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Takeaway: Stay with the “New China” vs. “Old China” trade as economic growth looks to stabilize then accelerate in 1Q14.

CONCLUSIONS:

  1. We continue to think Chinese growth is slowing and we think it is likely continue to slow for the next 1-2M.
  2. From there, Chinese growth should stabilize and then accelerate throughout the balance of 1H14. It’s tough to have a strong view beyond that given the continued lack of clarity on the economic reform implementation front.
  3. That said, however, all signs continue point to a dramatically reduced threat of the banking sector’s structural liquidity constraints spilling over into the real economy in a meaningful way – for now at least.
  4. Recent reforms centered on curbing explosive growth in shadow banking activity will act as a marginal headwind to growth over the intermediate-to-long term, but will introduce-much needed disclosure and regulation to an otherwise opaque segment of the Chinese financial system.
  5. We continue to think the best way to play China is via a “New China” vs. “Old China” pair trade. In effect, this amounts to being overweight Chinese Information Technology and Consumer Staples names, while being underweight or short Industrials and Financials names.

1) Chinese growth is currently slowing and may continue to slow into FEB. In fact, all four of China’s main PMI indicators (NBS and HSBC) slowed in DEC, the first such occurrence since APR ’13.

CHINA STRATEGY UPDATE: MORE OF THE SAME - 1


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CHINA STRATEGY UPDATE: MORE OF THE SAME - China PMI Table

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2) Extremely easy growth comps, easing money market conditions and seasonality are all supportive of an acceleration in Chinese GDP growth in 1H14.

CHINA STRATEGY UPDATE: MORE OF THE SAME - 9

CHINA STRATEGY UPDATE: MORE OF THE SAME - China Money Market   Rates Monitor

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CHINA STRATEGY UPDATE: MORE OF THE SAME - CHINA

3) For now at least, it would appear that the PBoC has been successful in convincing the market that there is adequate liquidity in the marketplace assuming financial institutions are broadly compliant with regulatory quotas for credit growth, etc. Additionally, their persistence in marking the CNY higher is supportive of capital flows into China at the expense of other emerging markets.

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4) Shadow banking activity has been a key source of credit for the most marginal borrowers according to existing regulations (i.e. LGFVs and property developers) and standard industry practices of only extending credit to the largest, safest SOE borrowers (i.e. SMEs). That said, shadow banking does not represent an overly material source of credit for the broader Chinese economy, nor is it being curbed excessively at the current juncture.

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5) We continue to think that investors should overweight Chinese Information Technology and Consumer Staples names, while underweighting/shorting Industrials and Financials names as economic rebalancing continues, at the margins. It’s worth noting that this trade has returned a cumulative +1,576bps (assuming equal weighted allocations) since we first outlined it back on 12/4. Given China’s structural GIP fundamentals, we think there is plenty of room for this strategy to continue working from here.

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Darius Dale

Associate: Macro Team