This note was originally published December 04, 2013 at 14:44 in Macro.
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- Conflicting signals from Chinese officials have made it difficult to handicap China’s TREND & TAIL GIP outlook(s) in recent months. We offer our latest thoughts in the note below.
- We are decidedly back to analyzing China with a sanguine lens and are increasingly of the view that it probably warrants playing China alone (i.e. not via consensus ancillary “China plays”) on the long side with respect to the intermediate-term TREND.
- With respect to the long-term TAIL, we still would like to see concrete implementation of capital account and FX reforms, as well as more safeguards put in place to limit the risk of a broadly destructive transition to a fully liberalized financial system (email us if you’d like to receive a walk-though of the specifics and a recent collection of confirming evidence).
- It could be over a year before we have meaningful clarity on the latter, so our best solution for clients at the current juncture is to overweight “new China” (i.e. consumption and deregulation) while underweighting (or shorting) “old China” (i.e. the concomitant bubbles in credit and fixed assets investment), as highlighted in the chart below.
At the bare minimum, 2013 has been a weird year to be involved in China – either directly through Chinese equity exposure or indirectly through consensus ancillary plays like EM assets, commodities, and the currencies of commodity-producing nations.
While we consider it a huge victory for our team to have kept our clients out of or on the short side of those ancillary plays all year (and prior), that is certainly not to say we’ve nailed China or anything to that nature.
In the following table, we highlight the absolute bloodbath that has occurred across the commodity complex since we first introduced our structurally negative view on commodities back in APR ’11 as part of our Deflating the Inflation quarterly macro theme. We’ve obviously followed that up with numerous notes and presentations over the past couple of years, so please email us if you’re not yet familiar with our long-held bearish bias on the commodity complex and we’ll be happy to forward you the relevant materials.
Going back to not nailing China, we’ve been keen to change our stance on China multiple times in the YTD (% changes reflect the performance of the Shanghai Composite Index over the respective duration):
- Bullish from 12/10/12 to 4/19/13: +7.7%;
- Neutral from 4/19/13 to 6/7/13: -1.5%;
- Bearish from 6/7/13 to 9/6/13: -3.2%; and
- Neutral from 9/6/13 to present: +5.2%.
The predominant reason we’ve changed our tune on China so many times this year has been due to policy inflections that have materially altered (or complicated) our rolling-thee-to-six-month forward expectations for the Chinese economy. Amid this ~3M long period of admittedly-unattractive neutrality, we’ve analyzed China in both a positive and negative light, highlighting both the key opportunities and risks to China’s long-term GIP outlook along the way:
- DEBATING THE BULL CASE FOR CHINA (9/12): In the note below, we debate the merits of the long-term bull case for China. We’re not impressed, but we’re not "not impressed" either.
- THE DEVELOPING BULL CASE FOR CHINA: PROGRESSING (9/25): Chinese policymakers appear to be embarking on a clever strategy to offset internal headwinds to growth with foreign capital.
- CHART OF THE DAY: CHINESE #GROWTHSTABILIZING (9/27): On the margin, key initiatives in the Shanghai FTZ reform package are positive for China’s structural economic outlook.
- IF YOU HAVEN’T YET HEARD, CHINA IS TIGHTENING MONETARY POLICY (10/24): The PBoC’s recent tightening of monetary policy is in-line with our call for China to take a brief trip to Quad #3 on our GIP model in 4Q13.
- PREVIEWING CHINA’S THIRD PLENARY SESSION: CREDITHOLICS ANONYMOUS? (11/8): Heading into China's 3rd Plenary Session, we are looking for concrete solutions (if any) to China’s ongoing credit binge and financial risks.
- CHINESE BANKING REFORMS: SHORT OF DETAILS; LONG OF RISKS (11/13): Chinese policymakers appear committed to ignoring the risks embedded throughout the country’s financial system.
We are decidedly back to analyzing China with a sanguine lens and are increasingly of the view that it probably warrants playing China alone (i.e. not via consensus ancillary “China plays”) on the long side with respect to the intermediate-term TREND.
With respect to the long-term TAIL, we still would like to see concrete implementation of capital account and FX reforms, as well as more safeguards put in place to limit the risk of a broadly destructive transition to a fully liberalized financial system (email us if you’d like to receive a walk-though of the specifics and a recent collection of confirming evidence).
It could be over a year before we have meaningful clarity on the latter, so our best solution for clients at the current juncture is to overweight “new China” (i.e. consumption and deregulation) while underweighting (or shorting) “old China” (i.e. the concomitant bubbles in credit and fixed assets investment), as highlighted in the chart below:
Going back to the intermediate-term TREND outlook, we think China has the opportunity to surprise consensus growth expectations to the upside into and potentially through 2014, after what is likely to be a brief dip into Quad #3 here in 4Q13:
Moreover, we think China has the potential to continue distancing itself from the carnage that has become the emerging markets space. It will seek to accomplish this by enticing international capital flows (both FDI and portfolio) away from beleaguered EM economies, at the margins, through a combination of strengthening the CNY and promoting its use internationally, as well as through incremental deregulation and investor-friendly incentives.
Below is a compendium of data points we’ve come across in the past couple of weeks that support this view:
- Reuters noted that the PBoC said China will begin rolling out financial liberalization reforms in the Shanghai free-trade zone within three months. PBoC Shanghai chief Zhang Xin said the reforms would be launched within three months, evaluated after six months and formal policies would be fully implemented by the end of a year. He added the policies will serve as models for other regions as they move to create their own FTZs. (StreetAccount)
- Xinhuanet noted that Zhang Xiaoqiang, deputy head of the National Development and Reform Commission, said China will simplify its foreign investment approval process in order to introduce a registration-based system for foreign investment projects. Zhang said that the government will further enhance the role of foreign investment in its market-oriented economic development. (StreetAccount)
- Reuters reported that the yuan overtook the euro in October to become the second-most used currency in trade finance. SWIFT said the market share of yuan usage in trade finance grew to 8.66% in Oct, up from 1.89% in January 2012. The yuan now ranks second behind the US dollar, which has a share of 81.1%. (StreetAccount)
- Dim Sum bond issuance has accelerated to the fastest pace since June 2012 as China’s pledge to move toward yuan convertibility boosts demand for the currency. Sales reached 27 billion yuan ($4.4 billion) in November, almost five times as much as October’s 5.8 billion yuan, according to data compiled by Bloomberg. Yuan savings in Hong Kong rose the most since April 2011 to a record 782 billion yuan in October. (Bloomberg)
- The WSJ noted that foreign real estate developers eager to capitalize on rising consumption in China are increasingly raising funds to invest in warehouses and shopping malls. Data from PERE showed developers and their subsidiaries have raised $3.5B for China projects so far this year, eclipsing the $2.2B raised in all of 2012 and just shy of the $4B raised by private-equity and other fund managers. (StreetAccount)
- Xinhuanet noted that Zhou Xiaochuan said China should increase the qualification and quota of QDII and QFII investors to help them with their activities. He added that administrative approval procedures for QDII and QFII qualification and quotas shall be eliminated "when conditions are ripe". (StreetAccount)
All told, we still think China has a lot of credit bubble-related skeletons in its closet that will increasingly become a headwind to Chinese economic growth over the long-term TAIL. For the time being, however, we think Chinese officials are putting the right policies in place to offset those headwinds, at the margins.
Please feel free to email us with any follow-up questions.
Associate: Macro Team
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