, the idea is you take the piecemeal workout where as to the regulators, back to the legislative, back to the regulators, and it could just go on and on and nobody knows what's going on. At least it gets organized in a bankruptcy court and people start to say, Okay, what do you need? What do you need? And the judge ultimately brings everything together. And I think in this case, the state of California

would say what we need is a functioning utility. So kid a lot of people are saying that this is basically political warfare, and this is p g N saying, Okay, you're not going to bail us out, fine world, file for bankruptcy and put our credit rating in jeopardy and throw the entire utility system, uh put it at risks.

So is this a dangerous precedent for other utilities. I don't think any utility would uh lightly go into the kind of situation that pg N is in so I'd say I'm not aware of any other utility out there now that has this kind of imbalance between as you were discussing the debt and equity. Uh so, let's just say it. You know, it's a very unpleasant situation, and nobody wants to go through it if they don't have to.

But pg N is now in a situation where the debt and the increased possibility of even much more debt to pay the liabilities, uh is much more than they can handle on their own at this point, and so they have to look for more extreme out outcomes than than you might hope for. Kick College, thank you so much for being with us. Just to also note the p g NI bonds that are maturing currently treating a six and a half percent yield compared to a six point one percent average yield on the junk rated bonds

with the top ratings of junk bonds. UM same about average maturity, if not the p g ANY bonds are actually maturing sooner, so they're being treated as junk in the bond markets, even though credit rating companies are not saying that that is what they are. Kick connle Edge, thank you for joining us, Senior utilities industry in the list for Bloomberg Intel legends he's bullish on markets for indeed, he believes that stocks are currently undervalued. Here to tell

us more, David Cats. He's the chief investment officer for Matrix Asset Advisors. He's got nearly eight hundred million dollars of assets under management. David Cats a pleasure to have you with us. Give us your thesis for for stocks. Well, basically, you've just gone through the worst quarter in about a decade, You've gone through the worst December in over uh ninety years. We think stocks are now at a level that's pretty attractive.

The ultimate driver of stock prices is usually price earnings ratios. The markets at about fourteen and a half times two thousand and nineteen numbers, so that's a pretty good level Historically you've done quite well from that, and we think there's just much, much too much pessimism built into stock prices right now, and there's a lot of room for them to go high. There are a lot of great

businesses that are selling a ten eleven times earnings. Historically, you're going to make pretty good money when you can do that. Yeah, David is sort of highlight the pessimism that you're talking about. Black Rocks annual survey of institutional clients overseeing seven trillion dollars in assets globally came out uh and more than half of them plan to cut stock exposure this year, up dramatically from the proportion that

said the same thing last year. So where are you adding opportunities and when did you start buying just one thing? I'm at black Rock. What's interesting is probably if they had done that Poul about six months ago, people were universally bullish. So you've just had this really sharp sell off and all of a sudden, sentiments turned pretty negative. We think that's chasing what's happened rather than the future. Now.

What what we like here is we think there are a wealth of industries and sectors that are pretty attractive. We like the financials a great deal. Um Technology has just been beaten up pretty badly, so we think there are opportunities there. Communications services another area. Energy we think it is poised to do a lot better. The stocks have really been washed out, and select healthcare, so really lots of different places to make money. The key driver

there is depressed valuation, good long term outlook. David I'm assuming that everyone has access to more or less the same information that you have access to so much it must be your reading of the information that causes you to be bullish and a bit of a contrarian. Maybe you could just give us an example, whether it is Comcast or whether it is Facebook or another stock, to

sort of highlight your strategy and why your perspective is different. Well, our perspective is different because we try not to get caught up in the day to day manias. So right now the market is very, very focused on the negatives associated with the trade war with interest rates. About six weeks ago they were rising. Earnings are going to be at a slower pace this year, so you hear that from many strategists that how can the stock market go

up with slower earning space. We actually looked at the period from nineteen thirty seven to two thousand and eighteen, uh the level of earnings growth and its impact on stock prices. How did the smp FI when earning s growth was higher when it was lower, and we found there was almost a zero correlation. So that really means that that's not going to be the driver in aggregate for stock prices this year. A lot of people are

getting caught up in that. We agree that earnings growth is gonna be a lot slower than it was in two thousand and eighteen, but you really can do pretty nicely in a five or ten percent growth mode. In terms of your question on individual stocks, Comcast has been a great business that's growing at north of fifteen percent

a year for the last ten years. We really like management, we like the acquisition that they made internationally, and you're you're getting this wonderful business at about thirteen point nine times earnings. UH Normally it'll sell UH at fifth seen sixteen seventeen times earning, So you're getting a really good business at a very attractive price. Another stock that you find attractive is Facebook, which is kind of interesting because there is a lot of pessimism around this one. Uh

the biggest bear on the street. Pivotal Research Group came out today saying that Facebook is likely to see another rough year and lowered their price target to a hundred thirteen dollars from a hundred and twenty five dollars previously. Currently shares it through a hundred and thirty eight dollars. I'm just wondering where do you see Facebook shares going

and what gives you conviction that these bears are wrong? Well, we're not that happy with Facebook management, and we really do think that they run a business without a lot of ethics. So we think regulation is going to be a much better thing for them. We think they can do a lot better in providing accurate information UH and not chasing the dollar as their sole motivation. Having said that, UM, they have a tremendous franchise, whether it's Facebook or Instagram

or What's app. UH, they make an enormous amount of money advertise dollars are going more and more to social media, and it really is one of the best ways to target your ad and get the consumer to buy. So, even though they've got a lot of business problems and they're gonna have to spend a lot more money uh in terms of uh managing themselves better, they're still going

to make a boatload of money. So for all of the negatives, right now, Facebook is telling it about sixteen point four times UH two thousand and nineteen earnings, they've got about fifteen dollars cash per share, So if you adjust for cash per share, it's at about fifteen times adjusted earnings, and historically, when you can buy a very good growth business at that type of price, you're gonna

do very very well. Tell us about your call for the industrial sector, is that geared towards global economic growth. So we we think that the global economy is going to be okay. It definitely is going to be a lot less robust than it was in two thousand eighteen. Uh, Europe is struggling a little bit, China has slowed down.

But having said that, a lot of these companies have sold off and are selling at twelve times earnings, and we think that, uh, it's an absolute imperative that the United States and China come up with some sort of a trade deal. It's in both of their interests. We think President Trump, while he might not like to do a deal, is going to have to in order to stabilize the US market. And if that's the case, we think industrials are very well positioned to start to grow again.

And you're getting these companies at really good prices, whether it's a United Technologies or an Eaton Corps or a T Connectivity, really good businesses that will do better in a reasonable global economy. So just real quick, are there any stocks that you're staying away from. So the one group that actually did pretty well last year, even though the business was not that good were utilities. Uh, they

were a flight to quality. As a result, they're selling at the high end of the evaluation range that we normally would like for such a slow growth group. So this is a group that we would be taking money away from and putting into all of these There areas that we just mentioned. So you're not buying pg N surely not. I mean, when you're when you're looking at that, that's just you're making a bet that they're not going

to go bankrupt. And generally when you buy utilities, you're buying it for safety, So that would not fall into that category if you're trying to buy a utility for safety. Uh. Companies like Duke are very good companies, but we think they're pretty fully priced. David Cats, thank you so much for being with us. David Kat's chief investment Officer Matrix Asset Manage Advisors. Matrix Matrix Asset Advisor is based in New York. Thanks for listening to the Bloomberg P and

L podcast. You can subscribe and listen to interviews at Apple Podcasts. SoundCloud or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo. It's One before the podcast. You can always catch us worldwide on Bloomberg Radio