Last week, we put out a note titled “REITERATING OUR RESEARCH VIEW ON CHINA” in which the conclusion read: “Recent economic data supports renewed optimism across Chinese capital markets, but we don’t think improvement in the former is sustainable.” While we weren’t wrong on the stocks per se (fortuitously, we never developed enough conviction in our fundamental view to recommend shorting China), that was still the wrong call to make.
Specifically, our latest analysis of the many puts and takes throughout the Chinese policymaking spectrum leads us to believe the current acceleration in growth is sustainable for at least one more quarter (the jury is still out for 4Q14E).
That being said, we weren’t necessarily wrong to believe that the “mini stimulus” efforts out of Beijing in recent months would result in a marginal-at-best boost to growth. What we missed, however, is that Beijing’s spate of efforts would send a shockwave throughout the various layers of Chinese policymaking.
In particular, a rash of expansionary fiscal policy at the local government level would suggest that there is significantly more stimulus hitting the Chinese economy than meets the eye at the current juncture. This is in stark contrast to the headline guidance out of the State Council and PBoC, which continues to downplay the likelihood of a major shift in monetary or fiscal policy.
Essentially, what Chinese policymakers are doing is stimulating growth behind the scenes while protecting their credibility in light of the 2009-10 four trillion CNY stimulus package that more-or-less got them in the current mess to begin with.
Again, there are a lot of moving parts here, so we’ll do our best to summarize the many stimulus efforts introduced throughout the Chinese economy of late:
- Early-APR: the State Council pledges to accelerate railway construction and investment in public housing
- Late-MAY: the State Council gives the go-ahead to launch targeted RRR cuts to enhance financial support to the “real economy”
- JUN 9: the PBoC announces a -50bps RRR cut for banks that focus on lending to the agriculture sector and SMEs, as well as for those engaged in various forms of consumer finance (e.g. automobile financing)
- JUN 10: Premier Li pledges to “intensify fine-tuning” and make [additional] “targeted changes” in policy
- JUN 12: following up on his recent pledge, Premier Li announces that the government will boost public investment in the Yangtze River Basin, while lowering tax rates for some utility companies
- JUN 12: Huang Min, head of the fixed-asset investment department at the National Development and Reform Commission (NDRC) reiterates the public sector’s commitment to investing in Chinese infrastructure, while also soliciting private investment (63% of all FAI in 2013) for 80 major projects
- JUN 30: the China Banking Association (CBA) “affirms” that the PBoC will continue with “slight loosening” of monetary policy throughout the year
- JUN 30: the China Banking Regulatory Commission (CBRC) made some changes to its loan-to-deposit calculus in a move to free up incremental capital for traditional credit expansion
- JUL 4: the China Securities Regulatory Commission (CSRC) announces that it will approve 100 IPOs through DEC at about ~20 per month – a move that effectively forces the PBoC to maintain relaxed liquidity conditions, as IPO gluts tend to freeze up capital across the Chinese banking system
- Mid-JUN: Premier Li convenes eight provincial governors and majors in Beijing to discuss the current economic situation, concluding that “downward pressure [on the economy] is still considerable… we should not ignore the challenges and risks”… “I took his remarks as criticism,” said Heilongjiang Governor Lu Hao
- JUN 25 though mid-JUL: the State Council sends a total of eight inspection groups to 27 ministerial departments and 16 provinces and municipalities… determining whether or not local governments did a good job of stabilizing growth was among the top priorities for the inspectors… Yang Chuantang, head of the inspection group, subsequently states that, “Local governments should step up pro-growth efforts and strive to accomplish this year’s target and lay a solid foundation for years to come.”
- JUL-to-date: in responding to Premier Li’s call to action, the Hebei province rolled out a series of preferential policies, including increased land supply, streamlined approval procedures and tax cuts, to support a variety of strategic emerging industries… the Heilongjiang province implemented similar measures to support its service sector
If you analyze any one of these measures in isolation, you’ll likely end up where we were prior to today: not all that impressed with China’s stimulus efforts. Analyzing them in conjunction, however, leads one to believe that there are indeed meaningful stimulus efforts being implemented across China’s state-run economy.
It’s worth remembering that mainland China has 32 provincial-level administrative units: 23 provinces, four municipalities (Beijing, Tianjin, Shanghai, Chongqing) and five autonomous regions (Guangxi, Inner Mongolia, Tibet, Ningxia, Xinjiang). In extrapolating the stimulus efforts of Hebei and Heilongjiang throughout the entire country, it’s easy to arrive at the aforementioned conclusion.
Is this trend of “mini stimulus(es) = major stimulus” sustainable enough to chase?
For now the answer is, “yes”. Real GDP growth was tracking at +7.4% YoY (i.e. only ~10bps south of the official target) when the bulk of these measures were rolled out, so perhaps policymakers want to see a meaningful acceleration in growth before they pull back on the stimulus reins. Moreover, CPI tracking well south of their official +3.5% YoY target in the YTD would seem to suggest they have plenty of scope to do so.
That being said, annualized currency weakness and easier policy should support a marginal acceleration in inflation from here.
But perhaps the real reason Chinese policymakers were content to ease monetary and fiscal policy of late was to shore up the country’s crashing property market.
