Dovish Growth Data + Dovish Inflation Data = A Dovish Policy Response
Overnight, the latest batch of high-frequency economic data showed that credit growth accelerated in AUG – albeit from insanely low levels – but still came in well-shy of consensus estimates:
- Total Social Financing: 957.4B CNY MoM from 273.1B in JUL vs. a Bloomberg consensus estimate of 1.135T
- New Loans: 702.5B CNY MoM from 385.2B in JUL
- Shadow Credit: 11.7B CNY MoM form -309.9B in JUL
- M2 Money Supply: 12.8% YoY from 13.5% in JUL (in line with Premier Li’s guidance from earlier in the week)
It is our view that soft credit growth combined with yesterday’s decidedly dovish inflation data will keep the PBoC “in the game” as it relates to being a net provider of liquidity. Specifically, the PBoC has pumped a net 72B CNY into the Chinese financial system over the past month via a combination of reverse repos as well as unsterilized repo and bill expirations. While that monthly total is down -31% from the rolling 3M average of +104B CNY, it’s up substantially versus the prior month sum of only +4B CNY.
Clearly, the PBoC’s dovish lean has had a dramatic impact on the cost of capital across the Chinese banking system, which, in turn, has completely reversed what had been a trend of rising cost of capital for Chinese corporates.
The “Beijing Put”
While we don’t see broad based easing measures such as a rate cut or a RRR cut(s) as a likely occurrence, we do think targeting monetary loosening such as the aforementioned liquidity provision, sector specific RRR cuts and relaxed regulatory quotas are all within the band of probable outcomes. Coupled with continued infrastructure investment at the municipal government level and relaxed home purchase restrictions on a city-to-city basis, we think enough will be done to prevent expectations for Chinese growth from falling off of the proverbial cliff.
They are going to need it. Be it seasonality in Chinese economic activity or marginally difficult GDP compares, Chinese real GDP growth is set to slow throughout 2H14.
This prediction is in line with the recent trend in China’s high-frequency growth data:
- Our favorite leading indicator for the slope of Chinese growth (i.e. the rolling 2M average of the arithmetic mean of the YoY % change in monthly average iron ore, rebar and coal prices) continues to decelerate sequentially and is negatively diverging from its trailing 3M, 6M and 12M trends.
- The official headline Manufacturing PMI and Non-Manufacturing PMI figures are negatively diverging from their respective trailing 3M, 6M and 12M trends.
- The National Bureau of Statistics (NBS) business cycle surveys are all either unchanged or negatively diverging from their respective trailing 3M, 6M and 12M trends.
- Fixed Assets Investment, Retail Sales and Industrial Production data are all negatively diverging from their respective trailing 3M, 6M and 12M trends.
- Export and Import growth decelerated sequentially and both are negatively diverging from their respective trailing 3M trends.
- FDI and “hot money” flows decelerated sequentially and both are negatively diverging from their respective trailing 3M, 6M and 12M trends.
- The only segments in China’s property sector that look “good” on the margin (i.e. going from brutal to less bad) are credit availability and housing starts. The rest of the segments in China’s housing compendium (i.e. construction, completions, purchases, prices and sentiment) are decelerating on a sequential basis, as well as negatively diverging from their respective trailing 3M, 6M and 12M trends.
But much like what we’re observing in the Eurozone of late or in the US during parts of 2010-12, marginally bad news is currently good news in China to the extent it maintains elevated expectations for the “Beijing Put”. Obviously really bad data would not be supportive of “investor” sentiment – which we’d argue is the primary directional driver of the Chinese stock market – but we doubt policymakers would allow growth data to slip much further from here, given that the property sector is the primary culprit for China’s current growth slowdown.
Specifically, the autocorrelated nature of property markets means that once a trend develops, actors and investors respond in kind by perpetuating the trend. This would effectively reduce Chinese policymakers’ ability to counter a deeper slowdown in property investment with more stimulus.
Net-net, while we don’t see a tremendous amount of upside to Chinese growth from here, we think there is a floor at/near the current level of economic activity and any threat of breaching that level should continue to be met with expectations of incremental stimulus from the marketplace.
Elsewhere In China…
There are few other noteworthy items to discuss that fall outside of the scope of our aforementioned bull case for Chinese equities, but we think they are important to factor into your analysis nonetheless:
- Shanghai-Hong Kong Stock Connect: While certainly not new news, we think there is still scope for this to be a catalyst to the upside for Chinese shares in the near term. Specifically, the A-Shares of mainland companies that have dual listings in both Shanghai and Hong Kong are trading at a discount of roughly 7% to their H-Share counterparts. We expect that valuation gap to narrow (in a good way) as a new class of investors enters the mainland market through this reform mechanism.
- New Economic Dashboard: Per NBS, Chinese policymakers are in the process of creating an economic dashboard of over 40 indicators to measure the efficiency and quality of growth, in order to shift investor and policymaker attention away from GDP. The indicators will concentrate on measuring eight criteria, including economic stability, economic security, optimized economic structure, industrial upgrading, profits and efficiency, innovation, the environment and people’s living conditions. This effectively raises the threshold by which Chinese policymakers are likely to react with incremental stimulus. By how much? We’re not sure, but it’s something to keep an eye on as we traverse the next few months of Chinese economic data and the accompanying rhetoric out of Beijing.
- Antitrust Crackdowns: Over the past month, Beijing has taken a lot of heat from international business groups and multinational companies from both the US and Europe after what had appeared to be a series of targeted probes into the Chinese operations of several noteworthy corporations, including Microsoft Corp. and Volkswagen AG. In addition to recent fines levied upon the Chinese operations of Audi and Chrysler, it also fined 10 Japanese auto parts makers a cumulative 1.24B CNY ($202M), which was the largest antitrust fine ever issued by Chinese authorities. In a rare joint press briefing in Beijing yesterday, China’s three antitrust regulators rebuffed such claims by saying only about 10% of anti-monopoly investigations have involved foreign businesses, echoing comments made by Premier Li Keqiang earlier this week. They also rebutted allegations that companies were denied legal representation during the probes. While far south of actually enacting policies that are supportive of FDI, we think acknowledging the issue with data is the first step towards China repairing its image in the eyes of global investors.
All told, now that you’re done reading this note, get out there and buy the dip in “Old China”! Our preferred way to play this thesis is via the iShares China Large-Cap ETF (FXI), which remains one of our macro team’s core long ideas (CLICK HERE for more details).
Have a fantastic weekend,
Associate: Macro Team