CONCLUSION: We see two key risks to Chinese and, by default, global growth from here: 1) incremental tightening in China’s property market and 2) a QE-inspired acceleration in global commodity price inflation. More importantly, we do not anticipate that either risk is being appropriately reflected in consensus expectations – expectations that anchor on the perceived panacea of broad-based central bank easing.
Yesterday in a paper released by economists Janet Koech and Jian Wang, the Dallas Fed overtly accused China of overstating economic growth – particularly industrial production – due to recent figures being divergent from what Chinese electricity consumption patterns would reasonably imply. While there is likely some truth to their view that Chinese economic statistics are being manipulated at the highest level, we highly doubt this is new news to buysiders. In fact, Li Keqiang, China’s Vice Premier, stated publically five years ago that China’s GDP numbers were “man-made”, implying a fair degree of manipulation.
We are of the view that most governments make up the numbers to some extent – including both China and the US (via complex and aggressive seasonal adjustments, as well as the now-infamous Birth/Death Adjustment). To China’s credit, however, their National Bureau of Statistics did consolidate the collection of output, consumption and investment data back in MAR, dramatically reducing the opportunity for municipal and provincial-level manipulation.
Jumping back to the earlier point regarding Chinese energy consumption, our analysis suggests that the rate of Chinese real GDP growth is roughly in line with Chinese energy demand, as indicated in the following chart:
Taking a step back from the “he said/she said” on Chinese growth, there are many broader points to made, or, perhaps, much more pertinent questions to be asking. Arguably the most important of those is whether or not Chinese economic growth is poised to continue slowing from here. This morning’s reported slowdown to 46.6 (from 52.3) on the New Orders component of China’s MNI Flash Business PMI for the month of AUG is supportive of such deliberation.
Recall that back in MAY, we were keen to signal a measured acceleration to the downside in Chinese economic growth, which has since shown up in official statistics. Another leg down from here would obviously portend negatively for the global economy. It’s important to note China alone has accounted for 43.9% of global real GDP growth since 2008, after only accounting for 15.9% in the five years prior.
What could perpetuate another leg down from here? For one, incremental tightening in China’s property market – a critical source of Chinese demand (broadly, fixed capital formation represents 46.2% of Chinese GDP) – is a growing risk. Simply put, building buildings and building things that help build buildings represents a meaningful source of demand within the Chinese economy and incremental tightening here is not baked into consensus expectations. For two, a QE-inspired acceleration in global commodity price inflation would also portend negatively for Chinese (and global) growth.
As an aside, we still maintain that $150 oil completely crushed the global economy back in 2008, setting the stage for the global credit freeze to be much more impactful than it might’ve otherwise been, as global growth was already on life support by the time Lehman went under. In line with Hedgeye DOR Daryl Jones’ remarks in today’s Early Look, the global economy simply wasn’t “flexible enough” to withstand a major bank failure then. If a “shoe” dropped today, would it be flexible enough this time around? While the answer to that question is grounded in uncertainty, we are certain that Europe’s sovereign and banking issues remain far from resolved at the current juncture despite SPX-1400/VIX-15 contributing to a broader sense of calm among US investors.
For more details on the aforementioned inflationary risks – specifically as it pertains to Chinese growth – please refer to our JUL 25 note titled “CAT-CALLING CAT: GROWTH SLOWING’S SLOPE JUST GOT A BIT MORE SLIPPERY”.
Regarding the former risk of incremental tightening, etc. in China, we’ve opened up our notebook to you via the notes below. For reference, we send out a collection of detailed notes on Asia and Latin America each Friday afternoon in the format below to a handful of clients who care on those regions. Please email us if you’d like to be added to that distribution list.
Beyond that, have a wonderful weekend with your respective families,
From AUG 10 through today (in reverse cronological order):
- What Happened: Per the official Xinhua News Agency, “China’s housing ministry and other relevant government agencies are studying further measures to strengthen control on property markets.” This is on the heels of the PBOC’s Hangzhou branch releasing a paper suggesting that regulators should dramatically ease restrictions on multiple home purchases and replace them with a broader property tax that escalates for each additional purchase.
- Why This Matters: We continue to warn that the next increment of policy in China’s property sector could be tightening rather than easing. Nationwide property prices bucked the trend of declines in JUL (post PBOC rate cuts), advancing in 49 of 70 cities – the largest increase in 14 months. SoFun Holdings, a real estate broker, confirm the government data, suggesting prices rose the most in over a year. The last thing the State Council needs ahead of the 4Q12/1Q13 leadership transition is to appear like they are losing control over this key segment of the Chinese economy. Recall that they’ve been officially combating property price speculation for over two years now (since APR ’10).
- What Happened: Chinese heavy excavator sales fell off a cliff in JUL, following a similar plunge in demand from China’s mining industry. Per Bloomberg: “Demand for the biggest and most expensive excavators, which weigh more than 40 tons, had largely withstood the slump because of demand from miners. A slump in coal prices has dented this sector, causing sales to tumble 53 percent in July. Total fixed- asset investment in Chinese coal mining slowed to a 3 percent growth rate from 19 percent in June.”
