Is Consensus Getting Chinese (or Global) Growth Right?

Conclusion: We think consensus is finally starting to come closer to our bearish estimates with regard to China’s intermediate-term growth outlook. They are, however, not at all bearish enough, as evidenced by the muted reaction to China’s 4Q/December economic data in US equity trading. Global equities will continue to come under increasing pressure as China helps drag down global growth alongside its own domestic moderation. It appears as if US equities will come crashing in to the party late.

 

Growth Outlook

 

By now it’s no secret that we think US consensus is wrong on China; we’ve been outwardly bearish on China’s 1H11 growth outlook since 10/21 (see post: “China Sets the World Up for a CRASH”) and the Shanghai Composite is down (-15.3%) since it peaked just over two weeks later. To contrast, over that same duration, the S&P 500 is up +4.6% aided by near-manic hope of a “strengthening US recovery”.

 

While the merits of that can certainly be debated, what is becoming less contentious by the day is the slope of Chinese growth in 1H11 and perhaps beyond. 4Q10 GDP came in overnight at +9.8% YoY, a +20bps acceleration from 3Q10’s run rate. Chinese officials evidently see this as an intermediate-term top, aiming for +8% GDP growth in 2011 (on top of +4% inflation and +16% money supply expansion (down from around 20% in 2010)), according to a leak from the National Development and Reform Commision.

 

We also think 4Q10 is an intermediate-term top for Chinese growth because of our outlook for Chinese monetary policy – it’s going to get [much] tighter from here. China’s bond market foresees a similar outcome, as China’s 7-Day Repo rate jumped +347bps since the start of the week, indicating Chinese banks are hoarding cash in anticipation of further rate hikes and reserve requirement hikes.

 

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Inflation Outlook

 

China December CPI came in in-line with the whisper number leaked yesterday, slowing from +5.1% YoY to +4.6% YoY; as an aside, the Shanghai Composite closed up +1.8% yesterday on the declaration. Today’s (-2.9%) move in the face of bullish growth data, bullish industrial production data, bullish retail sales data and moderating inflation data tells us investors are still concerned about the prospect for tighter monetary policy in China’s immediate future. They should be. With commodity prices continuing to accelerate on YoY basis and Real 1Y Deposit Rates remaining in negative territory, China’s fight with inflation is far from over.

 

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Two inflationary data points that support this outlook are:

 

Chinese banks are still at it: Chinese lenders have reportedly lent over 1 trillion yuan January to date, according to the 21st Century Business Herald. That would be roughly ~15% more than the trailing 5Y average for the month (871.5 billion yuan) and 200 billion more than the PBOC’s target for the full month. If that’s the case, the PBOC will likely continue increasing bank reserve requirements, now done on a bank-by-bank basis, in their next monthly review. As the chart below shows, credit expansion is crucial to the slope of Chinese growth. That’s not surprising considering that 40-50% of Chinese GDP is Gross Capital Formation.

 

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Cash surge in 1H11: Maturing central bank bills will flood the Chinese economy with cash in 1H11, adding to liquidity-based inflationary concerns. We’ve seen estimates around 1.2 trillion yuan coming due in 1Q11 and 869 billion yuan due in 2Q11. If that’s the case, the PBOC will either have to raise rates at future bill sells or continue hiking reserve requirements to prevent this influx of cash from filtering through the economy.

 

Side Effects

 

Aside from slower growth over the intermediate term brought on by tighter monetary policy aimed at quelling burgeoning inflation, there are other side effects that will negatively impact the Chinese economy.

 

One key area to watch is how Chinese corporations account for the slowdown in loan-denominated funding; as a result, we expect a shift to greater bond issuance. China’s bond market is relatively illiquid ($3 trillion in size), so a flood of issuance from Chinese corporations could send yields to new heights. To that point, yields on 10Y AAA Chinese corporate bonds have backed up +103bps from last year’s low on August 20th to 5.17% - near a 1Y high; the spread over similar maturity government debt widened +38bps from a 3Y low on November 5th to 119bps. To date, Chinese corporations have issued 91 billion yuan of debt, the most YTD since at least 2005.

 

No matter how you slice it, the cost of capital is on the rise in China, which will weigh heavily on CapEx-heavy industries and China’s highly speculative property market. Perhaps that’s another reason why growth in Chinese Property Prices has decelerated for the eighth consecutive month in December, slowing to +6.4% YoY from +7.7% YoY in November.

 

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Chinese equities (and to a lesser extent, many Asian and emerging market equities globally) reflect the pending slowdown in Chinese and global growth; China’s Shanghai Composite is broken from a TRADE and TREND perspective.

 

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Conclusion

 

All told, we think consensus is finally starting to come closer to our bearish estimates with regard to China’s intermediate-term growth outlook. They are, however, not at all bearish enough, as evidenced by the muted reaction to China’s 4Q/December economic data in US equity trading. Global equities will continue to come under increasing pressure as China helps drag down global growth alongside its own domestic moderation. It appears as if US equities will come crashing in to the party late.

 

Darius Dale

Analyst