PONDERING CHINESE GROWTH PART II

CONCLUSION: Contrary to consensus speculation, we are of the view that Chinese policymakers are likely not readying a stimulus package to be announced and administered over the intermediate term that would be substantial enough to meaningfully inflect the slope of Chinese economic growth. As such, it would be prudent to fade any incremental Chinese stimulus rallies for the time being.

 

ACTIVE THEME(S): Growth Slowing’s Slope

In a JAN ’11 note titled “PONDERING CHINESE GROWTH”, we wrote, “To date, we haven’t heard anyone mention the possibility that [the not-yet-released 2011-15 5YR Plan] may come with a more explicit slowdown in the Chinese growth model from the current high-single-digit-to-low-double-digit trajectory to a more modest mid-single-digit pace. While we won’t know until we know, we do know that this scenario is outside of consensus expectations.”

Those thoughts were the then unknowns; the known-knowns of today are as follows: 

  1. Chinese policymakers did, in fact, guide to lower economic growth target(s) in the so-called 12th Five-Year Plan (+7% per annum, down from a consistently-exceeded +7.5% per annum in the five years through 2010); and
  2. A structurally slower rate of Chinese growth is being increasingly priced into consensus expectations. 

To the latter point, global currency market participants have dramatically revised down their expectations for NTM yuan strength in both the onshore (Shanghai) and off-shore (Hong Kong) markets. The discount relative to the spot price embedded in 1YR USD/CNY non-deliverable forwards is -0.7%, which is down from an all-time high premium of +13% (MAR ’08). The discount relative to the spot price embedded in 1YR USD/CNH non-deliverable forwards is -1.3%, which is down from an all-time high premium of +1.9% (MAR ’11). Perhaps a greater callout is the sheer length of time the secular yuan-appreciation story has been more-or-less priced out of the market; at roughly 8MO, you’d have to pull the chart back to 2002 to see a comparable prolonged period(s) of expected yuan dormancy.

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As a result, we interpret the aforementioned FX trends as a sign that international investors hold a generally neutral-to-bearish long-term view on the Chinese economy, particularly from a GROWTH/INFLATION/POLICY perspective (i.e. slow growth = lower interest rates; widespread credit quality headwinds = fiscal expansion). That was certainly not the case in JAN ’11!

As an aside, we place substantially more emphasis on actual flows of capital to gauge investor and corporate sentiment rather than on traditional sell-side polls. Looking to flows of hard capital, Foreign Direct Investment growth in China slowed to -6.9% YoY in JUN, which is the slowest rate since DEC. From a 1H12 perspective, FDI inflows dropped -3% YoY. It’s clear that corporations, too, are revising down their expectations for Chinese economic over the long-term by slowing their rates of capital investment into the Chinese economy. In spite of Chinese policymakers’ recent +167% increase in QFII quotas to $80B (APR ’12), growth in capital inflows, as measured by Chinese bank’s foreign exchange positions, have slowed dramatically since last SEP.

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Needless to say, international investors and corporations simply aren’t buying into the sell-side-generated Chinese growth machine like they used to. While we certainly aren’t arguing for the Chinese economy to pack it in and go away, we do stick with the conclusion of our OCT ’11 note titled “PUTTING CHINA INTO PERSPECTIVE” as it relates our expectations for Chinese economic growth over the next three years:

“…a structural downshift in rates of Chinese economic growth is not at all out of the band of probable outcomes over the long term and this has major implications for a great many corporations and investor portfolios worldwide.”

In light of these expectations, it may very well be that consensus expectations for the Chinese economy over the long-term TAIL are as close to our subdued expectations as they’ve ever been. From an intermediate-term TREND perspective, however, they have farther to travel as it relates to narrowing that delta.

It was as clear as day to anyone at their desk last Friday that U.S. equity investors equated the sharp slowdown in China’s 2Q12 Real GDP growth into Pavlovian expectations of further rate cuts and perhaps a meaningful fiscal stimulus package (CNY4 trillion during 2008-10) fully-equipped with another state-directed lending spree (CNY17.5 trillion during 2009-10).

As we penned in a research note last Friday, titled “CHINESE GROWTH: STICKING TO THE [CENTRAL] PLAN”:

“…we maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth.”

In terms of updating our thoughts here, Chinese Premier Wen Jiabao was back in the media today guiding down expectations for Chinese growth [again], this time stating that China’s labor market will become “more severe” and “more complex”. He’s calling on Party Commissions and municipal governments to fulfill their role in promoting “proactive labor policy” by “maintain[ing] steady and relatively rapid economic growth”.

 

While it has been our official view that Chinese policy makers will surprise consensus expectations to the downside with regards to any announcement(s) of a fiscal stimulus package and/or a state-directed lending initiative, this does, on the margin, sound like the Chinese leadership is willing to turn an increasingly blind eye to local governments to do what they feel needs to be done to protect growth. That does not, however, include loosening restrictions on property investment – a clear directive Chinese policymakers have made repeatedly in recent weeks.

While it’s too early to tell if this is a meaningful inflection point in Chinese fiscal policy – which would provide a far-more substantial boost to economic growth than merely lowering the cost of capital – we are concerned by the fact Chinese equities simply aren’t pricing in any meaningful inflection point in China’s GROWTH/INFLATION/POLICY dynamics (the Shanghai Composite is still in a Bearish Formation). This leaves us to believe that it would be prudent to fade any incremental Chinese stimulus rallies for the time being.

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In contemplating the other side of this view, the Shanghai Composite bottomed just five days prior to the State Council’s economic stimulus announcement in NOV ’08, which does call into question the discounting mechanism of the Chinese equity market to some degree – though we’d argue NOV ’08 was a more panicked and rushed response to a negative growth shock vs. a deliberate and partially policy-induced growth slowdown. Net-net, either Chinese policymakers are being uncharacteristically tight-lipped about their plans to “stabilize” growth or they simply don’t have any a’brewing at the current juncture.

Needless to say, confirmation of the latter would likely deliver a crushing blow to consensus expectations of broad-based fiscal and monetary expansion in China over the intermediate term.

Darius Dale

Senior Analyst