CONCLUSION: We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here.
HEDGEYE ASSET ALLOCATION: 0% exposures to commodities; average daily exposure to commodities since the start of APR ’11 < 3%. Not being invested in an asset class is, in fact, a risk-managed decision.
THEMES AT PLAY: Deflating the Inflation; Bernanke’s Bubbles
If, in 2008, after a -28% drawdown in commodity prices from their YTD peak (as measured by the 19-commodity CRB Index), you increased your gross exposure to this asset class on the heels of China’s first interest rate cut (SEP 16 of that year), you were dead right – for five days. The CRB Index rallied +9.5% to another lower-high in the week post the Chinese interest rate cut and then proceeded to plummet -46.4% from there to its ultimate bottom on MAR 2, 2009.
As we penned in the conclusion of our FEB 21 note titled: “CHINA LOWERS RRRs – NOW WHAT?”: “… we think it’s important to note that the potential for Chinese growth to reaccelerate due to easier monetary policy is structurally impaired absent a removal of curbs within the property sector.”
Alas, GROWTH remains the most important factor in our core three-factor fundamental screening process. While each reflexive factor (GROWTH/INFLATION/POLICY) is indeed vital to the process, we continue to stress that buying on rate cuts alone is akin to buying stocks on valuation – neither are truly catalysts in and of themselves. A positive inflection in GROWTH needs to become a probable outcome in order for market participants to broadly see opportunity.
For China, whose benchmark Shanghai Composite Index closed down -0.7% ahead of the rate cut, that is simply not the case at the present moment given the current Chinese GROWTH model:
Moving along, at the current juncture we would add that given the recent acceleration to the downside in Chinese economic growth statistics/expectations, China may need to implement a fiscal stimulus package as well to cause the slope of its economic growth to inflect in a positive direction. On this front, has been our official view since early OCT ’11 that China is unlikely to pursue such a strategy ahead of the late fall changing of the guard atop the Politburo and perhaps even as far out as the MAR ’13 change in the presidency and premiership.
That’s a long time from now as it relates to the heighted financial market volatility borne out of gaming policy expectations emanating from the ECB to the PBOC to the Fed and back again.
Per Wikipedia: “ If previously implemented retirement policies are followed, no other current members of the [Politburo Standing Committee] will continue to serve in that capacity. About 70% of the members of the Central Military Commission and the executive committee of the State Council will also turnover in 2012, resulting in the most significant leadership transition in decades.”
Given the potentially massive changing of the guard atop China’s economic and political leadership, it is our view that it will take a material economic slowdown for China to announce an economic stimulus package and/or materially peel back the existing curbs on its real estate market over the intermediate term. The latest commentary out of various Chinese policymakers afford us conviction in this view:
- “The country will steadfastly continue curbs on the residential real-estate market and won’t flip-flop on its policies,” per an unnamed Housing Ministry Official via the Shanghai Securities News. This statement echoes a similar pledge out of the State Council (via the official state-run Xinhua News Agency) earlier in MAY.
- “China has no plan to introduce stimulus measures to support growth on the scale unleashed during the depths of the global credit crisis in 2008… The Chinese government’s intention is very clear: It will not roll out another massive stimulus plan to seek high economic growth… Current efforts for stabilizing growth will not repeat the old way of three years ago… Pumping in government money to achieve growth targets is not sustainable and China will instead focus on encouraging private investments in railways, infrastructure, energy, telecommunications, health care and education,” per an article on economic policy via Xinhua.
Briefly looking back, the 2008 stimulus package was CNY4 trillion or 12.7% of GDP at the time – that’s a fairly large hurdle to climb for an economy that is roughly ~50% larger in size (on a nominal basis) from its year-end 2008 level. Moreover, some CNY2.8 trillion of that package ultimately wound up in the form of incremental LGFV debt – an asset class that poses material risks to Chinese banks’ balance sheets over the long-term TAIL.
All told, we don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here. If China is signaling anything to those willing to pay attention – it’s that both Chinese domestic and global growth are slowing at a faster rate in the immediate term. Be on the lookout for confirmation of this conclusion in China’s MAY economic growth data dump this weekend.