Wednesday, November 11, 2015

How worried should we be about a China slowdown?

The figures coming out of China was mixed. Industrial production is decelerating and missed expectations; fixed asset investment slowed, but was in line with expectations; and retail sales rose and beat expectations. The overall picture is a slowing industrial, export and infrastructure spending and an upbeat household sector.

Tom Orlik summarized it as a good news and bad news story. The good news is the Chinese economy is re-balancing growth towards the consumer, but FAI is slowing and consumer growth isn't rising very quickly to make up for the lost growth (annotations in white are mine):

Here, we see that Old China style growth, powered by credit driven infrastructure spending, is decelerating along a number of dimensions:

I have written about China re-balancing before by highlighting this pair chart of New China-Old China ETF pairs. When the lines are rising, New China consumer led growth stocks are outperforming and, when the lines are falling, Old China credit driven infrastructure growth is ascendant. We have seen the New China stocks begin to outperform in April and they haven't looked back since.

What about the slowdown?
Many investors I have talked to are bewildered by the China bull and bear debate. The bulls will point to evidence of re-balancing as a positive sign for the Chinese growth outlook, as exemplified by Alibaba's Singles' Day sale of USD 14.3 billion, which surpassed last year's sales of USD 9.3 billion. The bears, on the other hand, will contend that, at the end of the day, Chinese growth is still slowing.

To settle the argument, I turned to Mr. Market for his verdict. The chart below shows the relative performance of the stock markets of China's major Asian trading partners, Hong Kong, Taiwan and South Korea, relative to the Chinese market. I used USD denominated ETFs to filter out any currency effects and used FXI as the proxy for China. As the chart indicates, the major Asian market ETFs that trade and export to China are all outperforming FXI. If Mr. Market was indeed worried about a China slowdown affecting her Asian trading partners, then these markets would be underperforming.

If the market doesn't seem to be all that worried a China slowdown, should you?

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