Saturday, May 24, 2014

Measuring market expectations on China

The news out of China continues to be mixed. On one hand, the HSBC China Manufacturing flash PMI beat expectations with a reading of 49.7, which was a five-month high suggesting stabilization, but remained below 50 indicating contraction.

On the other hand, Tom Orlik pointed out that the Li Keqiang Indicator continued to decline, which suggested deceleration.

Measuring market expectations
Rather than try to prognosticate myself, I thought that I should ask Mr. Market what he thought of what is happening in China. For the long-term view, I measured the relative performance of several equity market indices against the MSCI All-Country World Index (ACWI). All returns are total returns and measured in USD, so we have an apples-to-apples comparison in a single currency. The countries and regions that I measured are:

  • US (SPY)
  • Eurozone (FEZ)
  • Resource markets, as they are sensitive to both world growth and Chinese demand: Canada (EWC), Australia (EWA) and South Africa (EZA) on an equal-weighted basis.
  • Greater China, defined as China (FXI), Hong Kong (EWH), Taiwan (EWT) and South Korea (EWY), as a way of better measuring the China than just analyzing FXI, which is a somewhat narrow index.

As the chart shows, the US markets have been on a outperforming ACWI since mid 2009 and eurozone equities had been declining but turned around in mid-2012. Greater China has been in a long relative downtrend since mid-2009, indicating a loss of momentum. The resource markets, which are sensitive to both global growth and Chinese demand, had been in a relative downtrend since 2012.

If we were to zoom in further, the next chart shows the relative performance of the Resources basket relative to the Greater China basket and Old China (FXI) to New China (FXI), which is heavily weighted in financials, against New China (PGJ), which is heavily weighted towards the consumer-oriented internet and technology sector (see my previous post A New China vs. Old China pair trade).

When the lines are rising, Chinese growth expectations are being led by credit-driven infrastructure growth - which is the old formula for growing the economy. When the lines, especially the blue Old vs. New China line, are falling, growth expectations are being led by the new policy of re-balancing growth towards the Chinese consumer and household sector.

Based on the last two charts, I can conclude the following about the general level of market expectations:
  • Chinese growth has been slowing for years and continues to slow; but
  • The latest uptick is expected to be led by the same-old-same-old formula of another round of macro infrastructure spending led stimulus, despite all the official rhetoric.
Indeed, Premier Li Keqiang stated last week that the economy needed some "fine tuning" in the face of "downward pressure":
"Currently, the economy is generally stable and we see positive structural changes, but downward pressures are still large and we cannot be complacent," Li said during a visit to the northern region of Inner Mongolia.

"We should use appropriate policy tools and pre-emptive fine-tuning in a timely and appropriate manner to help resolve financing strains for the real economy, especially small firms' difficulties in financing and high borrowing costs," he said.

Such policy fine-tuning should help maintain "reasonable growth" in money supply and bank credit, he said.
If market expectations are correct, China will not crash, but down that road lies a Lost Decade (see China turns Japanese?).

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

1 comment:

Rik said...

Fully agree with your conclusions how markets see things btw.

I see however opportunities that Say Japan didnot have post 1990.
Japan's assets were completely overpriced (Price>>value). Probably we see some of that or a lot of that here as well.
However Japan was worldclass also in rspct of labourcosts.
And its cies were just worldwide competitors.

What I call overpricing is especially a problem as the correction will basically have to be absorbed by future growth (when no drastic reforms are done like in Japan). (Well a bit of a short cut but not far from the truth).
Say 2% stuctural growth, 1% inflation and 100% of GDP problems asetbubbles or bad loans not written off. takes around 24 years to get back to normal.
Bring Japan's aging and before the bubble is solved you have run into the next problem.

So the trick for say China should be if they will not go for the hard way to generate as much growth as possible and a relatively high inflation.
Say 3-4% growth and 4% inflation.
Which means in one decade the bubble issue can be solved.

I see real growth possibilities in China that 1990 Japan didnot have. Still alot of the country could be brought to 300-400 USD a month level.
But more strategic going upmarket.
They have basically the labourforce for that. Both for new technique as well start up your own brands. Creativity in say Shanghai is not worse than that in say Tokyo or London.
They have the added advantage that their homemarket is a lot bigger than Japan's as well.
Anyway even without the crisis they would have come to a point where they had to go upmarket to keep growth.

In a nutshell if they can generate growth from there (would imho be much better to invest in marketing and R&D iso more concrete), likely inflation can be kept at acceptable levels (and not go Japanese) and the bubble can be deflated in a relatively short time.