Posts tagged China Economic Outlook
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.
There has been almost nothing “happy” about the New Year thus far. It’s probably a good thing that investors had a whole weekend in which to shake off New Year’s Day hangovers before showing up to face a sea of red arrows on Monday morning. Those red arrows, of course, came courtesy of yet another series of bafflingly inept moves by Beijing’s financial policymakers. It would be an exaggeration to say that the world’s second largest economy is in a swoon, but its financial markets certainly are.
But while the dramatic pullback in world equity markets and rising volatility are strong reasons to give pause, we do not believe this is the right time to pull the panic switch. While unquestionably a critically important component of the global economy, China depends on other world markets for its exports more than other world markets depend on China’s domestic demand for their own fortunes. Moreover, the fortunes of US companies still depend more on the US consumer than anything else. This year may provide a decisive answer to the question of whether the US economy can continue to prosper as the world’s growth engine despite increasing weakness elsewhere. We don’t yet know that answer – but based on the data we have on hand, we are not ready to jump into the lifeboats. If today’s environment bears any resemblance to past periods, we think more of 1997-98, and less of 2007-08. It is worth revisiting what happened back then before we conclude with our thoughts on the current market.
Asian Currencies, Act I
The Asian currency crisis of 1997 had an effect on equity markets around the world, including the US. The chart below shows the price performance of the MSCI All Counties Asia Pacific index from January 1997 to December 1998, versus the S&P 500 for the same time period.
The carnage in Asia was fast and brutal, with currencies falling as much as 40 percent against the dollar, and regional stock exchanges losing as much as 60 percent. As the above chart shows the S&P 500 (in green) suffered a rapid succession of pullbacks of 5 percent or greater between the summer of 1997 and January 1998 (the pullbacks are indicated in the chart along with the magnitude of each peak-to-trough drawdown). These pullbacks came on the heels of a near-10 percent correction that took place before the currency crisis. Many investors at the time interpreted this shaky performance – in the context of a deeply troubled global economy – as presaging an end to the bull market that had run nearly uninterrupted since early 1995. Asia was seen as the world’s emerging growth region, with great promise for US companies to manufacture, source labor and materials, and sell to the fast-growing middle class households in the region. The currency crisis threatened to bring a swift end to the good times and to provide a headwind to US companies’ EPS growth.
Russia Unleashes the Bears
As dire as the currency crisis was for Asian markets, which continued to fall through most of 1998, the US channeled its inner Taylor Swift and “shook it off” to rally strongly through the first half of 1998. Investors’ focus turned away from turmoil elsewhere to focus on the strength of the domestic US market, particularly the tech boom riding on the Internet’s penetration into commerce and social life. Then another foreign time bomb went off in August, when Russia devalued its currency and defaulted on its sovereign debt obligations. Another massive selloff took place in US equities – this one approaching the 20 percent threshold for a bear market. Caught up in the Russia collapse was the hedge fund Long Term Capital Management, which over the course of a tense few days threatened to turn this pullback into a genuine pandemic.
After all the drama, though, it turned out that the best way for investors in US stocks to navigate these two volatile years was to…do nothing at all. The S&P 500 registered a 66 percent cumulative price gain from the beginning of 1997 to the end of 1998. It was undoubtedly tempting to sell out at various critical junctures, but patience and discipline were rewarded.
Asian Currencies, Act II
Asian currencies are once again at the center of things. Most fell sharply against the dollar last year, though so far by generally less than they did in 1997. The Malaysian ringgit, for example, is about 23 percent lower versus the dollar over the past twelve months, and the Thai baht is softer by some 11 percent. Of course, this time it is the China renminbi – largely not a factor in the ’97 crisis – that is the center of focus. The RMB has devalued by just over six percent from where it was before the first bout of devaluation last August. What should not be forgotten, however, is that the renminbi was largely flat against the dollar in the first half of 2015, while the euro and other developed and EM currencies were falling.
