Last Bubble Standing

EM debt bubble… emaciated, FX Carry… crucified, Crude…crushed, High yield bonds… burst, Chinese equities… blown, Trannies… trounced, Small Caps… slammed, Biotechs… busted, and FANGs finally FUBAR! But there is one big (very big) bubble left in the world that no one is talking about, and a rather large liquidity-busting pin beckons…

In May 2015 we first explained exactly why China was blowing its equity market bubble. Simply put, with more “equity,” companies were better able to refinance/roll (note, no interest in debt reduction or deleveraging) their record-breaking mountain of debt and avoid the systemic collapse that is utterly imminent for just a few more months/years.

Now that the equity market bubble has burst, Chinese authorities have chased investors into another bubble.

In October 2015, we warned of the relative risk building in the Chinese corporate bond market.

As the rout in Chinese stocks this year erased $5 trillion of value, investors fled for safety in the nation’s red-hot corporate bond market. They may have just moved from one bubble to another.

Into Chinese corporate bonds…

As we detailed just two months ago, this historic bond bubble is paradoxical for the simple reason that China’s credit fundamentals have never been worse, and as we further showed, as a result of the ongoing collapse in commodity prices (which today’s Chinese rate and RRR-cut will have absolutely no impact on), more than half of commodity companies can’t generate the cash required to even pay their interest, a number which drops to “only” a quarter when expanded to all industries.

“The equity rout merely reflects worries about China’s economy, while a bond market crash would mean the worries have become a reality as corporate debts go unpaid,” said Xia Le, the chief economist for Asia at Banco Bilbao. “A Chinese credit collapse would also likely spark a more significant selloff in emerging-market assets.”

“Global investors are looking for signs of a collapse in China, which itself could increase the chances of a crash… This game can’t go on forever.”

They will find it soon, because while China may have managed to once again kick the can on its most recent default when state-owned SinoSteel failed to pay due principal and interest last month only to get a quasi-government bailout, every incremental bail out merely forces even more cash misallocation and even more foolish “investments” into this high risk asset class as investors ignore any concerns about fundamentals, assuming instead that the government will always bail them out.

Worse still, it is not just the most creditworthy of Chinese corporate bonds that are at record low yields. As the following shocking decoupling shows, even BBB credits are in an extreme bubble – entirely separate from the reality of their underlying business risk (as indicated by the equity market and equity vol)…

The problem with that is that as BofA’s David Cui notes today, China’s bond market is the epitome of a “potential source of financial instability.”

Here is Cui:

Our analysis shows that:

the bond market is clearly not pricing default risk properly;

the bond market has taken a few SME bond defaults in stride and seems to be counting on bail-outs of the few SOE bonds that are reportedly facing default risk; and

leverage in the bond market is rapidly building up.

But most importantly, Bank of America has now given a time frame in which China’s bond market will blow up, resulting in far more dire consequences that the equity bubble bursting this summer.

On the current trajectory, we doubt the market can stay stable beyond a few quarters, especially if some SOE and/or LGFV bonds indeed default.

Finally, to answer the question on everyone’s mind – here is the full list of most likely upcoming Chinese debt default cases. When the bubble bursts, these names will be the first to blow up.