Happy Thursday!

📝 Focus

• China: Deflation Nation… like Japan?

📊 In the Markets

• Gambling on Disney; Banks… US loan losses vs Italian windfall tax; Amazon Anchoring Arm; WeWork Won’t Work?

📖 MoneyFitt Explains

🎓️ What could be worse than Inflation?!?

📝 Focus

China: Deflation Nation… like Japan?

China's National Bureau of Statistics reported a 0.3% year-on-year drop in the consumer price index (CPI) for July, marking the first decline since February 2021. Simultaneously, the producer price index (PPI) recorded its tenth consecutive monthly decline at 4.4%, exceeding the projected 4.1% fall, underscoring the challenge faced by the second-largest global economy in reviving demand. A slowing down of inflation🎓 (the rate prices go up) is called "disinflation"🎓. This is generally good, especially if inflation has been high. Falling prices is known as "deflation"🎓 and that's a whole 'nother kettle of fish, and not in a good way (see below). Pressure is mounting on Beijing to enact larger and more direct policy stimulus as concerns grow that China could be heading into a prolonged period of sluggish or negative growth similar to Japan's dreaded "lost decades" of stagnant prices and wages. Stock prices are still below their highs from last century!

..... ▷ While central banks elsewhere have been battling decades-high levels of inflation, with some signs that we may be approaching the tail end of it, China's price indicators are looking increasingly worrisome, particularly as we hit ten months of PPI deflation in particular. Producer (sometimes called "factory gate") prices are often a leading indicator of consumer prices since producers often pass on cost changes to consumers with a lag. When costs are declining, prices can drop to stoke demand and grab share from competitors. The relationship between PPI and CPI is rarely one-to-one, and many other factors are at play, but at a macro level, the signs are rather bleak: lower prices to those living in high inflation environments, especially of late, may sound awesome, but pushing back buying and investing crushes growth and sets off an arguably even more miserable vicious cycle than inflation does. (To be fair, China has stumbled in and out of both CPI and PPI deflation on numerous times in the past.)

..... ▷ The post-pandemic recovery's initial momentum in the first quarter waned as both domestic and international demand weakened, with various support policies failing to boost activity. The March export growth figures had been particularly (suspiciously) high, and we were rather sceptical about them at the time. Sure enough, export data softened sharply since then, with both imports and exports dropping sharply in July, underscoring concerns that the economic recovery was mild and very, very short. Exports contracted 14.5%, the fastest decline since the start of the pandemic, while imports fell by 12.4%. Falling exports lead to weaker production, exacerbating the already feeble domestic demand, and imports fell more than the projected 5% decline (though also partly from falling commodity prices.) The grim trade data could prompt authorities to release additional stimulus to stabilise growth, though any stimulus is expected to focus on targeted measures and supply-side policies rather than extensive interventions.

..... ▷ In our "China: Old before it gets Rich" Focus piece from June, months before CPI flipped to deflation, we wrote that: "Longer-term comparisons with Japan do look a bit more ominous... The Japanese economy had decades of economic stagnation after the bursting in the late 1980s of the asset price bubbles in stocks and property [SEE BELOW], which contributed to a massive banking crisis, which then led to years of feeble lending and persistent deflation... Another shared characteristic is a shrinking population... economic potential is a function of population (workforce) and productivity growth. Japan's population has been declining since 2010... Last year, China's population fell for the first time in 60 years ​​after a multi-year decline in its birth rate that experts now say is irreversible... But unlike its rapidly ageing rivals, China potentially faces the prospect of becoming old before it gets rich."

Meanwhile: China's largest private developer, Country Garden, missed interest payments on two international bonds worth $500mn, deepening the woes of a struggling property sector grappling with a liquidity crisis. The bonds, already trading at distressed levels, plunged further on news of the missed coupon payments. Despite liabilities approaching $200bn, Country Garden survived the real estate crisis after Evergrande’s default almost exactly 2 years ago sparked a wave of defaults and had generally been seen as among the best of the surviving developers. At a macro level, paying down debt after the bursting of a property bubble can, as happened in Japan, lead to a "balance sheet recession".

📊 In the Markets

Wall Street stocks declined as attention shifted to Thursday’s US inflation data, expected to show a rise to 3.3% YoY in July, the first acceleration since last June. Traders are fully pricing in a "soft landing" scenario, so any sign of a recession could lead to a sharp reaction. Nvidia dropped 4.7%, and the KBW Bank index (see below) slid 1.7%. Brent crude reached $87.55 per barrel, up roughly 20% since June, due to Saudi and Russian production cuts. In Europe, natural gas prices soared 40% on a potential supply disruption from Australia, and Italian bank stocks rebounded after a windfall tax scare (see below). Asia worried about China’s feeble recovery (see above) but was little changed.

