CHINA: LESS BORING; MORE CONFUSING

CONCLUSION: Chinese economic growth is slowing at a faster rate as of late while market-based indicators of monetary easing speculation are accelerating, leaving the Chinese economy at a perfectly confusing fundamental juncture. We do, however, continue to side with our research process – the net output of which points to a bottoming/inflection point in Chinese growth here in 2Q.

 

VIRTUAL PORTFOLIO: Long Chinese equities (CAF).

 

THE BAD

The month of APR certainly brought some fairly sour economic growth data out of China. The headline data was as follows: 

  • APR Industrial Production: +9.3% YoY vs. +11.9% prior
  • APR Retail Sales: +14.1% YoY vs. +15.2% prior
  • APR Fixed Assets Investments YTD: +20.2% YoY vs. +20.9% prior
  • APR M2 Money Supply: +12.8% YoY vs. +13.4% prior
  • APR New Loans: +CNY681.8B MoM vs. +CNY1010B prior
  • APR Exports: +4.9% YoY vs. +8.9% prior
    • To US: +10% YoY vs. +14% prior
    • To EU: -2.4% YoY vs. -3.1% prior
  • APR Imports: +0.3% YoY vs. +5.3% prior
  • APR Manufacturing PMI: 53.3 vs. 53.1 prior (improved at a slower rate, though)
  • APR Services PMI: 56.1 vs. 58 prior 

Behind the scenes, APR also saw a slowdown in Chinese energy demand and an incremental deterioration of conditions within the country’s property market: 

  • APR Electricity Production: +1.5% YoY vs. +7.3% prior
  • APR Processing of Crude Oil: -0.6% YoY vs. +1.9% prior
  • APR Real Estate Climate Index: -7.3% YoY vs. -5.9% prior 

CHINA: LESS BORING; MORE CONFUSING - 1

 

CHINA: LESS BORING; MORE CONFUSING - 2

 

As an aside, we flag these lesser-tracked data points because of their signaling power into the current Chinese growth model: 46.4% of GDP is Gross Fixed Capital Formation and Industrial Production accounts for 70% of all electricity use.

 

Moving along, it also appears that April’s Showers invited themselves into MAY, as the nation’s four largest banks are reported to have recorded only +CNY20B of Net New Lending MTD (per the Shanghai Securities News, citing unidentified sources). If this report is indeed accurate, it is an early (and extremely negative) read on the state of Chinese economic growth here in MAY, given the capital intensive nature of the Chinese economy.

 

THE GOOD

Looking ahead, our models continue to point to a bottoming/inflection point in Chinese growth here in 2Q and the APR inflation data (CPI: +3.4% YoY vs. +3.6% prior; PPI: -0.7% YoY vs. -0.3% prior) lends credence to our long-held view that Deflating the Inflation alone would prompt the State Council, PBOC and the China Securities Regulatory Commission to continue “fine tuning” policy in support of growth. NOTE: we are not of the view that incremental easing is a function of slowing growth data; the latter has been purposefully engineered by Chinese policymakers starting as early as 1Q10 (recall our then-bearish Chinese Ox in a Box thesis).

 

China’s near world-beating currency strength has been supportive of domestic disinflation and that looks to continue despite what we see as TREND and potentially TAIL duration CNY weakness (commodities have higher beta on the downside) – a view that is increasingly being priced into forward-looking FX markets and in the yuan-sensitive Dim Sum bond market (yields breaking out as CNH deposit growth slows).

 

CHINA: LESS BORING; MORE CONFUSING - 3

 

CHINA: LESS BORING; MORE CONFUSING - 4

 

CHINA: LESS BORING; MORE CONFUSING - 5

 

Most importantly, Chinese interest rate markets have dramatically accelerated their pricing in of easier domestic monetary policy over the past week (all spreads relative to the PBOC’s Benchmark 1yr Household Deposit Rate): 

  • 1yr Sovereign L/C Yield: -120bps vs. -70bps 1wk ago
  • 1yr OIS: -70bps vs. -24bps 1wk ago
  • 1yr PBOC Bill Yield: -78bps vs. -28bps 1wk ago 

CHINA: LESS BORING; MORE CONFUSING - 6

 

In short, while we don’t view a material acceleration in Chinese economic growth in 2H as a probable event absent a removal of the property market curbs, we do think further RRR reductions and actual interest rate cuts will start to filter through the economy and provide an eventual boost to Chinese economic growth.

 

THE CONFUSING

Given that Chinese interest rate markets have put on a marked move towards the expectation of further/more aggressive monetary easing of late, it strikes us as odd that the equity values of China’s most capital intensive industries (Financials and Industrials) are not outperforming on a S/T basis. We do expect them to outperform in the aforementioned scenario, so we’ll continue to monitor this for signs of eventual follow-through or further hold-out.

 

CHINA: LESS BORING; MORE CONFUSING - 7

 

Even rumors that the China Securities Regulatory Commission may grant foreign pension funds access to China’s capital markets wasn’t enough to boost Chinese stocks at large this week. It is our view that improving TREND-duration fundamentals will spell outperformance of Chinese equities over that duration. TAIL-duration questions remain; a potential property price collapse and a dramatic deterioration in systemic bank credit quality are two key structural issues we need to see resolved before we’d argue that the Chinese economy is in the clear from a L/T perspective.

 

THE VERDICT

All told, Chinese economic growth is slowing at a faster rate of late while market-based indicators of monetary easing speculation are accelerating, leaving the Chinese economy at a perfectly confusing fundamental juncture. We do, however, continue side with our research process – the net output of which points to a bottoming/inflection point in Chinese growth here in 2Q.

 

Darius Dale

Senior Analyst


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