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Takeaway: The Chinese economy continues to improve, albeit slowly. No change to our fundamental outlook.

SUMMARY BULLETS:

  • Inclusive of the November GROWTH and INFLATION data, we stand pat on our intermediate-term G/I/P outlook for the Chinese economy – an outlook that calls for directionally positive, but relatively muted GROWTH figures; higher-highs in reported INFLATION readings; and limited POLICY based economic reflation. We realize that’s not as sexy as some of the more aggressive “China has bottomed” claims being bandied about the Street, but our call has been and continues to closest to reality.
  • Since our 11/1 note titled: “TAKE THEIR WORD FOR IT – CHINA HAS BOTTOMED”, we continue to affirm that the Chinese economy is in the latter stages of a bottoming process and the data continues to bear this out. That said, however, China’s likely bottom doesn’t mean investors should run out and buy production-related commodities and their producers; China’s strategic economic rebalancing means the slope of Chinese demand growth for raw materials is likely to be flat-to-negative for a really long time.
  • If you are looking for a less consensus way to play the China recovery theme, we are positive on the Chinese consumer and consumption-oriented sectors and subsectors throughout the Chinese stock market, as well as international consumer companies that are taking market share in China – especially with the CNY hitting a ~20-year high vs. the USD in recent weeks. Refer to our 11/8 note titled: “HU SPEAKS; IS ANYONE LISTENING?: NOTES FROM CHINA’S 18TH PARTY CONGRESS” for more details.
  • We are also have been positive on Hong Kong’s Hang Seng Index since 11/16 for its own merits, but also see incremental upside potential stemming from institutional capital flows as sentiment regarding the mainland economy continues to improve. As a point of reference, the Heng Seng Index has appreciated +5.3% from that date.

Over the weekend, China reported a plethora of NOV economic statistics.  On balance, China’s GROWTH data was flat-to-up sequentially in NOV; Retail Sales and Industrial Production accelerated, while FAI came in flat and the Trade Data slowed. The country’s NOV CPI and PPI readings came in faster sequentially, underscoring previous calls by Chinese policymakers for a hawkish trend in INFLATION readings on the mainland over the intermediate term and throughout 2013. We summarize the data below:

  • NOV CPI: +2% YoY from +1.7%
    • Food: 3% YoY from 1.8%
    • Non-Food: +1.6% YoY from +1.7%
  • NOV PPI: -2.2% YoY from -2.8%
    • Manufacturing: -2.9%
  • NOV Industrial Production: +10.1% YoY from +9.6%
    • Cement Production: +6.9% YoY from +10.2%
    • Electricity Output: +7.9% YoY (strongest since DEC-2011) from +6.4%
  • NOV Retail Sales: +14.9% YoY from +14.5%
  • YTD through NOV Fixed Assets Investment: flat at +20.7% YoY
    • Real Estate Development: +16.7% YoY from +15.4%
    • Local Projects: +21.7% YoY from +21.8%
  • NOV Exports: +2.9% YoY from +11.6%
  • NOV Imports: flat YoY from +2.4%
  • NOV Trade Balance: $19.6B from $32.1B

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Since our 11/1 note titled: “TAKE THEIR WORD FOR IT – CHINA HAS BOTTOMED”, we continue to affirm that the Chinese economy is in the latter stages of a bottoming process and the data continues to bear this out. That said, however, China’s likely bottom doesn’t mean investors should run out and buy production-related commodities and their producers; China’s strategic economic rebalancing means the slope of Chinese demand growth for raw materials is likely to be flat-to-negative for a really long time.

Additionally, we find it flat-out silly that US-centric investors are using China as a reason to be incrementally bullish on US stocks now – especially given that they were bullish on domestic equities the entire time China was slowing. We’re not sure why the Chinese economy suddenly matters to perma-bulls now, but it is indeed a sentiment nugget worth flagging:

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If you are looking for a less consensus way to play the China recovery theme, we are positive on the Chinese consumer and consumption-oriented sectors and subsectors throughout the Chinese stock market, as well as international consumer companies that are taking market share in China – especially with the CNY hitting a ~20-year high vs. the USD in recent weeks. Refer to our 11/8 note titled: “HU SPEAKS; IS ANYONE LISTENING?: NOTES FROM CHINA’S 18TH PARTY CONGRESS” for more details.

We are also have been positive on Hong Kong’s Hang Seng Index since 11/16 for its own merits, but also see incremental upside potential stemming from institutional capital flows as sentiment regarding the mainland economy continues to improve. As a point of reference, the Heng Seng Index has appreciated +5.3% from that date.

Jumping back to China specifically, the Shanghai Composite recently recaptured its TRADE line (now support), which is the first time our quantitative signals have confirmed our updated fundamental view on the Chinese economy. We would be incrementally more positive on the situation there if the Shanghai Composite were to recapture its TREND line (just +30bps above today’s closing price). To some extent, however, the recently revised IPO rules (shelving new issues through at least Chinese New Year) might have had an immediate-term positive effect on the Chinese equity market.

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Again, we are keen to temper our comments with respect to the intermediate term outlook for Chinese GROWTH. As recently as a couple months ago, we were in the overwhelming minority in calling for a lack of POLICY based economic reflation over the intermediate term. To some extent, our initially contrarian call has become reasonably consensus – after all, both Xi Jinping and Li Keqiang (China’s future President and Premier, respectively) have been out confirming that more-or-less in recent weeks. Another example of this is Chinese interest rate markets having completely priced out the possibility monetary easing over the NTM, replacing that with some expectations of tightening (OIS).

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Other PRICE trends in Chinese financial markets that support our directionally positive, but relatively muted intermediate-term outlook for Chinese GROWTH are:

  1. Compression in the sovereign yield curve (10Y-2Y spread), largely driven by a demonstrable back up on the short end; the less aggressive back up on the long end is positive, however.
  2. Expectations for NTM weakness in the CNY and CNH vs. the USD, per the NDF market; the widening CNH premium to the CNY is a positive sign from a sentiment perspective, however.
  3. Chinese rebar prices continue to make lower-highs from an intermediate-to-long-term perspective; the mostly normal sloping curve is a recent positive phenomenon, however, after  having been inverted for quite some time.

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All told, inclusive of the November GROWTH and INFLATION data, we stand pat on our intermediate-term G/I/P outlook for the Chinese economy – an outlook that calls for directionally positive, but relatively muted GROWTH figures; higher-highs in reported INFLATION readings; and limited POLICY based economic reflation. We realize that’s not as sexy as some of the more aggressive “China has bottomed” claims being bandied about the Street, but our call has been and continues to closest to reality.

Darius Dale

Senior Analyst