image

Facts, Fears and Opportunities in China


  • Even if China is slowing down, the growth is still excellent and the potential is huge.
  • The Chinese market is 43% down from its 2015 high.
  • Short term fears might give trading opportunities as the long term trend is a growing one.

Introduction

In the last twelve months there has been a lot of talk around China with various economic forecasts and explanations which resulted in a severe negative influence on markets ranging from stocks to commodities. This article is going to give an overview of what happened in the last year, and some scenarios of what might happen and how that should influence financial markets.

China

In August 2015, China’s central bank (PBOC) made a move to devaluate the Yuan in relation to the dollar. The move was influenced by the government’s worry about slowing growth and to make the currency more market driven. The move created various market shockwaves and shows what kind of power and effect China has in today’s world. By the end of August, the S&P 500 fell by 12% and commodities further declined to five year lows based on fears of slowing Chinese demand. The devaluation of the currency was made in combination with quantitative easing where the aim was to stop the steep fall of the Chinese stock market. The Shanghai stock index started its steep decline in June 2015.

1 Shanghai

Figure 1: Shanghai Stock Exchange Composite Index. Source: Bloomberg.

From a multi-year perspective, it is clear that the market was in a huge bubble because it grew from 2,000 points in 2014 to 5,166.3 points in June 2015. The current level of the Chinese market is down 43% from its peak, but it is still up 50% from the 2014 levels. The PBOC intervened in order to lower the possible repercussions of a market meltdown. All of the above was mostly influenced by the slower growth of the Chinese economy.

2 China GDP growth

Figure 2: Chinese GDP growth per quarter. Source: Trading Economics.

The slower growth and a switch from a manufacturing economy to a service economy is what has made the global market tremble. The International Monetary Fund expects the Chinese economy to grow at a rate of 6% in 2016 and 2017, and a switch to a service economy is feared to lower demand for commodities. An even slower growth than expected could have repercussions similar to the ones the financial and commodity markets experienced in 2015. The last info about Chinese growth is a 6.8% increase for Q1 2016 which was considered positive news and further fueled the recovery in commodity prices, but the information from the Chinese Bureau of Statistics shows that despite quantitative easing and a stronger real estate market, Chinese manufacturing grew at a slower pace in April in relation to March. The manufacturing index was at 50.1 for April which still indicates expansion but flirts with contraction as it is close to the 50 mark.

With the exception of manufacturing, the question is not if the Chinese economy will continue to grow, but how fast it will continue to grow. As the Chinese GDP per capita increases the country loses some of the competitive advantages it had in comparison to the rest of the world but the increased development enables a different, more service oriented growth. Chinese GDP per capita is currently $7,990 which is only 14% of the US’s and shows how much potential China still has.

But, the service oriented and less construction oriented growth has severe implications. The exports of most emerging countries and Australia are strongly related to Chinese demand and therefore those markets are severely affected by any kind of Chinese slowdown, especially a manufacturing or real estate one.

3 economicst

Figure 3: Percentage of exports to China. Source: The Economist.

Australia, African countries, Middle East oil producers and South American commodity exporters are all highly dependent on the Chinese economy. As the above mentioned countries and regions are big enough to influence the global markets, every investor should keep an eye on what is going on in China.

Short and Long Term Forecasts

It is important to look at China from an objective perspective and not in comparison to what happened in the last 25 years. Growth rates higher than 10% are much more easy to reach when the starting point is low like it was for China. As the economy grows, the global competition kicks in and levels economic growth. The current situation is one where exports are lower, bad loans are rising, and the industrial sector is at its weakest since 2009. Capital outflows in 2015 were $1 trillion and the PBOC is trying to limit the damage by injecting fresh capital into the market.

At the same time industrial and structural trends are turning against China.

4 trends

Figure 4: Chinese industry trends. Source: OECD.

As shown above, industrial output growth has declined from 9% to the current 6%, manufacturing investing has fallen and state-owned enterprise profits are falling. This in combination with the negative demographics where the Chinese working-age population is shrinking due to the one child policy, which does not paint a rosy picture. But the forecasts are all still indicating growth, albeit a slower one. Also the demographic fears should reflect on the Chinese economy only in the very long term; currently 47% of the population is between 25-54 years, thus in prime productivity.

The government targets a growth rate from 6.5% to 7% and has planned the highest budget deficit in the last 25 years which should help the economy. The IMF forecasts Chinese growth at 6.3% in 2016 and 6.0% in 2017, while the OECD forecasts 6.2% in 2016. Not to forget that even if the economy will grow slower it will still grow. A growing Chinese economy can only benefit the global economy and markets. Therefore, the question is not if China will grow or not but how much imbalance it will create in financial markets in relation to it over performing or underperforming expectations. In any case, as a well-diversified portfolio should have some assets in the soon-to-be World’s biggest economy, below are some ideas on how to invest in China.

Chinese Investing Opportunities

One way to be exposed to China is to buy stocks of companies that have a strong exposure in China like Alibaba, Baidu or China Life Insurance that are traded on US markets. The list of Chinese stocks traded on US markets can be found on Nasdaq. A warning here, Chinese accounting and the Chinese securities and exchange policies might vary from US ones and deeper scrutiny is necessary to understand what is really going on in the business represented by the stock. Another opportunity to invest is through ETFs.

Conclusion

Even if China is currently experiencing a slowdown in growth it is almost certain that China will continue to grow in the short term and in the long term. A well-diversified global portfolio cannot miss out on such a growth potential. The Chinese GDP per capita has to grow 7 fold to reach the US GDP and the Chinese seem determined to grow at all costs. If the market has reached its bottom depends mostly on the short term news on Chinese growth and there lies the risk of investing in China, it takes a lot of courage to invest in a market that is more than 40% down in the last year, but such markets also create the best opportunities. For anyone more interested in trading short term, expectation misses in Chinese performance might give good trading opportunities as the underlying long term trend is a growth one.

 

Previous
Next