We’re probably a bit late with this research note, largely because the last few months of mixed policy signals amid rapidly souring economic data left us in “do nothing” mode with respect to our preferred China exposures. Recall that we’ve been advocating a long “New China”/short “Old China” investment strategy since early December:
- AVIATING CHINA: CRASH LANDING OR SMOOTH TOUCHDOWN? (12/4): http://app.hedgeye.com/feed_items/32246
- CHINA STRATEGY UPDATE: MORE OF THE SAME (1/6): http://app.hedgeye.com/feed_items/32777
- ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? (1/15): http://app.hedgeye.com/feed_items/32977
- IS CHINA ABOUT TO GET LOOSE? (2/19): http://app.hedgeye.com/feed_items/33646
- IS THIS THE BEGINNING OF THE END FOR CHINA? (3/10): http://app.hedgeye.com/feed_items/34035
- EARLY LOOK: China Jitters (3/14): http://app.hedgeye.com/feed_items/34129
- DOES THE EM RELIEF RALLY HAVE LEGS? (3/26): http://app.hedgeye.com/feed_items/34393
That investment strategy has performed modestly well (+577bps on an equal-weighted basis using the CQQQ, CHIQ, CHIX, and CHXX etfs as proxies), though it has certainly given up a lot of performance juice in recent weeks. This narrowing of performance between “New China” plays and “Old China” plays was a key leading indicator of the fundamental outlook we are now modeling in from a GIP perspective – with policy guidance being the other.
Our GIP outlook for China isn’t all that negative from an absolute perspective (I mean, does anyone actually care if Chinese growth is +7.2 or +7.4 percent?), but we now see Chinese #GrowthStabilizing in 2Q (vs. an initial projection of #GrowthAccelerating) amid a likely acceleration in reported inflation (i.e. the GDP deflator – assuming China’s real GDP calculus is, in fact, “real” calculus).
The back half of the year should see the Chinese economy mired in Quad #3 (i.e. growth slowing as inflation accelerates) – largely because the Chinese economy lacks sufficient sequential momentum for us to justify China “comping” increasingly difficult comps as we progress through the year.
Moreover, both credit growth and headline GDP growth tend to be weighted towards the first half of the calendar year, so seasonality is in favor of this research view.
Lastly, now-consistent policy guidance out of key members of the Politburo, State Council and PBoC have severely quashed our expectations of any major fiscal or monetary stimulus over the intermediate term.
Going back to China’s lack of sufficient sequential momentum, the balance of Chinese economic growth data shows a general trend of rather muted MoM improvement – if any – across a number of key indicators. On a trending basis, Chinese growth data remains more-or-less flat – with the exception of Chinese trade data, which has shown marked improvement in recent months.
Looking to China’s property market tells a sharply divergent tale – particularly one of sharp deterioration on a trending basis. Specifically, headline measures of financing, supply, demand and price are all crashing with respect to their trailing 3M, 6M and/or 12M trends. It’s worth noting that the recent collapse in land areas purchased is a headwind for both prospective real estate development and local government finances – the latter of which could limit the scope of any additional targeted fiscal stimulus efforts.
Given that property investment accounts for ~20% of Chinese GDP according to some estimates, this is not good. So much so that the PBoC had to embark on qualitative easing today, urging banks to accelerate residential mortgage lending in order to help curb the sharp deceleration in demand that has spilled over into China’s Tier 1 cities in recent months (residential sales values dropped -31% YoY in APR and are trending -27% YoY in the YTD).
One thing Chinese banks can do is lower mortgage rates; while they are allowed to lend down to 70% of the PBoC’s benchmark 5+ year mortgage rate (currently at 4.5%), they’ve actually kept the cost of capital fairly high in the YTD. The PBoC’s latest Quarterly Monetary Policy Report showed mortgage rates averaging 6.7% in 1Q14, up +17bps QoQ.
The aforementioned maneuver out of the PBoC follows a plethora of piecemeal easing measures in recent months, including but not limited to:
- Rhetorically extending the implementation of the nationwide property tax trial;
- Allowing developers to tap equity markets for fuding;
- Allowing property developers to markedly accelerate off-shore bond issuance ($8.8B in the YTD vs. $17B for all of 2013); and
- Allowing insurers to boost quotas for real estate investment (up to 30% - inclusive of infrastructure assets – from 10% previously).
In summary, our call on China is simple: with real GDP growth upside seemingly capped at/near +7.5% for the foreseeable future and asymmetric downside heading into 2015 (e.g. principle due on listed Chinese property developer debt more than doubles to 69.7B CNY next year as funding slows sharply currently; deposit rate deregulation threatens both marginal lenders and borrowers as the cost of capital remains artificially low throughout the Chinese financial system; and capital account deregulation without broad expectations for structural CNY appreciation could be disastrous), we see no reason for investors to get involved in China here other than “valuation”.
Valuation is not a catalyst…
What are catalysts, however, are GIP fundamentals and tail risk. While we continue to believe that both the political resolve and fiscal & monetary firepower will continue to mitigate the latter, neither are currently skewed in favor of being long anything China at the current juncture. At best, investors should remain on the sidelines.
Don’t ever forget that China’s economic reform agenda, while likely structurally positive for the Chinese economy, may not be all that fun for investors in the short term – which is actually something we concluded roughly 2.5 years ago! Dozens of research notes and several conference calls later, what have we really learned?...
Enjoy your respective evenings; feel free to ping us with follow-up questions.
Associate: Macro Team