CLSA's Chris Wood Explains Why Chinese Tightening Moves Are A Whole Lot Of Noise
With everyone speculating what China's actions may mean, we go to one of the few true experts on the world's most populous country - CLSA Chris Wood (author of Greed and Fear).
Risk is suddenly “off” again. After a two-week “road show” in the US GREED & fear met his first “stressed” investor last Friday. This was a reminder that many in the long-short absolute-return investment community are not temperamentally positioned for price moves to go sharply against them for even more than one day. This is also a reminder that many in the same community were still running low risk positions going into September. As “risk” was piled on in the proceeding two months in the run up to QE2, there is a natural desire to lock in any profit outstanding on any hint of weakness, most particularly with the end of year score line pending. This dynamic clearly creates the potential for more of a correction.
What about the cause of the latest scare in Asia? That is the China inflation/tightening scare. Fundamentally, GREED & fear cannot get too concerned. As noted by CLSA’s China macro strategist Andy Rothman, this remains primarily a food inflation story (see CLSA research Sinology – Food fight!, 11 November 2010). Food CPI rose by 10.1% YoY in October, accounting for 74% of the 4.4% YoY increase in headline CPI, while core CPI (excluding food and energy) rose by only 1.3% YoY (see Figure 1). Most particularly, consumer prices for fresh vegetables and fresh fruit were up 31% YoY and 17.7% YoY respectively in October.
The reality is that, for now at least inflation ex-food remains remarkably tame based on CPI inflation data. Still the political sensitivity of food means the PRC is making executive decisions, such as imposing price controls on specific food items or threatening to lock up commodity hoarders. This makes investors nervous. Such measures have put a policy risk on the commodity stocks in the same way that policy risk has capped the Chinese property stocks over the past year and more. Still GREED & fear would use this correction to add to positions in Chinese bank and insurance stocks which would seem to be the beneficiaries of higher interest rates in China.
As for monetary tightening in China it is important to remember, amidst the present noise, that the key tightening measure in the command economy system is the loan growth quota not interest rate hikes or increases in the reserve requirement ratio. For now CLSA is estimating that the new loan quota for 2011 will be reduced relatively marginally from Rmb7.5tn this year, or 18% loan growth, to Rmb6.5-7tn or 14-15% loan growth. CLSA’s head of HK & China financial research Kevin Chan also expect full-year new loans to surpass the Rmb7.5tn mark this year, with new loans for the first ten months of this year already reaching Rmb6.9tn or 92% of the full-year target (see CLSA research China Banks – Ahead of target, again, 12 November 2010).
Meanwhile, it is also worth remembering from an overall stock market perspective that the last time inflation and interest rates went up, which was in 2007, the A share market rose as its focus then was on the positive of a stronger economy. Thus, the A share market rose by 110% during a period when there were six interest rate hikes in China between March 2007 and December 2007 before the one-year lending rate peaked at 7.47% (see Figure 2). While CPI inflation rose from 2.7% YoY in February 2007 to a peak of 8.7% in February 2008.
With the Chinese property market still the subject of government cooling down measures, it will be interesting to see if the same dynamic takes hold now. There is certainly the domestic liquidity to fuel a stock market move. Household savings deposits totalled Rmb29.9tn at the end of September, compared with the current A-share tradable market capitalisation of Rmb20tn. While average daily A-share market turnover rose to a record high of Rmb470bn last week, up from Rmb100bn in early July (see Figure 3).