• It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

Takeaway: Chinese policymakers remain inclined to resist consensus demands for any meaningful monetary and/or fiscal easing.

SUMMARY BULLETS:

  • We maintain conviction in our view that Chinese policymakers have no intention to meaningfully stimulate economic activity over the intermediate term – absent a “decrease [in economic growth] to the ‘lower limits’ set earlier” (according to Premier Li’s most recent commentary). The Party’s own economic rebalancing agenda, its preference for economic and social stability, accelerating property price inflation and a recent upside inflection in CPI all remain a headwind to monetary or fiscal easing.
  • Given that Chinese officials remain content to pursue slower, more sustainable rates of economic growth for the foreseeable future, we can’t help but anticipate a continuation of recent negative trends for Chinese equities, which continued to be pressured from a top-down (#EmergingOutflows) and bottom-up (structural banking sector headwinds) perspective.
  • With that in mind, don’t mistake the manic media’s interpretation and attempted explanation of today’s dead-cat bounces across Chinese equities and industrial metals as anything more than that. In fact, the Shanghai Composite Index can rally another +9% from here to its TREND line of resistance and our interpretation of the fundamental outlook for Chinese equities won’t have changed a bit.
  • In the immediate term, macro markets mean revert and we recommend having a tried and tested quantitative risk management process to properly interpret the price action. Over the intermediate-to-long term, however, macro markets tend to trend in the absence of a fundamental inflection(s) in economic gravity. With respect to Chinese stocks – specifically bank and property developer shares – we think that trend remains south.

To borrow and manipulate a quote from the late Rick James, “[monetary easing] is one helluva drug”. Indeed, it’s interesting to see yet another salty batch of Chinese growth data inflate consensus expectations of monetary and/or fiscal easing out of Chinese policymakers. Such has been the case for much of the past 18 months, despite Chinese equities and Chinese economic growth making-lower highs in the process.

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - 7

 

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - 8

Needless to say, we remain inclined to take the other side of such speculation.

Specifically, we maintain conviction in our view that Chinese policymakers have no intention to meaningfully stimulate economic activity over the intermediate term – absent a “decrease [in economic growth] to the ‘lower limits’ set earlier” (according to Premier Li’s most recent commentary). The Party’s own economic rebalancing agenda, its preference for economic and social stability, accelerating property price inflation and a recent upside inflection in CPI all remain a headwind to monetary or fiscal easing.

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - China Real Estate Climate

 

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - 2

Explicitly in the 12th Five-year Plan and implicitly through their [in]action during the recent credit crunch Chinese officials remain content to pursue slower, more sustainable rates of economic growth for the foreseeable future. Heck, the Ministry of Finance actually just issued a country-wide directive for central government agencies to cut spending by an incremental 5% for 2013.

It should be noted that the Politburo, the PBoC and the State Council all came out at varying instances last week and talked down market expectations for GDP growth, credit expansion and/or monetary/fiscal easing going forward. Why some market participants appear content to ignore the data is beyond us:

  • President Xi Jinping said officials shouldn't be judged solely on their record in boosting GDP. He added, “the Communist Party should instead place more importance on achievements in improving people's livelihood, social development and environmental quality when evaluating the performance of officials”.
  • Premier Li Keqiang said the conditions for the Chinese economy to achieve its growth targets are [already] in place. Specifically, he noted that “conditions exist for China to realize its economic targets for this year and for sustainable, healthy development”.
  • PBoC Governor Zhou Xiaochuan affirmed our belief that the recent cash crunch was primarily caused by excessively rapid YTD credit expansion at some banks and was a timely reminder that many Chinese financial institutions need to adjust their businesses models. Specifically, he stated, “the PBoC refused to inject liquidity because it wanted the banks to adjust their practices, and the message has been correctly understood by the market”.
  • The State Council on Friday reiterated that it will maintain a prudent monetary policy to support economic restructuring. While it pushed back against requests from commercial lenders to loosen policy, it did note that credit growth will be kept at a reasonable level.

Just because we were largely on holiday last week doesn’t mean the Chinese economy took a vaca as well…

To play devil’s advocate and indulge the Pavlovian consensus hysteria, even if Chinese policymakers wanted to put the easing pedal to the metal, the law of large numbers rests as a meaningful roadblock for a material inflection in Chinese GDP growth (from our JUN ’12 note titled: “CHINA’S RATE CUT IS LIKELY A BAD SIGN OF WHAT LIES AHEAD”):

“… the 2008 stimulus package was CNY4 trillion or 12.7% of GDP at the time – that’s a fairly large hurdle to climb for an economy that is roughly ~50% larger in size (on a nominal basis) from its year-end 2008 level.”

In case “Pavlov” (i.e. consensus) is actually right for once and the PBoC does cut rates in the intermediate term – a highly improbable scenario based on Chinese OIS spreads – please note the title of the aforementioned research note and the fact that Chinese economic growth and Chinese equities continued trending down from the time of its publication until their respective inflections in late 2012.

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - 3

With Manufacturing PMI hitting a 4M low and Services PMI hitting a 9M low in JUN, a lack of meaningful easing measures (i.e. PBoC reverse repos won’t cut it) does not bode well for China’s TREND duration growth outlook.

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - 4

Given that Chinese officials remain content to pursue slower, more sustainable rates of economic growth for the foreseeable future, we can’t help but anticipate a continuation of recent negative trends for Chinese equities, which continued to be pressured from a top-down (#EmergingOutflows) and bottom-up (structural banking sector headwinds) perspective.

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - China SHCOMP

 

CHINA WON’T STIMULATE UNLESS GROWTH FALLS OFF A CLIFF… IS THAT WHAT CONSENSUS WANTS? - HSI

With that in mind, don’t mistake the manic media’s interpretation and attempted explanation of today’s dead-cat bounces across Chinese equities and industrial metals as anything more than that. In fact, the Shanghai Composite Index can rally another +9% from here to its TREND line of resistance and our interpretation of the fundamental outlook for Chinese equities won’t have changed a bit.

In the immediate term, macro markets mean revert and we recommend having a tried and tested quantitative risk management process to properly interpret the price action. Over the intermediate-to-long term, however, macro markets tend to trend in the absence of a fundamental inflection(s) in economic gravity. With respect to Chinese stocks – specifically bank and property developer shares – we think that trend remains south.

Darius Dale

Senior Analyst