Posts tagged China Economic Outlook
There is a predictable visual theme that accompanies articles covering the quarterly release of China’s GDP growth statistics. Pictures of vast, creepily empty real estate development projects festoon the pages of analytical pieces by the likes of the Financial Times and the New York Times, introducing readers to little-known place names like Luoyang and Tianjin. The imagery helps underscore the central importance of the property sector to China (by some accounts 30 percent of its total economy), as well as the increasingly clear evidence that in this sector supply has vastly exceeded demand.
Feed the Beast
And that trend won’t be changing any time soon. In 2018 China’s growth started to slow noticeably. The stock market fell, fears of the effects of a trade war increased, and consumer activity flagged. As sure as night follows day, Beijing flooded the economy with stimulus, in the form of some $180 billion worth of local government bonds. The effects of that stimulus are evident in the chart below, showing the fixed investment trend over the past five years.
The dramatic uptick in the first three months of 2019 (the crimson trendline) is all about state-owned enterprises, through which that stimulus largesse was funneled. The vast majority of the largesse went right into infrastructure and property projects. There will be plenty more of those sprawling ghost cities for journalists to attach to their future reports.
The spree of property project-bound regional bonds was not the only form of stimulus; there was also a major tax cut aimed at small and midsized businesses to encourage them to invest in their markets. That seems to have had some effect on real economic activity (by which we mean things other than property projects in Nowheresville). Retail sales ticked up slightly in the first quarter after the pace of growth fell dramatically in 2018. This trend is shown in the chart below.
China’s economic authorities for years have been trying to rebalance the economy away from the old infrastructure/property schemata to a more consumer-oriented model. The problem is that every time growth starts to slow, the old playbook comes right back out. Notice in that earlier fixed investment chart the timing of the previous surge in state-owned investment spending: 2015 and 2016, when major parts of the economy seemed headed for a dramatic reversal of fortune. Each time this happens, it expands a credit bubble already of historic proportions. China’s debt to GDP ratio was 162 percent in 2008; it grew to 266 percent by last year. Waiting for the rebalancing is like waiting for Godot, while the debt piles up.
It Matters for Markets
The principal headline in this week’s data release was that the overall rate of GDP growth was somewhat better than expected, at 6.4 percent. The reaction among much of the world’s investor class appeared to take this at face value and chalk up one more reason to keep feeding funds into the great market melt-up of 2019. But those same analytical pieces featuring Luoyang’s empty towers point out that, as much of the economic stimulus was front-loaded in the first quarter, a double dip may well be in store. That may matter for markets at whatever time the equity rally takes a pause from its blistering year-to-date pace. Not everything matters for markets, but the performance of the world’s second largest economy is one of the more reliable attention-getters, at different times for better and for worse. The durability of the current stabilization will be something to watch heading into the year’s second half.
The Lunar New Year in 2019 falls on February 5, a bit shy of two months from now. According to a New York Times article today, managers in some factories in China – where Lunar New Year is one of the big holiday events of the year – are letting their employees off for the holidays starting this week. Imagine if your boss came into the office one sunny October morning and said “Merry Christmas all, and I’ll see you in January!” Pretty weird. Such, apparently, is the extent to which the cadence of growth in the world’s second largest economy is slowing.
Tales From the Not-Yet-Trade War Front
A rather dour investor sentiment has been traveling across time zones from east to west this morning, cutting a swath of negative figures through the major equity indexes of Asia and Europe before showing up for another down day on Wall Street. The culprit appears to be another set of macro data releases from China coming in way below the already modest expectations of analysts. We show two of them below – retail sales and industrial production – along with the current state of things in China’s equity and currency markets.
Both these figures are notable in that they represent multiyear lows: in the case of retail sales, a 15-year low. Robust double-digit growth in sales has been the norm even through the 2008 financial crisis, but today’s read is just 8.1 percent year-on-year growth. The other point worth making is that these numbers have relatively little to do with the trade war. China’s exports have not turned down notably even after the implementation of successive waves of tariffs by the US. The problem appears to be domestic sentiment – households are turning down the volume on their spending habits and businesses are cutting production shifts accordingly (hence those extended “holiday breaks” noted above).