Also worth remembering is that China as well as its Asia EM neighbors are in far stronger FX reserve positions today than they were in 1997. The threat of a debt default by any regional government is considerably more remote than it was nineteen years ago. China’s policymakers may demonstrate a tin ear when it comes to considering the likely short term impact of their decisions on world financial markets, but it is hard to imagine them making the kind of policy mistake that would trigger a real economic freefall.
And that brings us to China’s real economy. All the drama this week started with a below-consensus manufacturing report representing a fifth month of contraction. At the same time, though, recent indicators of consumer activity have been good – retail sales have been growing at double-digit rates for most of the last twelve months. If China’s economic transition is going to succeed, it is going to succeed thanks to the consumer, so these trends are absolutely consequential to the larger picture.
And if China does export price deflation to other markets through a weaker currency? Well, lower prices for China imports could be stimulative for US consumer activity. As we said earlier, what is good for the US consumer will likely be good for US stocks. Admittedly, this is a rational argument being made at the end of an irrational week. We may not be out of the woods as far as the current pullback is concerned. But we are not panicking.
In what has become an increasingly event-driven year for capital markets, Monday looms large on the calendar with the expected announcement of China’s third quarter GDP growth. Given China’s front-and-center role in the recent stock market correction, investors will want to see what the data say about how things are really faring. Not that the data will necessarily tell them much. The longstanding debate over the extent to which China manipulates its headline data continues apace, with the spectrum of opinion ranging from “a bit” to “entirely.” To grasp what is going on in the Middle Kingdom requires a careful focus on the likely source of whatever growth is in store: the Chinese consumer.
How We Got Here
For an understanding of how central the Chinese consumer is to the growth equation – and by extension to what may be in store for global asset markets in the coming months – it is worth a brief visit back to the path of China’s rise to economic stardom. The chart below shows the country’s real GDP growth for the past fifteen years, encompassing its meteoric rise in the early-mid 2000s, the market crash and Great Recession, and the post-recession recovery.
There are three distinct economic stories to tell over this fifteen year span of time. While the Chinese economy was kicking into gear in the 1990s, it was really in the first decade of this century that we saw it rise to become the preeminent supplier of all manner of goods to the rest of the world. Demand in key developed export markets in Europe and North America recovered after the 2001 recession. China’s growth trajectory was largely export-driven, with soaring industrial production and equally soaring imports of energy and industrial commodities.
The Great Recession of 2007-09 brought an end to those good times, but only briefly. With cooling demand in its major export markets China turned inward, commencing a massive, debt-fueled stimulus program in late 2008 that continued through the early years of the present decade. Construction and investment, focused primarily on property development and infrastructure projects, drove this second wave of growth. Even while the rest of the world struggled with low-to mid-single digit growth, China continued to grow at or close to ten percent during these years. But consumer spending lagged, accounting for an unusually low 35 percent of GDP as compared to 70 percent in the US and more than 60 percent in most European economies. Eventually the investment boom ran into the headwinds of oversupply. Visitors to China are rife with anecdotal tales of sprawling, eerily unoccupied commercial and residential real estate projects. As investment waned, China’s policy leaders explicitly acknowledged the need to rebalance the economy away from its traditional growth drivers towards something else. Enter the consumer.
Let a Billion Consumers Bloom
Stimulating domestic consumption has thus been a top priority for the government of Xi Jinping ever since coming to office in 2012. What do the results to date tell us? Well, the news headlines over the past several months, not to mention the ham-handed debacle of the government’s trying to control the stock market’s rise and fall and the subsequent devaluing of the currency, would seem to indicate that all is not well. But there are some indications that consumer activity is perking up rather nicely.
Overall retail sales are up more than ten percent this year – faster than the economy overall. Key consumer sectors like furniture and home electronics are up more than fifteen percent. Yes – again, one has to handle published China economic data with some skepticism. But there are enough positive appraisals from those close to the country’s consumer markets to give some support to the numbers. Recall Apple CEO Tim Cook’s sanguine appraisal about his own company’s China prospects amid the panic of the late August market selloff. Nike’s China sales grew by 27 percent in the most recent quarter – the strongest market in a very strong quarter for the company.