- Why This Matters: We continue to warn of material long-term risks to the “Weak Dollar/Long Energy, Mining, and Resource Related CapEx” trade, as we see an asymmetric setup in the market value of the US dollar. The slope of US fiscal and monetary policy could inflect materially over the next 6-24 months. In fact, a secular bull market in the USD is arguably the most asymmetric and impactful risk we can identify across global financial markets and the global economy today. For more on our thoughts here, refer to our JUN 8 note titled, “TWO SCHOOLS OF THOUGHT PART II”.
- What Happened: Companies listed on the Hong Kong Stock Exchange are guiding down at a historic pace. Per Bloomberg: “Such warnings have been issued by 331 companies since the start of June, the most for a three-month time frame since Hong Kong Exchanges & Clearing Ltd. started compiling the data in July 2007…. Of a record 138 companies that issued such statements last month, 79 percent derive more than half their revenue from China, while 45 percent are industrial-related or commodity producers…”
- Why This Matters: We are inclined to view this as a leading indicator for broader negative revisions to corporate guidance across developed markets over the intermediate term. Corporate executives across the developed world are constantly getting their heads pumped full of expectations for economic “stimulus” out of the Fed, PBOC and/or ECB by their bankers and the manic media. If and when the stimulus A) doesn’t come or B) comes and is ineffective ($150 oil?), we would expect a material slowdown in global economic activity. Expectations remain the root of all heartache…
- What Happened: Yields on PBOC bills and MOF deposits are rising in recent days/weeks as Chinese banks continue to feel the effects of reduced liquidity. Per Bloomberg: “The yield on one-year central bank paper rose 20 basis points since July to 2.86 percent, headed for the biggest monthly increase since August 2011, Chinabond data show. Chinese lenders paid a 3.52 percent yield when the government auctioned 40 billion yuan ($6.3 billion) of three-month deposits today, compared with 3.5 percent at the last sale on July 24.”
- Why This Matters: We’ve been vocal about our expectations for Chinese fiscal and monetary stimulus to surprise consensus expectations to the downside over the intermediate term for a variety of reasons – including the 4Q12/1Q13 massive leadership transition and the fact that the current growth slowdown was, in fact, intentionally engineered by Chinese policymakers themselves. Taken in context, it makes little sense for them to overreact to having their own economic targets being met.
- What Happened: People’s Bank of China Governor Zhou Xiaochuan said adjustments to interest rates and banks’ reserve requirements are still possible after the central bank stepped up temporary cash injections this month. (Bloomberg)
- Why This Matters: We continue to affirm that as long as the brakes are being officially applied to China’s property sector, it’s unlikely that additional monetary stimulus will be enough to meaningfully boost Chinese economic growth. Investment in fixed capital (i.e. building stuff) is 46-47% of Chinese GDP, so headwinds there continue to translate to broader economic headwinds throughout the Chinese economy, given that so much of China’s broader industrial activity is a function of activity this sector. At multi-year lows, Chinese steel prices continue to signal slowing domestic growth.
- What Happened: China’s new-home prices rose in the largest number of cities in 14 months in July (49 of 70 cities).
- Why This Matters: As we’ve signaled in recent notes, we continue to see heightened risk of the consensus #BailoutBeggar crowd being disappointed with Chinese fiscal and monetary stimulus over the intermediate term. The PBOC remains focused on reverse repos rather than RRR and rate cuts to ease monetary conditions in the Chinese financial system, given the State Council’s keen focus on the potential for Chinese property prices to rebound – making their multi-year efforts to cool speculation and prevent an outright bubble/financial crisis all for naught. This is especially critical in the context of the broad leadership changes pending over the next 2-3 quarters; hardly a reason for them to “jump the shark” with growth tracking +40bps above target in the YTD.
- What Happened: China’s banking regulator told lenders to push developers for faster home sales, citing signs that credit quality is worsening. (Bloomberg)
- Why This Matters: Just as Chinese banks seemingly turn the corner as it relates to their LGFV exposure (6.1 trillion yuan in 1Q12 down from 10.7 trillion yuan at 2010 year-end), it appears property developer debt is poised to become a larger tailwind for broader NPL ratios in China – particularly the debt of smaller developers, who may be less liquid and diversified from an operation standpoint – amid continued tight macroprudential policy in the property sector. We continue to applaud the State Council for their ability to withstand incessant cries for stimulus from the manic Western media. Perhaps they are storing their policy bullets for a more worthy cause down the line, as we outline in our JUL 13 note titled, “CHINESE GROWTH: STICKING TO THE [CENTRAL] PLAN”.