Old Habits Die Hard
We’ve been writing about the “China rebalancing project” seemingly forever. For literally the entirely of this decade to date, Beijing has loudly proclaimed its intention to move the economy beyond the old formula of massive spending on state-run infrastructure and development projects, towards a more consumer-oriented society closer to Western economies in terms of consumer spending as a percentage of GDP. By some measures it has succeeded – while official published figures from China are not necessarily reliable, consumption has grown as a GDP contributor over the past ten years. But the old fallback growth formula of debt-funded infrastructure has not abated. Indeed, fixed-asset investment, led by housing and infrastructure, hit a five-month high in the most recent data release. With debt levels already sky-high, though, there is a serious question about how many more times policymakers can go back to their old quick fixes for further growth.
Abroad and At Home
China’s slowing domestic economy is a major reason for the weakness in global energy and industrial commodities prices that has persisted over the past several months. That, in turn, seems to be having a positive impact on consumer spending here at home. With gas prices down a couple percent over the past month, US retail sales for the same period jumped by 0.9 percent month-over-month, exceeding analyst expectations (this refers to the so-called “control group” basket of retail goods and services that excludes volatile categories like automobiles, building materials and food services). November was a particularly bright month for big-ticket items like furniture and electronic goods.
US companies will be hoping that trend keeps up domestically. The average S&P 500 company earns around half of its total revenues from markets outside the US, notably China and the EU (which is having its own particular growth problems). Flagging demand in those markets will be a drag on the pace of sales and earnings growth, which in turn will put pressure on stock price valuations, which in turn could feed into prevailing negative sentiment towards risk assets generally, which in turn can spill over into spending plans by households and businesses, which eventually has the potential to lead to recession.
Protectionist and nationalist rhetoric may fill the political airwaves around the world, but it is still a globally interlinked economy, where the fates of consumers and business managers in China, the US, Europe and elsewhere are joined at the hip.
It’s been one of those weeks where a virtual hailstorm of headlines overwhelms the normal mechanics of cognitive functioning. So much so, that one could easily turn one’s attention away from China for a brief second and turn it back to find that the currency has plummeted in a manner eerily similar to that of August 2015. The chart below shows the path of the renminbi over this time period, along with the concurrent trend of the Shanghai Composite stock index.
Remembrance of Shocks Past
In the chart above we highlight the two “China shocks” that rippled out into global markets in 2015 and 2016. The first was a sudden devaluation of the renminbi in August ’15, a move that caught global investors by surprise. The domestic China stock market was already in freefall then, but the currency move heightened broader fears of an economic slowdown and eventually pushed the US stock market into correction territory.
The second China shock happened just months later, when a raft of negative macro headlines greeted investors at the very start of the new year. Another global risk asset correction ensued, though the drawdown was relatively brief.
Considering those past shocks, though, investors are reasonably concerned about the implications of this week’s moves in both the renminbi and Chinese equities – which briefly entered bear market territory earlier this week. Pouring fuel on the flames, of course, is the addition of an X-factor that wasn’t present for the previous shocks – the looming presence of a potential trade war. Coupled with renewed concerns about China’s growth prospects – with or without a trade war – there is a strong sense in some camps that a third China shock may reverberate out into the global markets.
Less Is More
We understand the concerns, particularly as they are far from the only news items creating a general sense of uncertainty in the world. But our sense is that China’s growth troubles are actually good – good for the country and ultimately good for the global economy. What has slowed down in China this year – well, ever since last autumn’s Communist Party Congress, in fact – has been leveraged fixed asset investment. This is where state-owned enterprises raise copious amounts of debt and invest in infrastructure and property development projects for the primary (seemingly) purpose of beefing up the headline GDP number.
Beijing’s economic authorities have been trying to rebalance the economy away from these repeated trips to the borrow-and-build trough since 2014, but the turbulent domestic financial market conditions of 2015-16 weakened their resolve. The deleveraging commitment got a new breath of life with President Xi Jinping’s consolidation of power after last October’s party congress. With little to worry about politically, Xi and the party formalized the model of “quality over quantity” in the growth equation. So while fixed asset investment and borrowing have slowed considerably, consumer spending has increased. The service economy is growing as a percentage of overall GDP. In the long term, this is a more sustainable model for the world’s second largest economy than unwise lending for the construction of bridges to nowhere.
