Conclusion: As of now, the data is not particularly supportive for China to meaningfully ease monetary policy (and thereby reflating import demand) in the near term. Moreover, inflation expectations need to continue trending down for Chinese assets to keep working and we anticipate that will happen as King Dollar continues to weigh on commodity prices over the intermediate-term TREND.
Virtual Portfolio Positioning: Long Chinese equities (CAF); Closed our long position in Hong Kong equities (EWH) earlier today.
Rather than react to the mania of financial media headlines and 1-day price moves, we think intermediate-to-long-term investors would be much better suited to have a process by which to properly contextualize the latest deltas in Chinese growth/inflation/policy. Our updated thoughts on each are below:
Growth: China’s 4Q/DEC economic growth data came in better than bad, which is in-line with our view that Chinese growth is slowing at a slower rate and looks to bottom-out here in 1Q12:
- 4Q11 Real GDP: +8.9% YoY vs. +9.1% prior vs. +8.7% Bloomberg Consensus; +8.9% is the slowest pace of growth since 2Q09 and well off the 1Q10 cycle-peak of +11.9%;
- Retail Sales: +18.1% YoY in DEC vs. +17.3% prior;
- Industrial Production: +12.8% YoY in DEC vs. +12.4% prior;
- YTD Urban Fixed Assets Investment: +23.8% YoY in DEC vs. +24.5% prior;
- M2 Money Supply: +13.6% YoY in DEC vs. +12.7% prior;
- New Loan Growth: CNY640.5B MoM in DEC vs. CNY562.2B prior;
- Manufacturing PMI: 50.3 in DEC vs. 49 prior;
- Non-Manufacturing PMI: 56 in DEC vs. 49.7 prior;
- Exports: +13.4% YoY in DEC vs. +13.8% prior;
- Imports: +11.8% YoY in DEC vs. +22.1% prior; +11.8% is the slowest rate of growth since OCT ’09 and highlights Chinese demand (or lack thereof) for things not produced in China (i.e. raw materials); and
- Trade Balance: +26.3% YoY in DEC vs. -36.5% prior.
Inflation: China’s DEC inflation data was dovish, on the margin, but still not supportive of a dramatic reversal in Chinese monetary policy from either an absolute or trend-line perspective:
- CPI: +4.1% YoY in DEC vs. +4.2% prior; though +4.1% is a 15-month low growth rate, we’d be remiss to join consensus speculation on monetary policy in the context of random 15-month intervals… instead we should focus on the fact that Chinese CPI has been above-target (+4% YoY) every month since SEP ’10; on a MoM basis, CPI accelerated +0.3% in DEC vs. -0.2% prior; sequential gains in CPI are a headwind to monetary easing;
- PPI: +1.7% YoY in DEC vs. +2.7% prior; a surprisingly coincident indicator for Chinese consumer-price inflation (we would expect it to be a leading indicator, but it is not); and
- Manufacturing PMI Input Prices: 47.1 in DEC vs. 44.4 prior.
Policy: Rather than interpret China’s latest batch of data as a leading indicator of what we hope China will do on the policy front (see: sell-side reaction below), we think it’s critical to focus on where China has been and where it wants to go with regards to policy. Before we do that, however, it’s important to highlight the consensus reaction to the latest Chinese economic data:
“Decelerating GDP growth will provide more room for policy makers to shift towards a pro-growth bias after an extended tightening cycle.”
-Jing Ulrich, Chairman of Global Markets for China at JPMorgan Chase & Co.
“Amid a slowdown of both domestic and external economies, the government will continue to roll out stimulus policies.”
-Sylvia Chiu, an economist at SinoPac Financial
“China has a lot of room to adjust policies to simulate growth or address any kind of weaknesses in the economy.”
-K.C. Chan, Hong Kong’s Financial Services Secretary
In that light, we find it critical to remember that Slowing Growth is all part of the plan for Chinese policymakers. Ma Jiantang, Head of China’s Bureau of National Statistics, said it best overnight:
“China is prepared for a slowdown in economic growth and a mild moderation is desirable.”
