“In Macro, everything that matters happens on the margin.”
Conclusion: China’s 3Q and September economic data tells us a lot of what we already knew about China and even more about what we “apparently” didn’t know about the global economy – growth is slowing; inflation is accelerating. Further, China vs. QE2 = a catch-22 that won’t end well for this current global rally.
Chinese 3Q10 GDP growth came in at +9.6% YoY, 10bps better than consensus expectations. Despite the “beat”, the Shanghai Composite Index fell (-0.7%) – the largest decline since September 16 – on the back of nasty inflation data:
- CPI quickened in September to the highest YoY growth rate in 23 months: +3.6% vs. +3.5% in August.
- Food inflation accelerated +50bps MoM in September to +8% YoY vs. +7.5% in August. As we have shown previously, roughly 36% of China’s citizenry lives on less than $2 per day (PPP), with food being their largest expense. That’s roughly 480 MILLION Chinese citizens who are being starved on the margin by Bernanke’s QE policy (CRB Foodstuff Index has a (-0.86) inverse correlation to the U.S. dollar since the June 7th peak in the dollar).
- Chinese CPI is still 110bps higher than the benchmark one-year deposit rate of 2.5%, despite Tuesday’s 25bps rate hike. As long as inflation continues erode savings, speculation will continue to be a thorn in China’s side.
The ugly inflation data combined with a marginal deterioration in Industrial Production growth (+13.3% YoY in Sept. vs. +13.9% in Aug.) to overshadow sequential upticks in retail sales growth, rural wage growth, and business confidence. Simply put, it’s not good when growth is slowing and inflation is accelerating; the absolute levels of growth and inflation are less relevant to astute investors. Think about the last stock you remember working when topline growth was slowing and gross margins were contracting.
As the chart below shows, 3Q10 marks the second straight quarter of China’s marginal stagflation:
What IS currently working in China’s favor is the Fed-sponsored, dollar-debased, yield-chasing rally we’ve seen globally. As such, Chinese equities, using the Shanghai Composite as a proxy, have rallied ~27% off their July lows.
We know China has been the world’s engine of growth for much of the last 18-20 months and, as expected, the data confirms growth is slowing. Now, China (AND THE ENTIRE WORLD) is in a serious catch -22:
- According to the yield chasers of the world, the U.S. (China’s largest customer at ~20% of exports) “needs” QE2 to grow demand for China’s products.
- QE2 crushes the U.S. dollar, which puts upward pressure on the prices of things Chinese citizens and businesses have to buy – the U.S. Dollar Index has an inverse correlation of (-0.95) to the CRB Commodities Index over the last 3 months.
- China gets smacked with more inflation, which leads to incremental tightening of Chinese monetary policy. On Tuesday, China reminded everyone how serious they are about fighting inflation with an “unexpected” 25bps hike in their benchmark one-year lending and deposit rates.
China’s rate hike Tuesday reminded everyone across the globe the amount of correlation risk associated with yield chasing fueled by excess liquidity. Therein lies the rub – more QE and China (the world’s growth engine) is forced to tighten incrementally or less QE and the global Fed-sponsored, dollar-debased reflation rally we’ve seen across nearly asset class comes crashing back down to economic reality.
I believe they call this “damned if you do; damned if you don’t.”
Our CEO, Keith McCullough, has been aggressively reminding our clients that at a point, dollar down becomes a very BAD thing. While our Chaos Theory mantra suggest that you never know which incremental granule collapses the sand pyramid, we are going on record saying that Chinese monetary policy will certainly catch a few finger points when it’s all said and done.
Elsewhere in China’s economy, we circle back to Chinese property prices as adding incremental fuel to the fire. China’s Property Prices (70 Cities) rose in September by +0.5% MoM, marking the first sequential uptick on a monthly basis since May. While prices decelerated on a YoY basis in September (+9.1% vs. +9.3% in Aug.), the +56% MoM gain in property sales value and +52% MoM gain in property sales volume exacerbate the slight monthly increase in prices in September and overshadows the marginal deceleration of YoY growth in September.
This latest reading may serve to speed up China’s implementation of a nationwide property tax trial and may also provide additional incentive for China to raise interest rates, should real estate prices continue to go the wrong way. As long as the spread between inflation (blame QE2) and one-year deposit rates is negative, China will find it difficult to fully oust speculation from its property market, all else being equal. That alone makes a compelling case for further rate hikes, which will crimp China’s growth on the margin (Gross Capital Formation is roughly 45-50% of GDP).
On the positive side of Chinese rate hikes, Todd Jordan, our Managing Director of GLL, has shown rate hikes to be positively correlated with Macau Mass Gaming Revenue (0.75). “Moreover, interest rates were statistically significant in explaining the changes in gaming revenues with the highest t-stat present in the Mass [Revenue] to Interest rate equation”, he remarks.
The takeaway here being that interest rate hikes provide upward pressure on the value of the currency (yuan), which ultimately filters into increased consumer spending and consumer confidence. Raising the value of your currency can actually be good for your citizenry? (shhhh… don’t tell Heli-Ben).
At the end of the day, incremental Chinese monetary policy tightening is bearish for Chinese growth, which itself is bearish for the speculative bid that has buoyed many emerging market equity markets and commodities YTD. This round of Keynesian Rallies is near its end. Don’t be caught holding the bag when China pokes a hole in it – that is to say if we haven’t popped it ourselves by standing up to the Fed’s weak monetary policy.