This note was originally published at 8am on March 14, 2014 for Hedgeye subscribers.
“We fear things in proportion to our ignorance of them.”
-Christian Nestell Bovee
All week I’ve been putting the finishing touches on what we think will be a revolutionary dynamic asset allocation model/global macro signaling platform; as such, I haven’t had much time to consume my “fair share” of financial news media in the week-to-date.
When I was able to perk my head up for a brief moment, I was somewhat startled to see the SPX down ~20 handles on “China jitters” yesterday.
Like many other financial news media headlines, I’m not quite sure how to interpret that one. Granted, no one is paying such platforms for differentiated, cutting-edge analytical insights, but sometimes I think their need for speed and coherent storytelling in a globally-interconnected, nonlinear ecosystem can get the better of them.
HEDGEYE POLL OF THE DAY: please reply “yes” to this email if it’s news to you that Chinese economic growth is slowing.
It’s worth noting that in the 15 quarters since Chinese real GDP growth hit a cycle-peak of +11.9% YoY in 1Q10, Chinese economic growth has accelerated sequentially only three times. It’s basically been a straight leg down for four consecutive years – so much so that on a trailing 3Y basis, the z-score for this series is (0.6x), which is actually up from trough of (1.6x) in 2Q12. In non-statistical speak, this implies that the “surprise factor” of Chinese #GrowthSlowing is burning off.
That isn’t to say that Chinese economic growth is not still slowing. In fact, the broad swath of high-frequency economic data (including yesterday’s releases) points to a continued slowdown. The current risk range in our predictive tracking algorithm has probable downside to +7.3% YoY for Chinese real GDP growth here in 1Q14, which would: A) be the slowest growth rate since 1Q09; and B) imply that the Chinese economy is not taking advantage of extremely favorable base effect tailwinds – a sign that sequential momentum is indeed decelerating.
For those of you who do not follow China closely, below we’ve compiled the relevant data points for your review, color coding them appropriately for ease of interpretation:
- Fixed-Assets Investment: +17.9% YoY in JAN-FEB from +19.6% in DEC; +17.9% is the slowest growth rate since DEC ‘02
- Industrial Production: +8.6% YoY in JAN-FEB from +9.7% in DEC; +8.6% is the slowest growth rate since APR ‘09
- Retail Sales: +11.8% YoY in JAN-FEB from +13.1% in DEC
- Total Social Financing: +938.7B CNY in FEB from +2,584.5B in JAN
- New CNY Loans: +644.5B CNY in FEB from +1,320B in JAN
- Non-traditional Financing (i.e. “shadow” banking): +17.2B in FEB from +993B in JAN
- Ratio of Non-traditional Financing to Total Social Financing: 1.8% in FEB from 38.4% in JAN
- Official Manufacturing PMI: 50.2 in FEB from 50.5 in JAN; 50.2 marked an 8M-low for the index
- New Orders declined 40bps to an 8M-low of 50.5
- Export Orders declined 110bps to an 8M-low of 48.2
- Official Non-Manufacturing PMI: 55 in FEB from 53.4 in JAN
- HSBC Manufacturing PMI: 48.5 in FEB from 49.5 in JAN; 48.5 marked a 7M-low for the index
- New Orders and Output both fell below 50 (i.e. contracted) for the first time in 7M
- Employment dropped to 47.2, which is its lowest reading since MAR ‘09
- HSBC Non-Manufacturing PMI: 51 in FEB from 50.7 in JAN
- Exports: (18.1%) YoY in FEB from +10.6% in JAN vs. a Bloomberg consensus estimate of +7.5%
- Imports: +10.1% YoY in FEB from +10% in JAN vs. a Bloomberg consensus estimate of +7.6%
- Trade Balance NSA: ($23B) in FEB from $31.9B in JAN vs. a Bloomberg consensus estimate of $14.5B; ($23B) marked the largest trade deficit since FEB ‘12
- Trade Balance YoY: ($37.8B) YoY in FEB from +$3.8B YoY in JAN
Lots of red indeed…
Back to the Global Macro Grind…
So what do you do with all of this? Like we’ve been saying since the start of DEC, you should simply allocate assets to “New China” plays in lieu of “Old China” plays. Refer to the Chart of the Day below for an example of how to implement this investment strategy.
The worst thing you can do as a fiduciary of other people’s capital is freak out about China ~4 years into a well-telegraphed, policy-induced growth slowdown.
That’s not to say the Chinese economy and its banking system won’t have its day of reckoning (it will; it has twice before in the last ~20-30 years after the popping of two credit bubbles that were also policy-induced); it’s merely to suggest that it might not be tomorrow. At any rate, we’ve done a ton of work on such risks over the past 6-9M, so please ping us if you’d like our help getting up to speed.
One key catalyst on the horizon is a potential shift to a monetary easing bias by the PBoC. To some degree, they’ve done this already: selling CNY in the open market to lower the reference rate – as they have done in recent weeks – floods the domestic banking system with liquidity. On the surface, they’ve mopped up this liquidity by issuing repos, but money market rates falling to near 2Y-lows suggests there is ample excess liquidity in the Chinese banking system.
Two additional points to consider regarding this potential catalyst:
- The Chinese yuan’s recent decline is not because of panic selling, but rather deliberate policy adjustments after speculative capital inflows helped fuel the fastest sequential rate of credit growth ever in JAN.
- Yesterday, for the first time since mid-2012, the State Council rhetorically supported the prospect of policy stimulus. This is in stark contrast to the “proactive and prudent” fiscal and monetary policy bias they’ve held for much of the past 18+ months.
While we all know they cannot stimulate indefinitely, there’s little-to-no denying the short-to-intermediate term impact increased government investment or a lower WACC could have on a Chinese economy that remains levered to fixed capital formation at roughly half of GDP. It’s worth noting that real interest rates (i.e. the benchmark 1Y lending rate less headline CPI) in China have backed up from a then-3Y low of ~0% in mid-2011 to near-4Y highs just north of 4%.
As always, time will tell on this catalyst. For those of you who crave a higher degree of analytical color at the current juncture, please refer to our latest report titled, “IS THIS THE BEGINNING OF THE END FOR CHINA?” (3/10).
Our immediate-term TRADE risk ranges across Global Macro are now as follows:
UST 10yr Yield 2.59-2.75%
Keep your head on a swivel,
Associate: Macro Team