TWO CHINAS?

Takeaway: Financial system headwinds continue to outweigh consumption tailwinds within the Chinese economy.

SUMMARY BULLETS:

 

  • All told, financial system headwinds continue to outweigh consumption tailwinds within the Chinese economy. This morning produced tons of dovish inflation readings out of Asia for the month of APR, which is very consistent with the formerly counter-consensus call we have been making since the start of the year (i.e. global disinflation). This morning’s incremental confirmation was headlined by China’s Input Prices PMI, which ticked down to the lowest level since DEC ’08. It’s too bad that financial system risks and regulation are what they’ve become in China – a headwind to economic growth, at the margins. We’re seeing that manifest to a small degree in the headline Manufacturing PMI and to a much larger degree in very crucial subcomponents of the Manufacturing PMI release: New Orders, Backlogs of Orders, and Purchasing of Inputs all ticked down MoM.
  • Over the immediate-to-intermediate term, the recent regulatory crackdowns on the credit instruments most responsible for perpetuating China’s buoyant property market and unsustainable fixed assets investment will weigh on Chinese growth. Over the long term, however, these macroprudential measures are quite necessary if the Chinese Communist Party is to accomplish its goals for economic rebalancing – a task so critical that the failure of which would undermine social stability and, with it, the Party’s claim to power.
  • Given the offsetting consumption tailwinds highlighted above, it’s tough for us to pound the table on shorting China here. That being said, we remain very negative on industrial commodities and the currencies and equity markets of the Latin American and African commodity producers. For more details, please refer to our recent EM Crises Black Book where we outlined this view in great detail.

 

This morning produced tons of dovish inflation readings out of Asia for the month of APR, which is very consistent with the formerly counter-consensus call we have been making since the start of the year (i.e. global disinflation). This morning’s incremental confirmation was headlined by China’s Input Prices PMI, which ticked down to the lowest level since DEC ’08. Needless to say, our thesis on the Chinese consumer economy continues to play out in spades.

 

TWO CHINAS? - 1

 

It’s too bad that financial system risks and regulation are what they’ve become in China – a headwind to economic growth, at the margins. We’re seeing that manifest to a small degree in the headline Manufacturing PMI and to a much larger degree in very crucial subcomponents of the Manufacturing PMI release: New Orders, Backlogs of Orders, and Purchasing of Inputs all ticked down MoM.

 

TWO CHINAS? - 2

 

TWO CHINAS? - 3

 

The -2.3ppt MoM decline in New Export Orders to 48.6 is a stark reminder that sluggish global growth remains a headwind to incremental liquidity flow into the Chinese banking system from abroad. That, coupled with an not-yet-quantifiable amount of NPLs associated with the 2009-10 stimulus package and a high volume of existing long-term loans, will weigh on monetary expansion in China for the foreseeable future.

 

TWO CHINAS? - 4

 

TWO CHINAS? - 5

 

That’s a direct negative for those sectors that rely most on said monetary expansion to drive performance – banks, property developers and raw materials producers (69.1% of the SHCOMP if you include the Financials at 44.2%, Energy at 16.7% and Materials at 8.2%). Moreover, there are some notable industries within these sectors that are rife with excess capacity (particular producers of raw materials that feed into fixed assets investment), especially in the context of a Chinese economic rebalancing.

 

TWO CHINAS? - 6

 

TWO CHINAS? - 7

 

The latest data point we came across with respect to the topic of industrial overcapacity in China came from the China Iron and Steel Association (CISA), which recently reported: A) slowing industry-wide profit trends (CNY 1.34 billion in JAN, CNY 998 million in FEB, and CNY 267 million in MAR); B) an accelerating number of loss-making enterprises (34.9% of the total in 1Q13, which trended higher throughout the quarter to 45.3% of the total in MAR); and C) record levels of output amid slowing economic growth (average daily crude steel output for 1Q13 reached a record 2.13 million metric tons). These figures rhyme with the latest Industrial Profits data, which slowed from a run rate of +17.2% YoY in JAN-FEB to +5.3% YoY in MAR.

 

All told, financial system headwinds continue to outweigh consumption tailwinds within the Chinese economy. Over the immediate-to-intermediate term, the recent regulatory crackdowns on the credit instruments most responsible for perpetuating China’s buoyant property market and unsustainable fixed assets investment will weigh on Chinese growth. Over the long term, however, these macroprudential measures are quite necessary if the Chinese Communist Party is to accomplish its goals for economic rebalancing – a task so critical that the failure of which would undermine social stability and, with it, the Party’s claim to power.

 

Given the offsetting consumption tailwinds highlighted above, it’s tough for us to pound the table on shorting China here. That being said, we remain very negative on industrial commodities and the currencies and equity markets of the Latin American and African commodity producers. For more details, please refer to our recent EM Crises Black Book where we outlined this view in great detail.

 

Darius Dale

Senior Analyst


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