Overall, market conditions are little changed. I’d be thrilled if we got trade deals (but I&rs...
How fast China grows in 2012 and worries about that growth rate are what will count for stocks no matter what happens over the next few weeks in Europe and the United States
09/27/2011 8:30 am EST
China is all that really matters for global stock markets.
If China’s economy slows more than expected in 2012 and grows at something significantly less than the 8.2% to 8.5% now expected, if won’t really matter what the EuroZone nations do about the Greek debt crisis or whether or not the United States stimulates its economy. In 2012 growth in the world economy will slip far enough to throw the developed world into something very close to a recession and global stock markets will suffer through yet another painful bear market.
In the short-term—let’s say for October, November and maybe December, what the United States and the EuroZone nations do does matter.
If the United States, through some currently unimaginable political alignment, were to implement a significant program of government spending on infrastructure and tax cuts to stimulate the domestic economy, global stock markets would rally.
If the EuroZone countries do manage to put together some credible package that kicks the euro debt crisis down the road into December at least and maybe into 2012, then global stock markets would rally.
But not for long if numbers and anecdotes fed into worries about slower than expected growth in China.
On the other hand, if the evidence started to point away from the possibility of slower than expected growth in China, then a temporary rally on good news from the United States and the EuroZone could turn into a lasting rally in global stocks markets.
And I think that China is so central to global stock markets right now that good news on China’s growth in 2012 would produce a rally in global stocks markets—and even to a degree in U.S. and European stocks—even if the U.S. didn’t do anything to stimulate growth and European nations wound up handling a Greek default. (Although under that scenario, I’d rather be underweight U.S. and European markets.)
If all this is true, then the big question is how real are current worries that China will slow more than is now expected in 2012.
There’s no doubt that China’s growth is slowing. China’s GDP grew at a 10.3% annual rate in 2010. In the first quarter of 2011 that growth rate dropped to 9.7% and in the second quarter it decline further to 9.5%. Economist forecasts call for a further drop to anywhere from 9.0% to 9.3% for the third quarter.
This is, of course, exactly the kind of controlled slowdown that China’s government has been looking to engineer in order to control inflation—which peaked, it looks like, at 6.5% in July—and to reduce speculation in the real estate market. And that would put China on a path for the 8.2% to 8.5% growth that the consensus is looking for as a bottom to China’s growth rate.
Just for the record I agree with this consensus about China’s growth in 2012.
But I also recognize that markets are on edge about China. So what are they worried about?
Three things, I think.
First, even in the best of economic worlds, bringing an economy this big in on a predictable glide path is extremely difficult. Most of the time governments overshoot—loosening too much when they’re trying to stimulate or tightening too much when they’re trying to slow growth, as in China’s case.
Second, this isn’t the best of all economic worlds. It’s unlikely that China’s government planners figured a global economic slowdown into their calculations when they were putting in place plans to raise benchmark interest rates or require higher down payments or to restrict mortgages for third homes.
Third, China’s official statistics and official policies are like those of most governments but more so—biased to make current conditions better than they are and often in deep internal contradiction. The worry here is that official statistics and policies don’t really reflect or address what’s going on in the economy.
Let’s take those worries one at a time.
China’s policies designed to produce a slowdown will overshoot. If you look at the most recent numbers for real estate prices, for example, it looks like China’s economy is right in the glide path. In August, data released on August 18 show, prices in 16 cities fell from their levels on July 16. In another 30 cities, including Shanghai and Beijing two of the cities showing the biggest speculative increases during the height of the boom, prices held steady. In another 24 prices continued to climb. Nothing in these numbers argues that we’re looking at a hard landing for China’s economy.
On the other hand, the figures from the Chinese auto industry are worrying. Auto sales in China climbed 6% from a year ago. That’s a significant slowing from the 32% annual growth recorded in 2010. Two particularly worrying aspects to that number—1) production growth of 8.7% outstripped sales growth meaning that the industry could be looking at a bigger future slowdown as car makers try to match production to sales, and 2) much of the sales growth went to Japanese auto makers who were making up for sales lost to a shortage of parts and finished cars after last year’s earthquake and tsunami. Many Chinese automakers actually saw sales fall in August.
Beijing had introduced limits on vehicle registration, added urban traffic restrictions, and ended incentives to car buyers in an effort to slow growth in the industry. But these August numbers have all the hall marks of an overshoot.
Nobody was thinking about the effects of a global economic slowdown when they designed policies to slow the Chinese economy. To see what this worry is about look at the HSBC/Markit Economics manufacturing purchasing managers survey index for August released on September 22. The index fell to 49.4 for September from 49.9 in August for a third straight monthly decline. In this survey any reading below 50 indicates that the manufacturing sector is contracting. The big culprit was in orders for exports where the survey showed new export orders falling at a faster pace than in August.
The fear, of course, is that slowing GDP growth plus a slowing global economy that reduces exports will be more slowing that Beijing’s planners counted on. And the added drag will slow growth more than expected in 2012.
