Workers cut up coal carts in December 2019 at a coal mine in Mentougou, west of Beijing, where many mines were closed as China sought to cut CO2 emissions.

Greg Baker | AFP | Getty Images

BEIJING – China’s bond defaults are increasingly concentrated in part of the country whose growth may be under greater pressure from tough new carbon emissions restrictions, according to an analysis by Nomura.

Fifteen regions in the northern half of China, including Beijing and Inner Mongolia, accounted for 63.4% of government bond defaults last year, up from 51.5% in 2019, Nomura said in an April 27 report .

This is the latest sign of growing economic inequality within the country, where GDP and population growth in the north are already lagging behind those in the south. China’s promise to cut CO2 emissions by 2030 now means that the northern region’s economy has production restrictions.

“The new environmental campaign has the potential to hit northern China – where a large part of steel, aluminum and other raw materials are manufactured and processed – particularly hard,” wrote the Nomura analysts.

“Since most of these steel and aluminum mills are located in lower tier (less developed) cities, these cities’ public finances are likely to be disproportionately affected, increasing the risk of credit default,” they said.

Historical factors

There are many state-owned companies and heavy industries in northern China. This meant that the region was disproportionately affected from the late 1980s when China began to reduce the role of state-owned companies in the economy, which resulted in many workers losing their jobs.

Meanwhile, southern China has more export centers such as Guangdong and Jiangsu provinces. The region has Shanghai and Shenzhen among its capitals and was an early beneficiary of China’s move to allow more foreign and privately owned companies to enter the relatively closed domestic market.

According to the Nomura analysts, historical factors and overcapacities built up after the financial crisis of 2008 contributed to a further weakness in the north. They estimate that northern China contributed only 35.2% of the national nominal GDP last year, while GDP per capita was only about three-quarters of southern China’s GDP.

The north is also more dependent on debt. The share of outstanding corporate bonds in GDP in northern China rose to 52% in 2020 compared to 30% in southern China, Nomura said.

“The north-south divide could become an important factor in credit differentiation in the coming years,” the report said. “Indeed, we have already seen some deterioration in the ability of northern China’s provinces to obtain funding from the bond markets.”

The north accounted for 10% of national corporate bond issuance in the first quarter, compared to 42% for all of last year, analysts said.

Investors are wary of larger risks

Pressure on the north is mounting as defaults in China rise overall, particularly among state-owned companies that investors previously believed had implicit government support.

While the level of defaults is still quite low compared to the overall market, the trend will push investors to differentiate between different issuers of bonds, said Ivan Chung, head of Moody’s credit research and analysis team in China.

According to Chung, issuers canceled bonds last month for two different reasons. One is that the issuer is too weak to arouse enough appetite for investors, he said. The other is that despite the good quality, market sentiment has driven the cost of the bonds up and made them too expensive.

Amid some signs of growing concern, investors feared in April that state bad debt manager Huarong would be unable to make payments.

Separately, 24 companies backed by the Henan provincial government plan to set up a 30 billion yuan ($ 4.6 billion) fund to help local businesses deal with debt risks, Chinese financial media website Caixin reported below Appeal to a government official. Henan is part of Nomura’s name “Northern China”.

Financing a renewable energy relocation

As China tries to balance growth with reducing carbon emissions, easing pressure on carbon-intensive projects may not be enough. Privately owned renewable energy companies may have difficulty obtaining funding from a system in which the largest banks are state-owned and prefer loans to similarly state-backed companies.

One option to fund renewable energy projects may be to issue “green” bonds, which Reuters said sold $ 15.7 billion in China in the first quarter, citing data from Refinitiv. That volume was almost four times what it was a year ago, the report said.

Foreign investment organizations such as the International Finance Center affiliated to the World Bank have also become increasingly involved. Some of the project plans IFC lists on its website for China include wastewater treatment and solar energy.

The size of IFC funding in China has increased from $ 500 million a year 15 years ago to $ 1 billion a year more recently, with about 60 percent being climate-related, said Randall Riopelle, acting regional director for East Asia and the Pacific and Country Manager for China for IFC.

The Wall Street Bull in the Financial District of New York City.

Mike Roy | MCT | Tribune News Service | Getty Images

The “sell and go away in May” strategy isn’t particularly popular on Wall Street this year.

Market professionals acknowledge that history clearly shows that the strongest six month period in the market is November through April, but they also say that it is not necessarily a factor that should shape investor plans each year.

“Any investment strategy you can put in some rhyme is likely to be a bad strategy,” said Jonathan Golub, chief strategist, US equities at Credit Suisse. Golub raised its S&P 500 target on Friday from 4,300 to 4,600 by the end of the year based on strong returns.

