5 reasons why China’s worries are not as bad as they look
Realising last decades’ 10% plus growth was not sustainable, the Chinese leadership has been engineering a downshifting in growth to a sustainable pace.
China grew 7.4% last year which was close enough to the Government’s 2014 target of “around 7.5%”. Well and good, but January and February data show a distinctly soft start to the year, with a range of indicators losing momentum including industrial production, retail sales, fixed asset investment, imports and money supply and credit.
Of course, this data needs to be treated with caution due to the distortions caused by the timing of China’s New Year (best wait for March data before getting too excited) and strong exports look like providing a bit of an offset to soft domestic demand. Nevertheless, growth does appear to have slowed.
The Government’s 2015 growth target is ‘around 7%’ with three factors posing downside risks:
Property has gone from boom to bust and this includes property investment. The slump in property investment and prices are all weighing on growth.
The desire to slow lending outside the banking system and a fall in inflation to 0.9% year on year for non-food inflation and to -4.8% year-on-year for producer prices has led to a de-facto monetary tightening with a rise in real borrowing rates.
Government reforms have been weighing on growth – notably crackdowns on corruption, pollution and excess capacity.
Assessing the worry list
Our view remains that China’s issues are not as bad as they look:
The investment/consumption imbalance is exaggerated – as consumption is understated relative to investment in China, investment per capita is low and reducing investment too quickly will only risk China going down the same inflation/trade deficit path seen in many other emerging countries.
China is not losing its competitiveness – wages growth is being offset by rapid productivity growth, China is still gaining global export share and inflation is low and falling.
There was no generalised housing bubble – household debt is low at 30% of Gross Domestic Product (GDP), house prices didn’t keep up with incomes and there’s an undersupply of affordable housing. Yes there has been excessive supply in some cities, but not in first tier cities.
The rapid rise in debt of 22% pa over the last decade is a concern – public and total debt relative to GDP is not excessive by global standards and strong growth in debt reflects China’s 50% savings rate with savings mainly being recycled via debt.
China’s ‘shadow banking’ system is small. While the shadow banking system (lending outside the banks) has grown rapidly but it is relatively small (30% of banking assets versus 100% in the US) and lacks leverage, complexity and foreign exposure. So it’s not comparable to the risks around US shadow banking that drove the Global Financial Crisis
Overall our assessment remains that these risks are manageable. Much of what goes on in China is controlled by the government; and the government has plenty of firepower to ensure growth holds up.
What does this mean for SMSF investors interested in the Chinese share market?
After a 77% gain from its June 2013 low Chinese shares listed in China (A shares) are no longer dirt cheap, with an historic price-to-earnings ratio (PE) of 15 times and forward PE of 13.5 times. However, they are still reasonable value, particularly against their own history.
Meanwhile, Chinese companies listed in Hong Kong, or H shares, have lagged in the recovery and offer better value with a forward PE of around 8 times. Both mainland and HK listed Chinese shares will benefit from further monetary easing and so both offer good return prospects for SMSF investors.
Implications for Australia
While China has slowed from last decade, it’s still consuming record quantities of Australian commodities. In fact, growth in volume demand from 7% GDP growth today is equivalent to 14% GDP growth a decade ago as the Chinese economy has more than doubled in size over that period. Rather the real problem for Australia is that the supply of commodities has now caught up with demand and this will continue to weigh on commodity prices going forward. The good news though is that the risk of a hard landing in China remains low and so a collapse in commodity demand is unlikely.