- What Happened: Per Bloomberg: “Puts with an exercise level 10 percent below the Hang Seng China Enterprises Index cost 1.26 times more than calls betting on a 10 percent rally, according to data on one-month options compiled by Bloomberg. The price relationship known as skew touched 1.13 on Aug. 10, its lowest level since April 2011.”
- Why This Matters: The sell-off in Chinese skew confirms what we are seeing domestically with the VIX < 15: investors are truly frightened to miss/be caught short on the announcement of a Chinese stimulus bazooka. 1) We think that is the consensus positioning across the buy-side; and 2) We don’t see a Chinese stimulus bazooka – particularly one that is meaningful enough to inflect the slope of Chinese economic growth – being introduced over the intermediate term, absent global growth really falling off a cliff, like it did in 2H08.
- What Happened: Hamburger Hafen und Logistik AG and Vale SA are taking/talking down their Chinese growth expectations with respect to the TREND and TAIL durations, respectively. Per Bloomberg: “Hamburger Hafen und Logistik AG, which handles two thirds of containers in Hamburg, cut its forecast for 2012 on July 25, saying it now sees container throughput at the same level as last year, compared with an earlier 5 percent growth estimate. Such an increase would have led to volumes exceeding the record 7.3 million standard containers handled in 2008, the year before the global financial slump prompted a 33 percent drop.” Per Vale DIR Castello Branco: “We are not going to see the spectacular growth rates of 10, 12 percent per year. The golden years are gone.”
- Why This Matters: While we continue to assign rather minimal weight to corporate guidance in our Global Macro process (companies tend to be equally as wrong as their bankers are at the turns), we do find it interesting that companies with sales exposure to China at 33% and 44%, respectively, would talk so frankly about the prospects for Chinese economic growth. More importantly, their subdued commentary is completely in-line with our TREND and TAIL expectations for the Chinese economy. Ping us for our collection of relevant notes on the subject.
- What Happened: Chinese financial institutions sold a net 3.8 billion yuan ($600M) of foreign currency in JUL, which suggests renewed capital outflows after two months of sequential inflows (though down from an outflow 60.6B yuan in APR).
- Why This Matters: We continue to anticipate both real money and investor capital leaving China over the intermediate and long terms, as speculators increasingly come to grips with a subdued Chinese economic growth outlook being driven lower by delays and disappointments on the stimulus front. Shakespeare was right: expectations are the root of all heartache; we blame the manic media for perpetuating such aggressive expectations for easing. Further, we continue to wonder how many investors and corporations are going to get caught offsides when they wake up and realize that Chinese economic growth is likely to be in the 7-8% range going forward, which is a major delta from 8-10%... For more on our thoughts here, see the following two notes: FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKETS (APR 16) and PONDERING CHINESE GROWTH PART II (JUL 17).
- What Happened: An index of property developers in China dropped -2.3% after the Financial News – a newspaper controlled by the central bank – said authorities want to keep funding for property tight.
- Why This Matters: The global equity bull thesis (i.e. bailouts, monetary easing, piling debt upon debt…) continues to meet Chinese headwinds. The PBOC confirmed that it was “cautious” about cutting the reserve requirement for lenders because it wants to keep the “spigot of funds” for real estate tight (Bloomberg). Chinese officials continue to remain hyper-focused on preventing a rebound in property prices; their 16-region inspection just came back in-line with their hopes that local governments aren’t relaxing policies out of accordance with broader curbs.
- What Happened: Chinese export growth slowed sharply in JUL to +1% YoY from +11.3% in JUN. Exports to the US (+0.6% YoY) and EU (-16.2% YoY) slowed to the lowest rates since NOV ’09 and SEP ’09, respectively.
- Why This Matters: We continue to harp on consensus being too bullish on global growth heading into 2H12 and China’s JUL Export numbers portend poorly for 3Q consumer demand in the world’s two largest economies/economic blocs (US and EU).
- What Happened: China Overseas Land & Investment Ltd., the country’s biggest developer by market value listed in Hong Kong, said first-half profit climbed 18 percent as it sold more properties (Bloomberg).
- Why This Matters: As we penned in our note yesterday (“CHINA’S ECONOMY: NEW DATA; SAME THESIS”), we think there is growing risk that Chinese policymakers tighten property market curbs incrementally in the immediate term. Per Bloomberg: “China may expand a property tax trial to additional cities this year, Shanghai Securities News reports today, citing an unidentified person close the housing ministry.” Chinese policymakers appear keen on promoting sustainable economic expansion, and, as a result, we should continue to expect more S/T pain for L/T gain. On the latter point, we did receive a positive L/T data point: LGFV debt outstanding has dropped -43% since year-end 2010 to a much more manageable 6.1 trillion yuan, signaling to us decreased risk in the banking system as relates to the default risk on these assets (LGFV loans are often backed by land values; land sale revenues). For more details here, please revisit our OCT ’11 note tilted, “ATTEMPTING TO QUANTIFY THE HEADWINDS FACING CHINA’S FINANCIAL SYSTEM”.