A few caveats about this survey. It’s a preliminary study called the “flash PMI” that comes out before the more complete official number, due on September 30. The flash PMI looks at a sample that tends to overweight small to medium size business and to underweight the large state-owned companies that are responsible for a good deal of China’s exports. The official index hasn’t yet shown this big slowdown in exports. The full index came in at 50.9 in August and has yet to fall below 50
And an emphasis on a drop in Chinese exports under weights changes in the Chinese economy that have made growth less dependent on exports than in the last global economic crisis. In 2008, the year of the Lehman Bros. bankruptcy, exports made up 35% of China’s GDP, according to the World Bank. By 2009, the last year for which the World Bank posts data, the percentage was down to 27%. That percentage rose slightly last year other data suggest but Beijing’s latest five-year economic plan places an increased emphasis on domestic-led growth through such elements as a program to build huge quantities of low-cost housing and to raise the minimum wage by an annual 17% a year for the life of the plan. All this means that while a global economic slump would have an effect on China’s growth, it wouldn’t devastate it. How much would a global economic slump subtract from China’s growth? UBS, which cut its forecast for China’s export growth to 15.1% for 2011 (down from 18%) and to 5.5% growth in 2012 (from 12%), estimates that the export slowdown would cut one percentage point from China’s GDP growth in 2012.
All these statistics are made up anyway and we can’t rely on China’s paper growth to bail out the real global economy. No doubt about it, it sometimes feels like an exercise in “imaginary economics” to talk about the Chinese economy with this degree of precision. Some economists doubt that there’s much connection between China’s official numbers and what’s happening in the real Chinese economy. I think it’s always good practice to check any government’s official figures against data from lots of other sources. To my mind the comparison, on the whole, doesn’t indicate that China’s official GDP numbers are more cooked than official figures in the United States on inflation or unemployment, to take two examples. (I don’t know if you find that reassuring or not.) For example, in the second quarter, official GDP growth came in at 9.5%, down from 9.7%. Electricity consumption in August was up 9.1% from August 2010 and down 0.1% from July 2011. That strikes me as reasonably in line with the GDP numbers.
But we do know that there’s one area where the official numbers don’t accurately report what is happening in the economy.
The People’s Bank has increased the official benchmark interest rate to 6.56%. But that benchmark rate has absolutely no relevance for large numbers of either small to midsize companies or for politically unconnected companies that are currently unable to borrow money at any price. Even the underground lending market, where funds were available at interest rates of 25% or 35%, has stopped lending to many companies in this segment of the Chinese economy.
For the big companies with access to state-owned banks and with local political connections that have let them tap into loans from investment vehicles affiliated with local governments, the tightening engineered by the People’s Bank has been a significant inconvenience. For the small and unconnected, it has meant a cash crunch that has just started to play out across China’s economy. And given Beijing’s drive to limit lending to companies by investment vehicles affiliated with local governments it is impossible at this point to know how far this cash crunch will extend.
For example, on September 23 Caixin Online reported http://english.caixin.cn/2011-09-23/100308836.html that the local government of Wuhan had moved in to suppress a protest at local manufacturer Center Group. The company is apparently bankrupt: having been cut off from bank loans, the company owes about $190 million to private lenders. And those private lenders, it seems, have decided not to throw good money after bad. The shock waves from this are just starting to hit the Wuhan government itself. One Center Group subsidiary, Center Optical, paid 12 million yuan (about $1.7 million) in local taxes in 2010.
That result of monetary tightening and the way it ripples out into local government revenue—and then spending—isn’t yet mapped in the official statistics.
But I think it’s a mistake to assume that the manipulation of data or the lags and inadequacies of official data cut in just one direction. Yes, they might understate the speed of any slowdown in the Chinese economy. But these gaps and lapses also hide many ways in which the Chinese government continues to stimulate its economy in clear contradiction to its stated economic and monetary policies.
Beijing has said over and over again that it wants to reduce the flow of money from investment vehicles affiliated with local governments into the real estate sector. Local governments have a vested interest in financing real estate development since the leasing of land provides a major source of tax revenue for tax-strapped local governments. From this perspective it makes sense for a local government to provide a loan to a developer through a government-affiliated investment vehicle even if the project being funded is built on questionable economic foundations. Beijing has rightly tabbed this alignment of interests as a major source of the cash that has fed the real estate bubble in China. And the government has moved to control and reduce the practice.
But that’s just one official policy. A recent meeting led by Premier Wen Jiabao has also resulted in a policy that would encourage lending to “qualified” local government financing vehicles for “public-rental” housing projects. Banks and other financial institutions may lend to such projects directly or through qualified local government financial vehicles. “The central government will continue to increase subsidies and the local governments also need to add financial investments,” said a notice on a government website.
This came just weeks after the China Banking Regulatory Commission banned banks from rolling over or renewing loans to local financing vehicles.
Your guess is as good as mine on how these two “official policies” net out for the Chinese economy.
So where does this leave the poor investor who believes that nothing much matters but how slow China will grow in 2012? First, waiting for the official purchasing managers index on September 30 with the knowledge that in the current state of uncertainty this number has the clout to move global stock markets. Second, knowing that since we won’t know anything for certain about China’s growth in 2012 until, well, 2012, in the short-term, that is for the rest of 2011, we’re left with markets that will react to every China data point but where the “unimportant” events in Europe and the United States are likely to decide if we get an end of the year rally or not. And, third, confronting continuing uncertainty in global markets because of uncertainty about China’s growth rate well into 2012. The least risky way to invest in China in this uncertainty is to put your money into domestically-oriented Chinese companies, rather than exporters, but be prepared for lots of volatility in 2012 to test your convictions.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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