We are certainly not Pollyannas when it comes to China. There is plenty that could go wrong with its ambitious rebalancing plan, not the least of which is the massive debt overhang that looms over the economy. China’s debt to GDP ratio, already high, grew by more than 80 percent from 2007-14 according to a study by consulting firm McKinsey. And China’s rebalancing has other implications elsewhere in the world. For one, stocking the shelves of department stores and supplying trendy apps and gadgets to discerning young Chinese technophiles will not replace an import base weakened by declining demand for aluminum, zinc and nickel ore. That’s bad news for resource exporters like Brazil, Russia and Australia.
Nonetheless, we do believe the whirlwind of panic that sprung up in August was overblown. We will study Monday’s GDP numbers carefully, but are much more interested in how these consumer trends will continue to fare in the coming weeks and months. So far, two cheers. Let’s hope for three.
Ah, yes, it is turning out to be another one of those unpredictable Augusts. US East Coasters woke up Tuesday morning to news of a major devaluation of the Chinese currency, the renminbi (RMB). Global asset markets then spent several days lurching this way and that as investors attempted to divine the meaning behind the sharply lower RMB reference rate set by the People’s Bank of China (PBOC), the nation’s central bank. As another summer weekend approaches, the preliminary consensus appears to be of the “tempest in a teapot” variety. Most bellwether asset classes have stabilized over the past forty eight hours. But investors heading back out to their boats and beach houses will likely still be pondering the Chinese currency’s near term prospects, and how this new twist adds to the brew of ingredients shaping possible Fed moves in September.
Market Adjustment or Currency War?
It is important to understand what did – and did not – happen this week. Every morning the Chinese monetary authorities set a reference rate for the RMB, and market makers are allowed to trade within a two percent range around that reference rate. Prior to Tuesday, the daily published reference rate had no explicit relationship whatsoever to market forces. There was no formula linking the reference rate to the previous intraday close or to perceived market supply and demand; rather, the reference rate was simply what the PBOC thought it should be.
Tuesday’s reference rate set the RMB at a level 1.9 percent below the previous close, and that announcement unleashed a flurry of pent-up selling pressure to take the currency down the daily maximum two percent from the morning rate. By the end of the week the net effect of the PBOC’s moves and market trading was a 4.4 percent decline in the value of the RMB versus the dollar. That was a move of a sufficient magnitude to push the topic of currency wars back into the discourse. However, the evidence so far does not support a clear-cut conclusion that China’s actions are motivated primarily by goosing up its export competitiveness.
Admission to the Club
Chinese policymakers this week pointed to the goal of a more tangible link between market forces and the RMB as driving the recent reference rate policy decisions. There is some convincing logic behind these statements. It is no secret that China would like to see enhanced reserve status for the RMB and a more prominent role for the currency in global trade and finance. An important milestone for this goal would be to have the RMB admitted to the elite club of IMF Special Drawing Rights (SDR) currencies, taking a seat alongside the dollar, euro, yen and pound sterling. Engendering more market transparency for the RMB is seen by many as a necessary box to check off for admission to the SDR club. Of course, proof that this is in fact China’s primary goal will require the People’s Bank of China to allow the currency to strengthen (thus weakening exports) as well as devalue when market forces so dictate.
Back to the Fed
Whatever the reason, a weaker renminbi is likely to factor into the calculus of the Fed’s forthcoming decision on whether to kick off its rate program in September. A rate hike that resulted in a sharply higher dollar, in the context of an already lower RMB, could have unfavorable economic consequences for US growth and prices. Such a scenario could give the Fed pause and push its decision back to December. The data would suggest this is likely, with recent headline GDP, employment and inflation numbers decent but certainly not indicative of an overheating economy. Alternatively, the Fed may simply want to get on with it and end the continual will-they-won’t-they chatter. If it does come in September, though, the rate hike may possibly be the most dovish ever.
