#ASIANCONTAGION PREVIEW

Takeaway: China’s secular slowdown will weigh on global growth and serve as an outsized drag on the regional economy.

SUMMARY BULLETS:

 

  • All told, we continue to think the Chinese banking sector will represent a material, long-term drag on Chinese economic growth as funding for incremental fixed assets investment dries up at the margins. Additionally, the Politburo’s economic rebalancing agenda and a pending acceleration in anti-pollution regulation will also eat away at Chinese growth at the margins.
  • As such, the confluence of these headwinds will remain a sustainable drag on the growth rates of the regional and global economies, though we do think the US is best-positioned to cope with this headwind.  
  •  In this scenario, the USD remains a ball-under-water trade from a TAIL perspective. Will Germany favor an increasingly weak EUR as China downshifts its growth rates (which, BTW, is the best case scenario; key tail risks remain)? Are investors bearish enough on Gold? Are speculators positioned for a secular decline in the energy markets? Are FX market participants bearish enough on the JPY?

On Monday, July 15 at 11am EDT, we will be hosting our highly-anticipated Quarterly Macro Themes conference call. To the extent you can join us, the dial-in details are below. If you can’t make the scheduled time, we’ll be sure to circulate the replay information after the call.

 

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 317583#
  • Materials: CLICK HERE (Slides will download one hour prior to the start of the call)

 

Today, we thought we’d kick things off with a sneak peek at one of our Q3 themes: #AsianContagion. To summarize the theme into a few digestible nuggets, we think:

 

  1. China’s secular slowdown will have an outsized negative impact on regional economic growth;
  2. RisingRates and #StrongDollar should continue to perpetuate #EmergingOutflows across the developing Asia region; and
  3. A likely resurgence of positive sentiment surrounding the Abenomics agenda and continued yen weakness should help Japanese equities continue to outperform the region.

 

Specifically regarding point #1:

 

At the US-China Strategic and Economic Dialogue yesterday and Washington D.C., China’s Finance Minster Lou Jiwei said that Chinese GDP growth might come in slightly below-target this year and that growth as low as +6.5% YoY may be tolerable in the future. If there is a caveat to his dour remarks, he did express confidence in achieving the existing +7% growth target (most recently affirmed by Premier Li in MAY), which is down from the official +7.5% as laid out in the 12th Five-Year Plan.

 

Lou continued: “I want to emphasize that the structural economic adjustment is a painful process. It won’t be possible to enjoy a comfortable life and a rapid growth rate with the structural adjustment. The slowdown is necessary to achieve a structural transition.”

 

With China’s Q1 real GDP growth coming in at +7.7% YoY, it doesn’t take a rocket scientist to figure out that Chinese growth is going to slow from here if +7% is in play on a full-year basis. Recent trends across China’s monthly economic indicators, including today’s JUN credit data (growth in total social financing slowed to a 14M low; M2 growth slowed to a 6M low) suggests a flat-to-slightly-down 2Q GDP print when it is released Sunday night; perhaps the “pain” will be back-end loaded as credit expansion continues to dry up.

 

Regarding China’s 2Q13 GDP specifically, consensus is at +7.5% YoY, which has trended down from an estimate of +8.2% at the start of the 2nd quarter. Another sharp immediate-term relief rally in Chinese equities from bombed-out lows could occur Monday if the numbers are doctored up to come in ahead of bombed-out consensus expectations.

 

Looking out further, however, this latest bit of economic guidance out of the Chinese officialdom all but confirms our TAIL duration expectations for the Chinese economy – the same expectations we’ve held for the past 12-18 months. The fact that the sell-side and western financial media outlets are overly focused on the hazy nature of the 2013 GDP growth target (is it +7% or +7.5%?) reminds us that consensus doesn’t quite comprehend the secular nature of China’s downshifting economy.

 

Either that or consensus is paid to simply ignore the elephant in the room; we know for a fact that companies like CAT and FCX sure are!

 

Like Lou Jiwei, we also want to emphasize that structural economic adjustment will be a painful process – and not just for China:

 

  • At this  point, it’s trivial to say that the Chinese economy matters to Asia, but it’s worth noting China 37.7% share of regional GDP has more than doubled over the past 10 years;
  • Exports to China account for nearly 6% of regional GDP, a ratio that has also more than doubled over the past 10 years;
  • As a contribution to global GDP growth (trailing 10 years), China 19.3% share has nearly doubled over the past 10 years; and
  • Excluding the US, exports to China account for roughly 2.5% of global GDP, a ratio that has also more than doubled over the past 10 years… the US’s ratio is much smaller at 0.7%.

 

#ASIANCONTAGION PREVIEW - 1

 

#ASIANCONTAGION PREVIEW - 2

 

#ASIANCONTAGION PREVIEW - 3

 

All told, we continue to think the Chinese banking sector will represent a material, long-term drag on Chinese economic growth as funding for incremental fixed assets investment dries up at the margins. Additionally, the Politburo’s economic rebalancing agenda and a pending acceleration in anti-pollution regulation will also eat away at Chinese growth at the margins.

 

As such, the confluence of these headwinds will remain a sustainable drag on the growth rates of the regional and global economies, though we do think the US is best-positioned to cope with this headwind.  

 

In this scenario, the USD remains a ball-under-water trade from a TAIL perspective. Will Germany favor an increasingly weak EUR as China downshifts its growth rates (which, BTW, is the best case scenario; key tail risks remain)? Are investors bearish enough on Gold? Are speculators positioned for a secular decline in the energy markets? Are FX market participants bearish enough on the JPY?

 

Just a few noteworthy TAIL-duration risk management questions to start pondering late on a summer Friday…

 

Have a great weekend; we look forward to having you join us on the call Monday.

 

Darius Dale

Senior Analyst



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