To that point, we must not forget that the current growth slowdown in China is one that is: a) over two years old; and b) well within the State Council’s stated goals. Since 1Q10, Chinese policymakers have been implementing various measures ranging from property tax trials, to reserve requirement/rate hikes in order to “curb real estate prices”. In light of this, we see no reason for Chinese policymakers to panic and suddenly reverse course on monetary policy.
In fact, slowing rates of Chinese economic growth in order to combat inflation has been their focus for nearly two full years and that is highlighted by their 2011-12 and 5yr outlooks for Chinese real GDP growth (8% in 2011-12; 7% per annum in the latest 5yr plan). For reference, full-year 2011 real GDP growth came in at +9.2% – a full 120bps above the State Council’s target!
The net of it all is that the case for China to ease monetary policy in the near term is not as strong as consensus would have you believe. While we think a reserve requirement cut may be in order to alleviate interbank liquidity ahead of the Lunar New Year holiday (starting 1/23), we don’t see a strong case for a meaningful easing of monetary policy in the near term. While an RRR cut would be in line with Premier Jiabao’s monetary policy “fine-tuning”, the data just does not support consensus speculation for a dramatic reversal in China’s monetary policy stance.
In fact, looking at the day-over-day moves in Chinese 1yr O/S interest rate swaps (+11bps), the data (DEC in particular) is actually more hawkish, on the margin, than dovish. Intuitively, that makes sense, given where the current level of Chinese economic growth fits within the State Council’s strategy and our call for Chinese growth to Slow at a Slower Rate.
Do we expect China to embark on a rate cutting cycle over the intermediate term? Most certainly, given that both market prices and our fundamental models point to a dovish outlook for Chinese monetary policy. That would, however, likely coincide with lower prices across the commodity complex, given that QE2-fueled commodity reflation was one of the primary drivers of hawkish Chinese CPI and PPI readings. For reference, the CRB All-Commodities Index is still up +16.2% since Jackson Hole 2010.
All told, it takes a China bull (’09; late ‘11) and China bear (’10; early ‘11) to know one, and, more importantly, to know where to poke for holes in the consensus bull/bear theses on China. We continue to question the sustainability of Chinese equities/corporate credit working at the same time as commodities. To the former point, Chinese equities are up +7% from a near 3yr-low on 1/5 and China’s AAA/sovereign spread compressed -27bps last week to an 11-month low of 146bps wide.
To further that point, the two major lessons from the ‘08/09 turn which are a relevant guide for today’s uncertainly are: a) commodities aren’t priced in the vacuum of Chinese demand (the rest of Asia, Europe, and the U.S. matter alongside the USD’s market value); and b) buying commodities ahead of/on the first Chinese rate cut proved to be a bad idea. To that tune, the CRB Index bottomed nearly six months and -41.3% after China’s first rate cut in early SEP ’08.
Additionally, it’s important to understand that gross domestic capital formation is nearly half of Chinese GDP growth, which essentially means that investing in property has been the #1 driver of Chinese economic growth – not exports, consumption, nor government spending. On this front, China has pledged as recently as DEC to “unswervingly implement real estate curbs” in 2012. And as long as China’s property market is under siege, so will Chinese demand for raw materials (for construction, etc.).
On the flip side of this view, Zhang Xiaoqiang, Vice Chairman of China’s National Development and Reform Commission, did say that Chinese policymakers plan to actively expand imports in 2012 via lowering import taxes for some raw materials and energy products. On the margin, finding clever ways of lowering the cost of such imports is bullish for Chinese demand. Moreover, Zhang said the 8-plus percent gain in CNY/USD since its de-pegging in JUN ’10 will “continue for a certain period”. That said, however, getting the timing right regarding an actual reacceleration in Chinese physical demand for raw materials will be of utmost importance here.
As of now, the data is not particularly supportive for China to meaningfully ease monetary policy in the near term. Moreover, inflation expectations need to continue trending down for Chinese assets to keep working and we anticipate that will happen as King Dollar continues to weigh on commodity prices over the intermediate-term TREND.