“China is teeing themselves up to take over the financial world.”
-Keith McCullough, June 10th, 2010
Conclusion: China is starting to look interesting on the long side, as the stock market has priced in slowing economic growth.
Bottoms are processes, not points. With the Shanghai Composite down just over 21% YTD, it’s obvious that investors have been discounting what we are starting to see evidence of: slowing growth. At a point, however, that all gets baked into the market and bottomed-out, downward growth expectations begin to shift on the margin towards upward growth forecasts. Combined with the prospects of a simple intermediate-term mean reversion trade (China has underperformed all major equity indices YTD except Greece, Spain, and Slovakia), it’s easy to see why we’re starting to warm up to China on the long side – of course not at every price. We’ll wait for more confirmation of the Shanghai Composite’s higher-low to begin looking for an entry point.
For now, allow the charts below to tell the story on China and what the forward growth outlook is from here.
No surprise here: Chinese equity markets and Chinese demand for copper (as measured by our proprietary Hedgeye China Market Index) have been a leading indicator for growth. As our index would suggest, GDP growth peaked in 1Q10.
The YTD look at the Hedgeye China Market Index suggests that Chinese GDP growth will decline sequentially from its 11.9% peak in 1Q10. The markets have been pricing this in. At a point, what has been priced in will begin surprise to the upside.
Chinese real estate prices were up 12.4% Y/Y in May – the first sequential deceleration in a year. It appears the peak has been established, which has been priced into the Chinese equity market for quite some time. With peak property price growth perhaps in the rear view, the next question logical question will be where will the current cycle bottom out?
To a large extent, the answer to that question will be to watch the Chinese equity markets and the price of copper. With a positive 0.78 correlation (0.61 r-squared) to property price growth for the last three years, our Hedgeye China Market Index should prove to be a reasonably reliable concurrent indicator for the growth of one of China’s main industries. If Chinese property price growth continues to sequentially decline, we expect those declines to bottom out alongside, or shortly after we’ve put in a bottom in Chinese stocks.
Much to-do has been made about the Chinese trade numbers released overnight (Trade surplus – $19.5B in May vs. $1.7B in April; Exports up sequentially – 48.5% Y/Y in May vs. 30.5% Y/Y in April; Imports down sequentially – 48.3% Y/Y in May vs. 49.7% Y/Y in April). Members of the Manic Media appear puzzled that May could produce such large gains in exports – especially with a significantly weaker Euro. Analysis shows, however, that the May 2009’s export growth compare (-26.4% Y/Y) was the easiest “comp” on record. It appears basic math and probability analysis trumps even European sovereign debt scares, or the analytical skills of the Manic Media.
Lastly, a sequential deceleration in import growth is just what the Chinese wanted to see. With what is widely considered an “undervalued” currency, the Chinese are prone to importing inflation. To gauge real-time, we’ve created rolled out our Hedgeye China Growth Commodities Index, which indexes the price of copper, crude oil, and aluminum to the start of the year. The chart below suggests that China indeed imported deflationary commodity prices in May and is continuing to do so in June. No surprise that China’s copper and aluminum imports were down Y/Y in May (-6.1% and -71.5% respectively).
So what does this all mean? You have a government that put the screws to its economy in order to cool growth and it appears the peaks have been established, making it less likely we’ll see more tightening in the near term and likely that perhaps equities have already discounted future slowing growth.