The Trade Factor
Yes, but what about the trade war? Well, it’s true that uncertainty about the future of trade in general is a clear and present factor in the state of world markets. The unnerving headlines seem unlikely to go away any time soon – the latest today being Trump’s apparent intention to take the US out of the World Trade Organization (without really understanding what that organization is or how, legally, the US would untangle itself from the organization that is the successor to the General Agreement on Tariffs and Trade framework the US itself architected at the Bretton Woods meetings of 1944).
We haven’t had a global trade war since the 1920s, though, so while it is certainly possible to model alternative scenarios, there’s not much in the way of actual data to support persuasive analysis of potential winners and losers. In the meantime, as regards China, the recent patterns in the stock and currency markets merit some concern, but the underlying story is not as negative as some of the present day commentary would suggest.
Stop us if you’ve heard this one before. As the end of the year approaches, investor attention suddenly focuses, laser-like, on China’s financial system. Share markets stumble on the Chinese mainland and in Hong Kong, leading to excited chatter about whether the negativity will spill over from the world’s second-largest economy into the global markets and throw a spanner into what was shaping up to be a most delightful and stress-free (at least from the standpoint of one’s investment portfolio) holiday season.
It happened at the end of 2015, with the S&P 500 falling apart on the last two trading days of the year and continuing the swoon through the first weeks of the new year. The majority of broad-market benchmark indexes lost more than 10 percent – the commonly accepted threshold for a technical correction – before sentiment recovered and bargain-hunters swooped in to take advantage of suddenly-cheap valuations.
Minsky Says What?
Share prices on the Shanghai stock exchange have fallen about 6 percent since reaching their high mark for the year on November 22. Hong Kong’s Hang Seng index, with a proportionately large exposure to mainland companies, is down by about the same amount. The chart below shows the performance of the SSE and the Hang Seng, relative to the S&P 500, over the past six months.
Financial media pundits were quick to remind their readers of the “China syndrome” that played out, not only during that nasty month of January 2016 but also five months earlier, in August 2015 when Chinese monetary authorities surprised the world with a snap devaluation of the yuan, the domestic currency. It started to seep into the market’s collective consciousness that the phrase “Minsky moment” had been uttered recently in connection with China, drawing parallels to the precariously leveraged financial systems that fell apart during the carnage of 2008 (the late economist Hyman Minsky was known for his observation that prolonged periods of above-average returns in risk asset markets breed complacency, irresponsible behavior and, sooner or later, a nasty and sharp reversal of fortune).
Context is Everything
At least so far, fears of a reprisal of those earlier China-led flights from risk appear to be less than convincing. As the above chart shows, the S&P 500 has blithely plowed ahead with its winning ways despite the pullbacks in Asia. Now, US stocks have shown themselves time and again this year to be resoundingly uninterested in anything except the perpetual narrative of global growth, decent corporate earnings and the prospects for a shareholder grab-bag of goodies courtesy of the US tax code. But ignoring fears of another China blow-up is, it would seem to us, more rational than it is complacent.
For starters, consider the source of that “Minsky moment for China” quote; it came from none other than the head of the central bank of…China. Zhou Xiaochuan, the head of the People’s Bank of China, made these remarks during the recent 19th Communist Party Congress marking the start of President Xi Jinping’s second five year term. The spirit of Zhou’s observation was that runaway debt creation imperils the economy’s long-term health, and that is as true for China as it is for any country. In particular, Zhou appeared to be alluding to what many deem to be dangerously high levels of new corporate debt issuers (and speculative investors chasing those higher yields).
Working for the Clampdown
That message was very much in line with one of the overall economic planks of the 19th Congress; namely, that regulatory reform in the financial sector is of greater importance in the coming years than the “growth at any cost” mentality that has characterized much of China’s recent economic history. Following the Congress, the PBOC implemented a new set of regulations to curb access to corporate debt. These regulations sharply restrict access to one of the popular market gimmicks whereby banks buy up high-yielding corporate debt and then on-lend the funds to clients through off-balance sheet “shadow banks.”
