China Is Booming, but Don't Buy Now

07/08/2009 3:06 pm EST

Focus: MARKETS

Jim Trippon

Editor-in-Chief, China Stock Digest

Jim Trippon of China Stock Digest warns that the world's hottest market is vulnerable to a US-led correction.

Optimism about China’s economy continues to run high. The macro-economic numbers back up this bullish sentiment. Nevertheless we’re taking a very cautious approach to new stock purchases this month. As we’ve reported previously, many Chinese ADRs remain sensitive to movements of US stock indexes. [And] the Dow Jones Industrial Average has fallen well off its high for the month of 8800.

The coupling of Chinese stocks to New York indexes is an unfortunate fact of life, [though] it is becoming less important as time goes on. Many Chinese companies can be still be roiled by volatility on Western indexes. Currently the outlook for the market-leading US economy is dubious at best. Aside from a slight bounce in the disastrous housing market, there is little good news to report. Unemployment has hit its highest levels in decades as the nation’s GDP continues to shrivel.

The Dow is still up almost 30% from its mid-March lows. This suggests a degree of confidence about an economic recovery that simply cannot be realized in the near future, not with foreclosure rates, bankruptcies, and credit difficulties continuing to plague the economy at every level, from the personal to the corporate.

With the prospect of a serious market setback in the United States on the horizon, I am not going to take the risk of making any new buys of China-based ADRs at this time. Although many Chinese companies have reported double-digit profit increases for the first quarter and are likely to do so again in the second, their shares may suffer whiplash from the setbacks depressing the mood of the entire stock market in New York.

[Nevertheless,] decoupling continues to be the dominant trend in the Chinese economy. Nobody is expecting exports to bounce back anytime soon. But China’s internal economy and corporate profitability continues to grow at a rate that outstrips every developed nation on the planet.

China’s economy is in a “critical phase” Premier Wen Jiabao commented as the World Bank issued its gloomy forecast for the global economy. Premier Wen says he will continue pumping money into the financial system to sustain the nation’s growth in the face of recession around the planet. In his own determined words, Wen vows that China will “fully realize” stimulus measures which began with a $586 billion plan last November.

With new lending in May at 664.5 billion yuan ($97 billion), China-watchers had expected to see an ongoing reduction in lending from current record levels. Now it seems that China’s money supply will continue to grow with new loans totaling an unprecedented 6.5 trillion yuan ($951 billion) during the first half of the year. Internal economic indicators show that China’s ongoing flood of funding is expanding the nation’s economy. The auto industry continues to be one of the big winners among the industrial output contenders. Auto production in May rose 29%, driving a rise in the steel and coal industries which are also showing gains of 7.4% and 9.6% respectively. Auto sales are expected to hit 11 million units this year. [This would mark the first time Chinese auto sales have exceeded those in the US—Editor.]

Not surprisingly there are doubters and critics who look upon China’s internal boom as risky or unsupportable. There are concerns that China’s banks may acquire too many bad loans in the current lending push. It’s inevitable that there will be some non-performing loans in this scramble to push money into the economy, but China’s banks are generally very well capitalized and have been largely immune to the US-generated mortgage loan crisis.

Pushing too much money into an economy can also create inflation, as an excess of cash chases a finite supply of goods. There’s no sign of that happening yet. [Chinese] inflation as measured by the consumer price index fell 1.4% in May. The producer price index was also off in May, down 7.2% year-over-year.

The pace of housing sales in some cities has been frenetic. In Guangzhou, first-time residential transactions rose 108.2% while in Shanghai overall sales rose 65.5% in April (yoy). Despite the real estate boom, prices of new and existing homes in 70 large and mid-sized Chinese cities including Beijing [and] Shanghai fell 0.6% year-over-year in May. So far any inflationary bubble is not visible.

The picture in total shows an economy that continues to grow during a period of profound transition. Armed with extraordinary resources and authority, Beijing is steering the economy into increased internal production and consumption to make up for the weakness of the world’s developed countries. It’s not a strategy that Beijing can employ indefinitely. But the slump in western economies is unlikely to last indefinitely either.

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