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China's leaders decide reform is too risky and go for growth
07/20/2012 8:30 am EST
Remember all that rhetoric about the need to move China’s economy away from export-driven and toward domestic consumer-driven growth? Forget it.
Remember the pledges not to repeat the infrastructure and industrial sector spending that rescued the Chinese and global economies during the financial crisis in 2008? Toss ‘em in the trash.
Remember the efforts to damp real estate speculation and to cool China’s over-heated real estate sector? Stamp them “rejected.”
China’s leaders have read the official numbers that show China’s economy slowed to a 7.6% annual growth rate in the second quarter of 2012; they’ve looked at the unofficial numbers—things like electricity consumption—that strongly suggest the official growth numbers are significantly overstated; and they read the projections from the International Monetary Fund and others that Europe’s slowdown will be even more pronounced that expected in the second half of 2012 and the recovery in 2013 anemic.
And they’ve decided that the risk to their control of China is just too great. Maintaining the implicit bargain between China’s leaders and the Chinese population that rests of the ability of the Communist Party to deliver economic growth and a rising standard of living remains the government’s priority. And reform of the country’s economy will just have to wait.
Without fanfare, without any of the hoopla that accompanied the stimulus flood of 2008, without even a clear reversal of former rhetoric, China’s leaders have gone back to the tried and true playbook. China has, once more, embarked on an investment-driven, infrastructure heavy, government-financed effort to stimulate the economy.
In the short run I think the effort will work. Growth will rebound in China and that will push growth higher in the global economy too.
In the long run, though, it will leave all the inefficiencies and mis-allocations that the now abandoned reform program was supposed to address still in place. The fix has been put off to another day. With the hope, a dangerous hope in my opinion, that the problems won’t be much worse by the time China is ready again to deal with them. (I doubt that will prove to be the case. It will be just that much harder to tackle China’s fundamental economic problems from a crony-favoring banking system to zombie state-owned enterprises down the road.)
What has happened in the last few weeks to convince me that China has made this huge shift in policy—without a major policy announcement?
Take a look at two important indicators, airports and railroads.
On July 12 the web site of China’s State Council published a post saying that China will increase spending on construction of airports and other air travel infrastructure. The statement was the second recent official notice of the government’s intention to increase spending on air travel infrastructure. On June 11, the head of China’s Civil Aviation Administration, Li Jiaxiang, told the online version of the People’s Daily that China’s major airports are now running at full capacity and that China will build 70 new airports and renovate or expand 100 existing airports. That’s a big increase from plans for 45 new airports within five years announced in 2011.
On July 17 a document posted on the website of the National Development and Reform Commission’s Anhui office reported that the government had increased its investment goals for China’s railroad system by 9% from the previous 411.3 billion yuan ($64.5 billion) total. Full year spending will climb to 448.3 billion yuan. That would require about 300 billion of investment in the second half of 2012, up from 148.7 billion yuan in the first half of the year.
I think this expansion in railroad spending takes an axe to the argument that China wouldn’t be able to pursue a 2008-style stimulus package--$586 billion (or the equivalent of $780 billion to $1.35 trillion, depending on how you calculate China’s GDP, in the much bigger U.S. economy)—because the country’s banks, local governments, and government ministries have taken on too much debt. The new railroad spending total was preceded by a huge increase in the debt ceiling at China’s deeply indebted Ministry of Railways. In February 2012 the Ministry of Railways was brushing up against a ceiling that limited its debt to 40% of its assets. That limit would have let the ministry issue just $2.1 billion more in bonds. But on May 29 the State Council approved a proposal by the National Development and Reform Commission to increase the debt limit to 100% of the Railway Ministry’s assets from the previous 40%.
Yeah, China can’t stimulate its economy like it did in 2008 because it’s constrained by the debt it already carries on its books. [Sarcasm alert.]
Chinese speculators, traders, and investors, accustomed to reading the veiled hints that the Beijing government drops about changes in policy, have concluded that the government has not just begun another round of stimulus but is increasing the speed of that effort.
No matter what officials say about policy.
You can see this most clearly in China’s real estate market. Premier Wen Jiabao, as recently as July 7, pledged that the government would continue its efforts to slow real estate price increases and to stomp down hard on real estate speculation.
But it’s clear from recent data that the real estate market doesn’t believe the official line any more. Sales and prices have started to climb again and local governments are moving to relax some of their restrictions on purchases and mortgage financing. In June, for example, prices of new homes in 100 mainland cities rose—granted by just 0.5%--for the first time in 10 months, according to the China Real Estate Index System run by SouFun, China’s largest real estate website. Sales of homes rose for a second month in June by 41% from May according to the National Bureau of Statistics. Sales were up even though developers have started to eliminate discounts to buyers. Home prices are still down 1.9% from June 2011 and I think Beijing will try to keep enough controls in place to avoid a revival of the speculative fever of 2009 or so, but with mortgage rates falling, the market certainly shows signs of a bottom.
There is always the possibility that the real estate and financial markets are mis-reading the tealeaves and that China isn’t embarked on a program of increased stimulus. In that case the current so-far modest rise in shares of China’s real estate development companies, airlines, and infrastructure companies will be reversed or worse.
I don’t think that’s going to turn out to be the case, however. I think these tealeaves are indeed a reliable indication that China’s government has decided to press down harder on the gas pedal.
If you agree that’s the case—and if you agree, I think you’re going against the current negative consensus on China that seems to have lined up in favor of a hard landing—what stocks should you look at?
In the early stages I think you go with shares of companies with the most direct exposure to the increased stimulus spending. Among airlines, the New York traded ADRs (American Depositary Receipts) of both China Eastern (CEA) and China Southern (ZNH) look to have bottomed and to have begun to move higher on anticipation of increased stimulus. I’ve not been able to find a similar U.S.-traded play on railroads. China’s two big railroad construction companies, China Railway Group (390.HK) and China Railway Construction (1186.HK), both trade on the Hong Kong market. The commodity most sensitive to an increase in China’s growth rate is copper. Unfortunately, the best China copper stock, Jiangxi Copper (358.HK), also trades only in Hong Kong. A decent U.S.-traded substitute is Aluminum Corp. of China (ACH), which trades as an ADR. I don’t have a suggestion for a U.S.-traded China real estate developer. If you can buy shares in Singapore (ask your broker’s foreign desk), take a look at Keppel Land (KPLD.SP.)
If we get to September or October, say, and the evidence for the stimulus effort is clearer, I suggest moving on to stocks that are secondary beneficiaries of any increased growth in China’s economy. That would include in China, Home Inns and Hotels Management (HMIN), Ping An Insurance (2318.HK), Tingyi Holdings (322.HK), and Sands China (1928.HK.) I’d also look to China-linked stocks such as Freeport McMoRan Copper & Gold (FCX) and BHP Billiton (BHP.)
By all means wait for the September/October time frame if you’re not convinced these tea leaves are predicting the future of China’s economy. At all times China is one of the world’s more volatile stock markets but at the cusp of a possible transition from slump to pickup, it’s likely to be even more volatile than usual. The last thing you want to do right now is buy and then get shaken out by the next panicky day and then buy in and get shaken out again. That gets rather expensive.
Wait until you’ve got the conviction to stick out a slump or two even if that means you have to worry that you’ve missed a bottom. You always get plenty of buying opportunities from China’s volatility.
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 own shares of Freeport McMoRan Copper & Gold, Home Inns and Hotels Management, Keppel Land, Ping An, Sands China, and Tingyi Holding as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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