..... ▷ Betting Disney: Disney is wading into fresh culture wars with its ESPN unit partnering with old-school regional casino operator PENN Entertainment for sports betting, a massive shift from its family-friendly image. Penn will rebrand its Barstool Sportsbook "ESPN Bet" and will return the rest of Barstool back to controversial founder Dave Portnoy for free, 6 months after buying it for $551mn. Penn will pay Disney $1.5bn over a decade and offer warrants on Penn shares essentially for access to ESPN and streaming ESPN+'s viewer base. The US sports betting industry is still only 5-years-old, and fantasy league leaders DraftKings (in which Disney owns 5% from its acquisition of 21st Century Fox) and Fanduel (owned by Irish betting giant Flutter, formerly known as Paddy Power Betfair) currently have about 70% of the market between them. The industry overall faces losses due to high acquisition costs, but for The House of Mouse, it seems to be a gamble worth taking, despite the reputational risks, given the ballooning costs of its streaming businesses and the cord-cut decline of its broadcasting assets (never mind that Barbenheimer and Super Mario have blown every one of the studio's releases out of the water this year.)

Meanwhile, Disney reported fiscal third quarter falls in TV and movies, but higher prices and lower marketing spend led to lower losses in its streaming unit (Disney+, Hulu and ESPN+), where “core” Disney+, excluding the now-IPL-free India business, added 800k subscribers. CEO Bob Iger stated they were on track to exceed their $5.5bn cost-cutting goal by restructuring and boosting creativity. While revenue was slightly below Wall Street’s Finests’ best guesses, earnings per share of $1.03 was 7 above. DIS was up 2.8% in after-hours trading.

..... ▷ US loan losses: In Q2, US banks faced nearly $19bn in losses due to bad loans, the highest in over three years, driven by defaults from credit card and commercial real estate borrowers. Charge-offs, i.e. marking loans as unrecoverable, rose nearly 17% from the previous quarter and 75% YoY. Losses reached 61 cents per $100 loaned, the most since Q2 2020's pandemic impact. The situation is due to higher repayments from floating-rate loans following aggressive interest rate hikes by the Federal Reserve. Reduced savings from the pandemic and office space challenges also contribute. Banks, anticipating further losses, set aside $21.5bn in provisions during Q2. Credit card lending accounted for over half of the losses. (See “Leaping Loan Losses!”)

And meanwhile…

..... ▷ Backtracking in Italy: Italian bank shares rebounded after the populist, right-wing coalition government backtracked embarrassingly on its windfall tax announcement after just one day. The finance ministry capped the tax on net interest income at 0.1% of a bank's total assets, reducing the levy collection from €4.5bn to €2.5bn or less. Shares in Italy's largest banks rallied. The chaotic communication regarding the tax caused panic initially and followed political pressure to aid households affected by rising rates and inflation which was mirrored in several other European countries. While windfall taxes may seem fair to depositors squeezed by much higher lending rates, the cross-cycle logic is not as clear-cut (see US banks above), and the damage to investor confidence may raise future government borrowing costs.

..... ▷ Amazon Anchoring Arm: SoftBank is in talks with Amazon to involve them as a key investor in Arm's upcoming IPO, expanding their search for long-term stakeholders. SoftBank, which acquired Arm in 2016, aims to secure cornerstone investors for Arm's listing on Nasdaq. Initially focusing on chip manufacturers like Nvidia and Intel, discussions now include companies such as Google, Apple, and Amazon, which are reliant on semiconductors. Amazon's potential investment would endorse Arm's server market expansion as it ventures into producing its own chips. A notable anchor investor would support Arm's stock as SoftBank reduces its stake and stimulate IPO demand amidst slowed new listings. The valuation target reportedly ranges from $35bn to $80bn.

While on the subject...

..... ▷ Won’tWork: WeWork, once valued at $47bn by SoftBank (which invested a total of $17bn in it), disclosed "substantial doubt" about its "ability to continue as a going concern" in its Q2 earnings report. The company said that its future hinged on restructuring, searching for capital and favourable lease negotiations within the next year. The company put the blame for missing their own guidance on challenging economic and property market conditions, though net losses halved from a year ago, and a recent financial restructuring cut debt by $1.2bn. The shares were listed in 2021 through a SPAC (blank cheque company) merger at $10 a share, valuing the company at about $9bn. After Wednesday’s 37% slide, the shares have now lost about 99% of their value. More than 99%, actually.