CHINA IS IN NO MAN’S LAND

Takeaway: China’s fundamental outlook has become increasingly convoluted in recent weeks, posing material risk to its financial markets.

This note was originally published March 13, 2013 at 11:30 in Macro

SUMMARY CONCLUSIONS:

 

  • The benchmark Shanghai Composite  index is -2.6% below its immediate-term TRADE line of resistance and +2.7% above its intermediate-term TREND line of support – making it truly stuck in between the proverbial “rock and a hard place”. With such a now-convoluted fundamental outlook, we will stick to our tried and true risk management process by deferring to our quantitative signals on what to do with our Chinese equity exposure from here:
  • BUY [more] on a breakout above TRADE resistance (2,324): A probable sequential pickup in MAR growth data and a probable sequential slowing in MAR inflation data supports this action. Moreover, continued USD strength (and, by association, CNY strength) should weigh on int’l raw materials prices and allow the pace of economic activity to creep higher in China, as China’s heavy industry needs energy and raw material deflation to produce more with less credit expansion and the Chinese consumer needs food deflation to consume more discretionary goods and services.
  • SELL/SHORT on a breakdown through TREND support (2,205): As we’ve seen since 2009, the pace of activity in the Chinese property market has become the #1 factor in determining growth rate of Chinese economy – via credit expansion – and the returns of Chinese financial markets. That quantitative signal would be a clear-cut sign that there is likely more policy-perpetuated pain to come in the months ahead – especially to the extent those linkages have not broken down as much as the CCP would’ve liked.

 

Is the Chinese Communist Party and, by extension, the PBOC too concerned about inflation – both in housing and consumer prices? That’s fast become the most critical question as it relates to navigating fundamental risk in the Chinese economy.

 

Per PBOC Governor Zhou Xiaochuan’s latest testimony at the National People’s Congress:

 

“China should be on high alert over inflation… Monetary policy is no longer relaxed and is relatively neutral as demonstrated by a 13 percent target for money-supply growth that’s tighter than expansion in the last two years… Monetary policies to cool home prices will continue or even strengthen in the future.”

 

As an extension of the CCP, Zhou’s overt hawkishness underscores a broader political agenda to quash inflationary pressures on the mainland on all fronts.

 

Interestingly, the predominance of their prudence has been our base-case scenario for many months. As early as OCT ‘11 and all throughout 2012, we have been overtly flagging a sustainable lack of resolve to reflate the Chinese economy amongst Chinese officials.

 

Moreover, as most recently outlined on our 2/27 Best Ideas presentation, consensus finally coming to grips with a structurally subdued Chinese growth outlook was one of the key reasons we have liked Chinese equities on the long side since 12/10.

 

With the Shanghai Composite Index up +8.6% since then (besting the +7.9% advance for the MSCI All-Country Asia Pacific Index), that’s been a somewhat contrarian idea that has worked in our favor.

 

More recently, however, with the SHCOMP Index down -7% from its cycle-peak on 2/6 and the Shanghai Stock Exchange Property Index down nearly -15% from its cycle-peak on 2/5, it’s very clear to us that the latest round of property market tightening – which indeed caught us off guard from a magnitude perspective – is weighting on both price and sentiment in the Chinese equity market.

 

With a Global Macro Risk Manager’s process only as good as his/her last trades (hence our never-ending focus on evolution and embracing uncertainty), the most recent performance begs the question: where to from here?

 

The benchmark Shanghai Composite index is -2.6% below its immediate-term TRADE line of resistance and +2.7% above its intermediate-term TREND line of support – making it truly stuck in between the proverbial “rock and a hard place”.

 

CHINA IS IN NO MAN’S LAND - 1

 

With such a now-convoluted fundamental outlook, we will stick to our tried and true risk management process by deferring to our quantitative signals on what to do with our Chinese equity exposure from here:

 

  • BUY [more] on a breakout above TRADE resistance (2,324): A probable sequential pickup in MAR growth data and a probable sequential slowing in MAR inflation data supports this action. Moreover, continued USD strength (and, by association, CNY strength) should weigh on int’l raw materials prices and allow the pace of economic activity to creep higher in China, as China’s heavy industry needs energy and raw material deflation to produce more with less credit expansion and the Chinese consumer needs food deflation to consume more discretionary goods and services.
  • SELL/SHORT on a breakdown through TREND support (2,205): As we’ve seen since 2009, the pace of activity in the Chinese property market has become the #1 factor in determining growth rate of Chinese economy – via credit expansion – and the returns of Chinese financial markets. That quantitative signal would be a clear-cut sign that there is likely more policy-perpetuated pain to come in the months ahead – especially to the extent those linkages have not broken down as much as the CCP would’ve liked.

 

All told, we are watching China like hawks here and it should be noted that we are in the process of reconsidering our bullish bias on Chinese equities.

 

Needless to say, stay tuned.

  

CHINA IS IN NO MAN’S LAND - 2

 

CHINA IS IN NO MAN’S LAND - 3

 

CHINA IS IN NO MAN’S LAND - 4


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