Stockbrokers are a gullible lot ... especially when it comes to China. After better economic news from China, they've been tripping over themselves to declare a bottom to the economy there and project a sustainable recovery for 2013. What they've largely missed though is the shaky foundations to the improving data, including: 1) A large (baffling?) rebound in E.U. exports 2) Quietly implemented stimulus likely totalling north of 1 trillion yuan 3) Principally investment-fuelled growth - exactly what got the economy into trouble in the first place 4) Increasing project financing from outside the banking sector, a highly contentious and risky development. China's stock market probably has further to run but it's not because the economy is on a firmer footing.
The Data Don't Lie ... Much
On many trips to China over the years, I've always been struck by the inherent faith that the financial community has in the central government's ability to manage the economy. It's hardly surprising given the spectacular rise of the Chinese economy over the past decade. And faith in the supposed mystical powers of central bankers certainly isn't just confined to China.
That belief could well have some justification though, if the latest economic data out of China is anything to go by. The data shows a gradually improving Chinese economy. If that trend continues, the Chinese government will have performed a minor miracle: engineering what can hardly be described as a soft economic landing after the spectacular credit binge of 2009-2010.
First, let's take a look at the facts:
- China's monthly trade surplus widened to US$31.6 billion in December, from US$19.6 billion in November.
- The surplus was driven by a 14% increase in exports, up from 2.6% in November.
- Imports rose 6% in December after being flat in November.
- Bank lending figures disappointed, with 454 billion yuan of new loans in December, down from 523 billion yuan in November.
- Total credit financing was higher than expected though, increasing to 1.63 trillion yuan in December, up from 1.14 trillion yuan in November.
- Inflation figures came in higher than expected at 2.5% in December, from 2% in November.
- Money supply (M2) grew 13.8%, below analyst estimates.
Source: CEIC and Citi Research
Source: CEIC and Citi Research
The data left many an analyst tipping further economic improvement in China in 2013. HSBC economist Ma Xiaoping stating: "Exports in 2013 are likely to improve and show some upside surprises, as the U.S. economy could be better than expected and the situation in the E.U. will be stable".
Lots of assumptions in that one statement, but setting that aside, is the Chinese economy really on the mend? Count me a sceptic, for the following reasons:
- Chinese exports to its biggest trading partner, Europe, rebounded from -18% growth in November to +2.3% growth in December. Given the deterioration in European economies during this period, this has left me scratching my head. Suffice to say, it's highly unlikely to prove sustainable.
- Nobody is talking about the impact of major stimulus on recent growth. In September, China announced approvals for infrastructure projects worth 1 trillion yuan, roughly a quarter of the massive stimulus packaged announced by China during the GFC. It's not clear how much of this money has been spent, but recent strong infrastructure spend figures (25% growth year-on-year) and the spectacular rise of commodities such as iron ore (up from US/t in September to above US0/t) provide some good clues. It's clear China has pumped an extraordinary amount of money into the economy, but unlike the GFC, they've done it quietly.
- Investment spending - primarily evidenced by still strong fixed asset investment growth figures - has been a key driver of the recent turnaround. This directly undermines the government's goal to decrease the economy's reliance on investment in favour of consumption. In other words, a highly lopsided economy has just become more lopsided.
- Significant growth in lending from outside the banking sector is a major concern. In 2012, total credit financing grew 20%, with trust loans up 80%, FX loans up 27% and bond financing increasing 45%. Lending by the banking sector has slowed as liquidity is tight and one suspects there are many problematic loans from the 2009-2010 credit binge. Loans provided outside of the banks carry much more risk given minimal regulatory oversight. The so-called shadow banking system is becoming a central issue, with Fitch now estimating total credit to China GDP at 190%, up from 124% in 2008.
All of the above casts doubt on the sustainability of the economic recovery in China. While government measures to stabilise the economy have worked in the short-term, they may be sowing the seeds for a more serious downturn later on.