These and similar regulations are prudent, but the immediate practical effect was to sharply reduce the supply of available debt and thus send yields soaring. The spike in debt yields, in turn, was widely cited as the main catalyst for the equity sell-offs in Shanghai and Hong Kong.
If that is true, then investors in other markets are likely correct to pay little attention. China does have a debt problem, and if the authorities are serious about “quality growth” – meaning less debt-fueled bridge-to-nowhere infrastructure projects and more domestic consumption – then the risks of a near-term China blow-up should decrease, not increase. Stock markets around the world may pullback for any number of reasons, and sooner or later they most probably will – but a three-peat of the China syndrome should not be high on the list of probable driving forces.
The big news after last month’s National People’s Congress in Beijing was the announcement by Premier Li Keqiang of the government’s intention to set a range, rather than an individual target, for annual real GDP growth. The range was to be between 6.5 and 7.0 percent, seen as striking a balance between the admission that a steady rate of seven percent, the previous target, was not sustainable, while still delivering enough top-line growth to reach the country’s GDP targets for 2020. Today China released its GDP results for the first quarter of 2016 and – lo and behold – the number came in at 6.7 percent. Observers met the release with the usual skepticism over how much the reported figure varied from what is actually going on in the world’s second largest economy. We’re less concerned about whether the “real” top line is 6.7 or 7.0 or even 5.5 percent, and more concerned about what recent data tell us about the progress, or lack thereof, towards China’s much ballyhooed economic rebalancing.
More Bridges to Nowhere?
Specifically, much of the data released since the March NPC meeting points to an apparently deliberate decision on the part of Beijing policymakers to reach for the elixir of investment-driven stimulus – the key growth driver for much of the past 10-plus years – as a way to head off concerns that efforts to rebalance towards a more domestic consumption-driven economy may be falling short. Those concerns have manifested in recent months in the form of massive capital outflows and a resulting 20 percent decline from peak foreign exchange reserves. Premier Li’s NPC remarks reflected the view that a sugar fix is the best response. Markets took note: iron ore prices jumped by a ridiculous amount on the Monday after the NPC, and commodities generally surged in anticipation of a pickup in China demand. Were they right? Consider the chart below showing other recent key data releases.
Among these four charts, you can see the sharpest reversal of recent trends in industrial production and wholesale prices, both of which came in comfortably ahead of analyst expectations. Fixed asset growth – a key metric for China’s activity in infrastructure and property development – is still nowhere near the levels of recent years, but has actually increased for the first time since 2014. Meanwhile the growth rate of retail sales, an important benchmark of consumer activity, is lower than at any time in the past twelve months.
Corporate Debt – China’s Mountain Dew
Fixed asset investment doesn’t happen without infusions of new debt capital. New bank loans in China are up $351 billion in March, on the heels of an even brisker pace of $385 billion in January new loan creation. That January number represents the fastest pace of monthly loan growth on record. While January is often the busiest month of the year for new loan creation, with newly-approved projects tapping their sources of credit financing, the strong follow-up in March raises expectations that China’s outstanding debt will continue to set new high ground. Bear in mind that China’s total non-financial debt to GDP has soared from around 100 percent of GDP in 2009, at the outset of a new bank lending stimulus program, to 250 percent of GDP today.
The aggregate level of debt is not the only concern; much of the lending is still tied to the so-called “zombies” – troubled state-owned companies whose loans constitute a potentially significant credit quality problem for the banks that originate them. Bankruptcies and loan write-downs are a delicate matter in China, and reminiscent of the chronically inept way Japan’s financial institutions and regulators tried to deal with that country’s nonperforming debt problems in the 1990s.
When the Sugar Wears Off
All sugar highs come to an end, a fact not lost on Beijing’s Mandarins. We do not think it is on anyone’s agenda to try and embark on another decade of hypergrowth fueled by bank loans and fixed asset investment. The Mountain Dew is meant to buy some time and give the urban services sector a chance to establish enough momentum to take over as the economy’s growth engine. This is China’s own version of “kick the can,” a game in which almost every globally significant economy has indulged over the past seven years. For the time being we expect the China story to be net-neutral to positive in its contribution to the overall market narrative, premised on expectations of no imminent hard landing and a stimulative effect on commodities prices. Come autumn, though, policymakers may need to show they have an effective antidote to the sugar high.