“Every unhappy family is unhappy in its own way.” The opening sentiment in Tolstoy’s great novel Anna Karenina works just as well for commodities markets in the summer of 2015 as it did for Russian aristocratic clans in the 19th century. Every major commodities “family” – from precious metals to energy and industrial metals – is unhappy. And the reasons are quite specific to each. Oil suffers from a supply glut. Copper and nickel feel the brunt of contracting production in China. Gold has lost its luster as a safe haven – nobody went piling into gold during the recent turmoil in Greece, for example.
Oh, sure, there are exceptions to the rule out there in the byways and back roads of the commodities world. Traders put a “squeeze” on robusta coffee futures last month and bid September contracts up to a ridiculous spread versus July delivery. But by and large, it has been a long and hard summer for the global economy’s major physical inputs. The chart below illustrates the shared pain.
As dismal a picture as this chart paints, it does not even tell the full story. From its last six years’ high point in April 2011, Brent crude oil has tumbled 61 percent. Copper has fallen by nearly 50 percent over the same period, and gold’s retreat has topped 40 percent. Imagine what the conversation would be if major equity indexes had spent the past six years falling on an order of this magnitude. When the S&P 500 gives ground in the high double digits, retirement nest eggs look fragile and the prospect of recession looms large. When oil prices plummet – well, we just pay less at the pump. Good news, right? Not necessarily. Commodities price trends give us important information about the world economy. Right now the news is decidedly mixed.
Awash in Supply
Oil bulls got sideswiped by a steady drip-drip of supply news in July, with accelerating OPEC production dominating the headlines. Saudi Arabia remained firm to its commitment articulated last November to gain share rather than support prices through restricted output. Production in Iraq reached record levels. And the prospect of Iran – holder of the world’s fourth-largest proven reserves – reentering the market after years of sanctions added a further depressive element. Meanwhile, US shale producers still appear mostly determined to power through the downturn and find ways to further reduce their cost structures rather than let up on output.
The China Malaise
The unhappy story told by industrial metals is set in China, which is by far the world’s largest importer of copper, aluminum, nickel and other key metals. Forget about all the eye-popping gyrations on the Shanghai and Shenzhen stock bourses. The really important story in China is the slowdown in growth, punctuated by a sharper than expected manufacturing contraction in both June and July and coming on the heels of forty straight months of declines in the domestic producer price index. Whereas the oil story is mostly (not entirely) about supply, the plight of industrial metals has more to do with demand. And weaker demand from China has hit the export accounts of other emerging markets. It should come as little surprise that the MSCI Emerging Markets index is off by more than 12 percent from its June highs.
All That (Doesn’t) Glitter
Then there is gold. It would be fair to say that the gold bugs who went running for the hills in 2009, worried about the inflationary tinderbox the Fed was supposedly opening with its quantitative easing programs, have not been rewarded for their excessive caution. But at least gold was a part of the “risk off” trade back in 2011 when we had our last really big pullback in equities. Fast forward to July 2015, with Greece once again on the front pages and consensus forming around the idea that a breakup of the Eurozone is a matter of when, not if. Over the course of this month, with Greek banks shutting down and Chinese stocks plunging into bear territory, the price of gold actually fell by six percent. This is perhaps a useful reminder of something we have said from time to time on the pages of these weekly commentaries. There is nothing magical or mythical about gold. It is a commodity, with a price that goes up and down like any other commodity. Lately, the movement has been mostly down.
Trouble Ahead, Trouble Behind
Unfortunately for gold bugs, oil bulls and any other species looking for commodities gains to ring out the year, the road ahead does not look much more promising than the road behind. First of all, neither the oversupply of oil nor the slowing of growth in China look set to end any time soon. Those headwinds are likely to continue. Secondly, those headwinds are likely to compound further still if the Fed goes ahead with its rate program, as expected sometime between September and December. Higher interest rates impose a natural cost on holding commodities – after all, investors do not get any interest or dividend income from storing bars of gold or barrels of oil. Now, if a rising Fed funds rate signals a faster tempo to global real economic growth, we would expect that growth to translate into higher commodities prices at some point. From where we stand now, though, that “some point” still seems to be some distance away.