CONCLUSION: Inclusive of China’s July GROWTH and INFLATION DATA, we reiterate our intermediate-term view of the Chinese economy, which remains: A) we do not expect a meaningful inflection point in Chinese economic growth and B) we do not anticipate a meaningful acceleration in fiscal stimulus, state-directed lending or deregulation in the property market. If anything, we could potentially see increased tightening in the latter if speculative activity is detected in the July/August property price data and/or the State Council’s regional surveys. Lastly, we reiterate our bearish long-term thesis on the Chinese yuan and Dim Sum bond market – a position supported by the latest data points.
Overnight China reported incrementally-dovish July GROWTH and INFLATION data – which, of course, paved the way for aggressive media coverage demanding that the PBOC cut interest rates or RRRs. Those speculative demands were no doubt emboldened by the Chinese stocks’ intraday rally from trading flat-to-down to close up +61bps on the day. The close of 2,174.1 on the Shanghai Composite Index puts it at 5 ten-thousandths of a percent higher than our immediate-term TRADE of resistance.
While we don’t expect to see a sustained follow-through, we are waiting and watching for confirmation; our fundamental case on China (as laid out above) will not change absent a meaningful shift in the data or a quantitative breakout above our TREND line as indicated in the chart below:
Below, we neatly parse the July data into the following three buckets for you:
- JUL Industrial Production: +9.2% YoY from +9.5%
- JUL Retail Sales: +13.1% YoY from +13.7%
- JUL YTD Urban Fixed Assets Investment: flat at +20.4% YoY
- YTD FAI – Real Estate Development: +15.4% YoY from +16.6%
- YTD FAI – Construction: +19.6% YoY from +20.6%
- JUL YTD Source of Funds for Fixed Assets Investment – Foreign Direct Investment: flat at -11.1% YoY
- Key Takeaways: Chinese economic growth continues to slow across sectors and the continued weakness in retail sales indicates that the government isn’t “rebalancing” the Chinese economy (w/ respect to their current 5yr plan) as quickly as some might have hoped. Beyond that, we flag the -11.1% YoY rate of decline in foreign CapEx as a sign that international corporations remain particularly sour on the Chinese growth story and we continue to see longer-term negative implications here for China’s currency and cross-border capital flows. The recent occurrence of China’s sovereign Dim Sum bond yields normalizing with mainland rates is in support of our thesis, which we outline at the conclusion of this note.
Spot prices for Rebar and Hot Rolled Sheet steel continue in free-fall, as economic growth expectations remain muted in what is arguably China’s most important domestic commodity market from a economic growth perspective (Fixed Capital Formation = 46.2% of GDP).
- JUL CPI: +1.8% YoY from +2.2%; slowest rate since JAN ‘10
- While falling pig prices shaved -71bps off of the YoY headline figure, the food category overall contributed +78bps to the headline figure on a net basis.
- JUL PPI: -2.9% YoY from -2.1%;s lowest rate since OCT ‘09
- Key Takeaways: Despite rates of headline inflation falling to new multi-year lows, Chinese interest rate markets continue to price in incrementally less easing out of the PBOC, as indicated in the chart below. We interpret this as a sign that those closest to the source are taking the PBOC’s recent hawkish warning on 2H inflation at face value.
- JUL YTD Source of Funds for Fixed Assets Investment – State Budget: +30.5% YoY from +26.7%
- JUL YTD Source of Funds for Fixed Assets Investment – Domestic Loans: +6.7% YoY from 5.8%
- Key Takeaways: Consistent with the recent pledged increases in railroad investment and low-income housing development, the State Council continues to “fine tune” its economic policy with respect to “stabilizing growth” by increasing sovereign expenditures on investment. It’s important to note, however, that stabilizing ≠ stimulating. As it relates to a state-directed lending spree, growth in domestic loans earmarked for Fixed Assets Investment accelerated to +6.7% on a YTD, which remains far, far below the +20-40% YoY clips recorded during the 2009-10 lending spree. Mid-single digit growth rates is hardly stimulatory in comparison and is consistent with Chinese policymakers’ decreased willingness to stimulate. In fact, recent statements suggest that they appear keen to avoid the recent mistakes of overinvestment and capital misallocation – both of which contributed to the current property bubble – during this growth slowdown.
SEPARATING FACT FROM FICTION
If you haven’t yet had the chance, we encourage you to check out our recent work on China – particularly our thoughts on the outlook for Chinese policy over the intermediate term. Importantly, we are increasingly of the view that aggressive expectations for Chinese stimulus and the associated rebound in Chinese economic growth are being priced into “risk assets” broadly and that Chinese policymakers are likely to disappoint those expectations. For more details please review the following notes:
- FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKETS (APR 16): Given the asymmetry of both the pricing setup and fundamental outlook, secular yuan weakness and a bearish re-pricing of the Dim Sum bond market are two long-term TAIL risks we are flagging to you at the current juncture.
- CHINA’S INCREMENTAL GROWTH SLOWDOWN CONFIRMED (MAY 23): While Deflating the Inflation remains a bullish catalyst for the Chinese economy, the lag between this event and the turn in both the reported growth data and growth expectations may have just increased. As such, we are of the view that waiting and watching for clarity is the best strategy in the immediate term for China.
- As an aside, China’s Shanghai Composite Index remains in a Bearish Formation and is down -8% since we put out this initial bearish piece on the Chinese economy in this latest cycle. That is far and away the largest decline throughout the region over that duration and is vastly underperforming the regional median gain of +6.7% (same duration).
- CHINA’S RATE CUT IS LIKELY A BAD SIGN OF WHAT LIES AHEAD (JUN 7): 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.
- CHINESE GROWTH: STICKING TO THE CENTRAL PLAN (JUL 13): 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. Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
- PONDERING CHINESE GROWTH PART II (JUL 17): 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.
Best of luck out there,