China Markets Heading Higher
Why on earth do I see further upside for China's stock markets then? Back in October, Isuggested that it was time to buy China:
"It's trendy to be bearish on China. Newspapers, magazines, brokerage reports and blogs: the negativity is overwhelming. Can they all be correct? Maybe. But my experience tells me when everybody's betting on one side of a trade, it pays to take the other side of that trade. Especially when the negativity is largely baked into valuations, as it is with China, now close to 2008 financial crisis levels. And when there are potential turnaround catalysts of economic stimulus and/or reforms when the new leadership is formed next month."
I subsequently appeared on CNBC suggesting the Shanghai market had 20-30% upside from October levels. The call turned out to be five weeks early, but since bottoming in November, the Shanghai Composite Index has risen 16%.
The Chinese market probably has 10-15% further upside from here. The reasons are largely similar to those expressed in October, namely reasonable valuations coupled with obvious potential catalysts from structural reform via new leadership. To those reasons, I would add another: a wall of freshly-printed central bank money looking for a home, making likely targets of laggard markets such as China.
Note that the call to buy China in October didn't have anything to do with an improving economy. It's just that the stock market was already reflecting a hard economic landing. With the recent run-up in stocks, that's less the case now, but still largely holds true.
Game On: Japanese Stimulus Unveiled
My other favoured Asian stock market, Japan, is continuing its rise. It can thank the new Prime Minister, Shinzo Abe, for that. Mr Abe's unveiled a 10.3 trillion yen (US6 billion) stimulus package. He's boldly claimed the package will raise GDP by two percentage points and add 600,000 jobs to the economy.
Of the money, 3.8 trillion yen will go towards disaster prevention and recovery and 3.1 trillion yen will be directed towards private investment, including promoting clean energy and energy saving. Interestingly, the government is also considering introducing new measures to stabilise the currency market using a special account in the nation's foreign exchange fund. To help pay for the package, the government is going to compile an extra 13 trillion budget in the current fiscal year, including selling 5 trillion yen in bonds.
The market reaction to the news was swift. Stocks leapt higher while the 30-year government bond yield reached its highest level since August 2011. And the currency slid through 89 per dollar at the time of writing.
The country's bleak economic prospects were also highlighted by figures showing that its current account went into deficit in November. As mentioned last week, this effectively means that the government will have to fund its large budget deficit via loans from other countries rather than from its own citizens. Foreigners are likely to demand higher rates to compensate for the risks of holding Japanese government debt. Rates just need to rise to 2.8% for government expenses to equal government revenue.
The yen looks somewhat oversold in the near-term, being the world's most shorted currency at present. But the long-term picture seems pretty clear: the Japanese balance sheet is unsustainable and Mr Abe's measures will weaken the Yen and probably bankrupt the economy. Japan's endgame creeps closer.
Markets Elsewhere Look Vulnerable
Just a quick note on markets elsewhere. Developed markets, particular the U.S., look vulnerable here. The proverbial wall of central bank printed money is finding its way into stock markets, but not economies. This should become more apparent as the U.S. earnings season unfolds. Consensus earnings forecast growth of 2.9% for the fourth quarter of last year looks optimistic. I expect growth closer to 1% and downgraded expectations for coming quarters.
Given this, the upcoming fight over U.S. government spending cuts and the debt ceiling, plus many equity sentiment indicates showing risk appetite at elevated levels, a correction in the U.S. should happen soon.
Another thing to note is the sharp rise in U.S. bond yields. This is the result of rising real yields rather than nominal yields. In plain English, bond yields haven't risen from increased inflation expectations. This will need to be closely watched as hints of heightened inflation expectations would be very bullish for stocks and could spell the end of the more than 30-year bond bull market.
I don't expect this to happen though. As further weakness unfolds in developed market economies, you should see stronger bond prices and weaker equity markets.
A Year Older (If Not Wiser)
I'm celebrating my birthday today (37th, if you must know). As my father tells me: "You're getting closer to 40, son."
Besides more wrinkles and increased girth, I find ageing is mostly a pleasant experience. When younger, I was constantly trying to get more out of life. I suppose that's what led me to working and living in many countries across Asia.
I'm more content now. Perhaps that comes from having a young child. It doesn't mean that I don't want to get the most out of life, it's just I'm more thankful for what I've got.
Anyhow, enough with the reminiscing.
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Have a great weekend,
James
Source: Asia Conf.
