China – much fuss about very little
Willem Sels (pictured), UK Head of Investment Strategy at HSBC Private Bank on how recent data still points to a soft landing scenario in China…
In recent months, concerns have increased that China will experience a hard landing and that tightening measures by policymakers since October 2010 have been too aggressive, especially given the global slowdown we have witnessed in recent quarters. Our view has remained that a soft landing was achievable and that the slowdown in Chinese growth was both engineered and needed. Indeed, given the current size of the Chinese economy, 10% growth is no longer needed and the nominal rate of growth remains robust. We believe that growth needs to come down to a more sustainable pace over the next few years and also believe that where the growth is coming from (domestically rather than from exports) is as important as its rate.
The traditional data dump of Chinese activity releases last week showed that growth remains relatively strong and that activity levels have picked up in March compared to disappointing start of the year, although a few data points remain less-than-encouraging. Year-on-year GDP growth came in at 8.1%, slightly below the 8.4% consensus and below Q4 2011 8.9% growth, but still in soft landing territory in our view. From a quarterly perspective, growth only mildly slowed from 2.0% to 1.8%.
Industrial production has started to improve and retail sales have rebounded from their January and February lows, with a stabilisation in exports. The HSBC PMI came in below the official PMI, somewhat below expectations, but still in expansion territory. Importantly, new loans have increased – significantly above consensus – and M2 money supply is also moving back towards the 14% target level.
In our view, growth may remain near current levels for one more quarter, although Q1 2012 will probably prove to be the bottom. We expect policymakers to ease further – although an interest rate cut seems unlikely for the time being – and growth to rebound during the second half of the year for a full year growth rate well above the target 7.5% announced by
Premier Wen on 5 March. Further, policymakers have enough ammunition to support growth, including USD3.3 trillion of foreign exchange reserves, should it fall to levels they consider undesirable. While a new stimulus package would be surprising, we believe that looser credit standards will continue and ongoing infrastructure projects will continue to be funded, supporting growth.
Encouragingly, inflation has been on a sharp downward trend since its peak at 6.5% last July. It surprised on the upside in March at 3.6% but we believe it should continue to fall in the coming months, although it could prove stickier than previously expected given high energy prices and resilient food prices. In our view, if inflation maintains its downward trajectory, policymakers will have more ability to support growth with easing, cutting the reserve requirement ratio and maybe even interest rates, although this may not materialise for some time.
With stickier inflation, policymakers may also continue with the gradual appreciation of the renminbi as a tool to combat inflation while keeping an easing bias. Even during the market turmoil last year, authorities kept the gradual appreciation on track, and volatility has remained relatively low on CNY. This has also been positive for emerging market currencies, which tend to look at CNY as a regional benchmark.
China just announced the widening of its USDCNY intra-day trading band from 0.5% to 1%, which should also lead to higher volatility of CNH, in our view. In the past, any increased flexibility would probably have led to upward pressure on CNH, but we believe that appreciation will be less consistent in coming quarters.
In our view, Chinese equity markets have oversold recently as we believe that fears of a hard landing are overdone. While risks remain to the outlook, including rising non-performing loans, a cooling property market and the possibility of sticky inflation, we believe that fundamentals do not warrant the current levels. Further, we believe that stimulus will come through in some form in the coming months, which should provide support to markets.
Valuations are currently towards the low end of their 10-year range and well below the 10-year average of 12.3, with a P/E at 9.1. This is also lower than India, Indonesia, Brazil andMexico for example. While there are obvious differences to developed market equities, this is also significantly below the S&P 500 index’s P/E of 14.1.
Nonetheless, we expect the Chinese market, like other risk assets, to remain sensitive to Western developments and moves in global risk appetite. As such, we are likely to continue to see some volatility in the short term.
In our view, fears of a hard landing are overdone as growth is likely to remain above 8% for this year as policymakers have many tools available to support growth if needed. As a result, we believe that Chinese equity markets have been unduly punished for Western worries. We continue to expect some volatility in the short term given ongoing global uncertainties and still fragile risk appetite, but we believe that these provide attractive entry points for the longer term.
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