Along those lines, many local governments have taken matters into their own hands by easing home purchase restrictions (27 of 46 cities did so yesterday). Moreover, last week’s statement out of the Ministry of Housing and Urban-Rural Development (MOHURD) would seem to suggest that such easing in property markets at the local level have the official blessing of Beijing as well.
This is a major positive given the dour nature of China’s property market trends. New home prices fell in 55 of the monitored 70 cities last month – the most since JAN ‘11 when the government changed the way it compiles the statistics. This data point followed earlier data which showed a continued sharp deterioration in property price trends nationwide:
- JUN E-House Home Price Index (288 cities): 5.3% YoY from 5.8% prior
- Prices of new homes in 288 cities fell -0.1% MoM in JUN, the third sequential decline in a row
- JUN China Real Estate System Index (CREIS) Home Price Index (100 cities): 6.5% YoY from 7.8% prior
- Average prices in the 100 biggest cities fell -0.5% MoM, the second consecutive sequential decline
Such targeted easing measures have indeed stabilized China’s property market – albeit at brutal levels of new investment (i.e. land areas purchased and housing starts), demand (i.e. value and volume of building sales) and confidence (i.e. CREIS Real Estate Climate Index). Supply growth (i.e. housing completions) continues unabated, but that should slow in the coming months with decelerating units under construction and contracting levels of new investment.
Lastly, there are two more things to note as far as sustainability is concerned:
- Land sales account for nearly 60% of local government fiscal revenue, which means China’s local governments will likely need to dramatically accelerate the pace of [now-contracting] land sales to keep pace with all their spending
- China’s labor market remains in contraction territory from a PMI perspective; the latest reading of 48.6 compares to a TTM average of 48.7 and is supportive of the view that Chinese policymakers may need to “do more” to ensure their labor targets are being met
In our investment framework, which anchors heavily differential calculus and prospect theory, going from “absolutely horrendous” to merely “really bad” is bullish insomuch as going from “bad” to “good” is. This is especially true when the quantitative signals support it – which they now do for China in both of our proprietary risk management models.
Looking to Keith’s factoring of price, volume and volatility, the Shanghai Composite Index has now undergone a bearish-to-bullish TREND reversal and is threatening to do the same on a long-term TAIL basis as well:
Looking to our TACRM system, I’ve had the “great pleasure” of being told that “Old China” exposures (i.e. the CHIX and CHXX) were “BUYS” every day since JUL 3rd. Base metals, which remain overexposed to China from a marginal demand perspective, have been signaling “BUY” as well in recent weeks.
In spite of these signals, however, I chose to anchor on my existing fundamental research view on China, which obviously did not rhyme with what the market was signaling. Classic rookie mistake. Now, we are content to let the market dictate our interpretation of China’s macro fundamentals.
***CLICK HERE to learn more about TACRM’s world-class signaling capabilities***
GROWTH/INFLATION/POLICY TRENDS: BULLISH
Having spent my entire analytical career at Hedgeye, I have not yet had the opportunity to develop some of the more traditional skills in the sell side research toolkit, such as storytelling about “feel” and “valuation”. Instead, we’re confined to storytelling about slopes, deltas and inflections in the data – which is exactly what the following table attempts to supplement:
The key takeaways to highlight from this table are:
- The positive % deviations from the 3M, 6M and 12M trends in the preponderance of China’s PMI data
- The two latest (i.e. JUL) data points show flat-to-mid-single-digit improvement relative to their 3M and 6M trends
- Specifically, the JUL flash Manufacturing PMI data came in at an 18M-high, with the New Orders, New Export Orders, Backlogs of Work, and Quantity of Purchases sub-indices all showing sequential accelerations
- Chinese credit growth is accelerating markedly (the JUN Total Social Financing figure was the fast rate for any JUN since 2009) without capital inflows, which are now a net negative and well shy of its 3M, 6M and 12M trends
- Growth in sovereign fiscal expenditures is accelerating materially relative to its 3M, 6M and 12M trends
- The sovereign budget balance has now swung squarely into deficit territory, and should generally remain there given that Chinese deficit spending tends to be back-half loaded
- While the rate of liquidity provision has come in of late, the PBoC is still pumping over 100B CNY into the Chinese banking system each month, which is in stark contrast to the 6M and 12M trends of net liquidity withdrawals
- The aforementioned policy shift has materially tamed forward-looking expectations for Chinese money market rates, while the recently heavy IPO calendar has applied some upward pressure to near-term rates… we expect the PBoC to take note of this phenomenon and react accordingly
Indeed, Chinese economic growth has stabilized on a slew of monetary and fiscal easing measures and certain segments of the Chinese economy (e.g. trade data and credit formation… the latter of which is supported by BoP stabilization) are showing marked improvement on a trending basis.
All told, both our quantitative signals and fundamental research support buying China here. This stance is in stark contrast to our previous view, which concluded that investors would do better to stay out of China altogether.
While we’re certainly not making the case that China has turned the corner from a long-term TAIL perspective, we do see considerable upside to Chinese equities – specifically “Old China” exposures – with respect to the intermediate-term TREND. Because of the casino-like nature of the high-beta Chinese equity market, Chinese “investors” tend to extrapolate recent trends and “over-discount” in both directions.
As such, we think international equity investors should advantage of this phenomenon on the long side of Chinese equities; long-only fund managers should appropriately overweight China. Ping us with any follow-up questions.
Have a great evening,
Associate: Macro Team