He said that market performance, on average, follows the pattern of weakness between May and October, but it is not a reason to get out of stocks.

“That would be perfectly reasonable if every single May looked exactly like May of the previous year,” said Golub. The comparison of this year with last year alone shows a great contrast.

“Last May last year, the market jumped off the ground.” He said the backdrop has now changed from a country and economy ravaged by the pandemic last year to a period when a booming economy and profits should continue to generate profits.

“Look at what we have this earnings season. US companies beat estimates by 22% – 22% are unknown. The economic data is phenomenal,” said Golub.

The second quarter is expected to be even stronger and these earnings reports will be released in July.

“I’m not selling in May and wouldn’t advise anyone else,” said Golub. “I think the biggest mistake you can make in a market like this is getting too cute and getting out early. You’d better try to stay a little longer than get out early.”

Market leader?

A view of the New York Stock Exchange building on Wall Street in downtown Manhattan in New York City.

Roy Rochlin | Getty Images Entertainment | Getty Images

Carter Worth, chief market technician at Cornerstone Macro, agrees that investors generally would not be well served to get out of the market in May and stay out until October.

However, this year he expects the market to enter a weak phase. Seasonal factors aside, Worth expects the market to be at the top.

“It’s a time to reduce exposure. Midsoles can last three to five months,” he said.

Studying the seasonal trend, Worth found that November 1 through April 30, the Dow’s performance was 27.8%, making it the fourth strongest for that six month period through 1896.

“After a particularly good six-month run from November to April, the next six months are poor,” said Worth. He added that after stocks rallied sharply, it could do so for any six month period.

The average return for the Dow for the top 10 years from November to April was 27.5%, compared with an average of 2.9% in the following periods from May to October, Worth noted. The average total profit for the full year for the top 10 years from November to April was 23.7%.

For all years through 1896, the average return on the Dow was 5.2% from November to April and 2.1% from May to October, according to Worth’s analysis. The average performance over all years was 7.3%.

Although Worth expects the market to have spiked in the short term, he said the seasonal investment strategy is the wrong approach.

“The six month period from November to April produced higher returns than the six month period from May to October 1896 to 2020,” he said. “But by far the best strategy, as everyone knows, is to expose the capital to the market year after year.”

Worth calculated that $ 1 million invested in the market from 1896 to 1896 by investors who then went for cash from May to October would have returned $ 164.4 million.

Investors who stayed all year would see a return of $ 672.6 million on that original $ 1 million.

A tendency towards a summer rally

The pattern of seasonal weakness from May to October is also evident in the S&P 500, but the average return has been positive 66% of the time since 1928, according to Stephen Suttmeier, technical research strategist at Bank of America.

He said that because the index had an average positive return of 2.2% over that six month period, the sell in May strategy leaves something to be desired.

Suttmeier said his study confirmed the bias towards a summer rally and the May-October decline was “back-end loaded”.

“Instead of selling in May and going away, buy it in May and sell it in July / August,” he wrote in a note. “The monthly seasonality suggests that sales are in the strong month of April, buying in the weak month of May, and sales in July through August before September, the weakest month of the year.”

The summer rally can be even stronger in the first year of a new president’s term. The market is strong in April and July, but there was also a solid return in May, says Suttmeier.

“This spring-to-summer rally and fall correction will be amplified in the first year of the presidential cycle, with April-June rising an average of 5.5% and August-October falling an average of 2.4%,” he wrote.

Any investment strategy that you can sum up in some rhyme is likely to be a bad strategy.

Jonathan Golub

Chief Strategist for US Equities at Credit Suisse

Sam Stovall, chief investment strategist at CRFA, also examined the “sell in May” phenomenon based on the performance of the S&P Equal Weight 500. This index gives each stock the same weight, not the market capitalization of the S&P 500 index.

By April 30, the S&P Equal Weight 500 was up 16.2% over the course of the year. This is the third strongest four-month start since the index began in 1990.

“Investors are now asking if this benchmark for unweighted US large cap stocks has gone too fast and too far,” Stovall wrote in a note.

He said history shows that such early strength is typically followed by a period when the market digests gains in May. The market can be volatile through September before outperforming the last three months of the year.

With all of the focus on “sell in May and go away,” investors should know that the story of the adage may have more to do with vacation than bailing out the stock market.

“Sell in May and go away” comes from an English saying, “Sell in May and go away and come back on St. Leger’s Day,” Cornerstone told Macro’s Worth.

St. Leger’s Day refers to the St. Leger’s Stakes, a thoroughbred horse race that takes place in mid-September.

“It refers to the custom of leaving the city of London to escape the hot summer months,” said Worth.

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