China Poised For Surprise Rebound

Asia Confidential's picture

It seems the entire planet is bearish on China and questioning its economic data. But as most economists missed the bubbles created by China's 2009 stimulus, they're now missing signs of some economic resilience and a likely pick up in short-term growth as abundant liquidity starts to reach the economy. This means that China could once again defy the naysayers (I've been among them). Any short-term respite though is likely to lead to even greater dependence on debt to drive economic growth and more serious problems beyond this year.

Abundant liquidity to kick in

It appears everyone is an expert on China these days, even though many of these experts have never visited the country and certainly don't know the first thing about its economy. And these "experts" have been befuddled by the recent economic data coming out of China.

On the one hand, some of the data has been weak. Chinese manufacturing saw a slowdown in April, with the official purchasing managers' index (PMI) falling to 50.6 from 50.9 in March. Above 50 indicates economic expansion while below 50 indicates contraction.

This follows first quarter GDP which unexpectedly slipped to 7.7% growth from 7.9% in the previous quarter. And other key indicators have also suggested a slowing economy. For instance, retail sales grew 12.6% year-on-year in March down from the 15% recorded in the fourth quarter on last year. The two most likely explanations for this being a crackdown on corruption impacting luxury sales and some moderation in economic growth.

On the other hand, other economic data have been showing strength. For instance, exports increased 14.7% in April, up from 10% in March. And imports were also up 16.8% in April, from 14.1% in March.

The problem is nobody believes the export data. And rightly so, given the numbers clearly don't add up. Suffice to say that Asia Confidential questioned the reliability of the export data before any sell-side analysts, who were probably scared of getting on the wrong side of Chinese officialdom. Now that the export figures are so blatantly wrong, sell-side questioning has become a team sport. Even my old shop, CLSA, has belatedly jumped on the "dodgy export data" bandwagon over the past week.

Other data have been positive though. Surprisingly, property investment has rebounded after property sales bottomed at the start of last year. Infrastructure investment remains resilient at close to 20% growth, where it's been for much of the past 12 months.

There's also been clear improvement in the supply of key commodities including cement, steel and ethylene. This suggests that commodity producers are confident in future demand. However, steel inventories are rising and therefore it remains to be seen whether that demand will actually eventuate.  

Overall, the data hasn't been anywhere near as bad as many would have you believe. If anything, they've indicated a mild recovery from the third quarter of last year. 

What's confused most observers though is that a substantial uptick in loan and money supply growth hasn't yet translated into a better rebound in growth, reflected in figures such as GDP and the PMI. For example, monthly social financing (total financing including formal and informal lending) in the first quarter of 2013 was Rmb2.1 trillion, higher than the monthly average of any single quarter since the introduction of the data in 2002. While the absolute number is high, it's nowhere near the growth seen in 2009, though it does show a decent uptick.

China social financing - Apr13

China social financing YoY - Apr13

Now, there are a number of commentators suggesting that the reason that the resurgent liquidity isn't filtering through to the economy is because there is a lack of demand for loans ie. in economic parlance, the credit transmission mechanism is broken. This doesn't make much sense given the pick up in loan data.

More broadly, what these commentators don't get is that China isn't the West. Credit transmission mechanisms don't break down because it is a command economy. If the Chinese government wants loans to reach the real economy, it's going to get it. It controls the banking system and key players in vital industries. By contrast, the West can print money all the money that it likes, but it has little say about whether banks lend that money out (currently they're not, reflected in the lowest money velocity figures in the U.S. in 60 years).

The real explanation for increased loans and money supply not reaching the real economy is that there is normally a six month lag. For instance, the first quarter of 2009 stimulus didn't result in a rebound in economic activity until the third quarter of that year. Given much of the recent stimulus came late last year, you can probably expect a rebound in economic growth from mid this year.

China credit vs industrial output - Apr13

To be clear, I'm not expecting a substantial economic rebound but a much more mild one. The key point is that even a mild rebound will surprise markets, which remain overwhelmingly bearish.

Other reasons for a short-term uptick

Besides liquidity, there are other reasons to suggest that a mild rebound may be on the cards:

  • The latest export data have been somewhat encouraging, even if you strip out the blatantly incorrect data. There's little questioning of a mild uptick in exports to developed markets, particularly the U.S. and E.U. The biggest discrepancy appears to be the Hong Kong export data. Growth in Chinese exports to Hong Kong was an extraordinary 57% year-on-year in April and 93% in March. The discrepancy is likely due to over-invoicing in order to circumvent capital controls and bring foreign capital controls into China. The key point is though that if you strip out the Hong Kong figures, Chinese exports grew 9% in the first quarter of 2013, up from 4% and 0% in the previous two quarters.  

China exports - Apr13

  • The import data have been undoubtedly strong and no one has questioned these figures. This indicates improving domestic consumption. A key positive.
  • Retail sales did tick up in March after a disappointing first two months of the year. The impact of the corruption crackdown is likely much broader than just luxury retail. Many government agencies and businesses have historically given gift-cards to employees during holidays seasons. This has clearly slowed, hitting department store sales. I think the odds though favour an easing in the anti-corruption campaign as the new government settles in and focuses on other priorities.
  • Inflation remains subdued. Figures over the past week show producer prices - a measure of prices of goods before they reach the consumer - fell 2.4% year-on-year in April, the 14th straight monthly decline. It follows consumer price inflation (CPI) increasing 2.4% year-on-year in April. It's true that credit growth normally precedes inflation by 6-12 months and therefore you'd expect an increase in inflation in the second half of this year. But given the credit growth hasn't been of 2009 proportions, the impact on inflation and the economy should be more mild this time around. That's assuming agricultural prices are relatively stable.

Still a troubling long-term picture

If the short-term may surprise low expectations, the long-term, beyond this year, still looks highly problematic. The reason is that the economy has become ever more dependent on debt-financed investment for its growth. The chart above, highlighting credit growth versus industrial activity - clearly demonstrates that dependency since 2009. It's likely that the latest stimulus in the last quarter of 2012 has only delayed a sharper economic downturn.

There are four reasons why this is expected to end badly:

  • Credit bubbles always burst. It's not China's total debt to GDP of 190% which is most troubling. It's the rapid 60% increase in that ratio since 2009. As asset manager, GMO, points out China's expansion in credit relative to GDP is considerably larger than the credit booms of Japan in the late 1980s and the U.S. before 2008.

China debt bubble - GMO - Apr13

  • Credit booms that burst are almost always accompanied by property bubbles. There can be little doubt that there are significant real estate bubbles, particularly in the major Eastern seaboard cities. Government data suggest the value of unfinished housing stock represents an astonishing 20% of GDP.
  • The financing of the credit bubble is Ponzi-like. In essence, the central government and local governments have borrowed from largely state-owned banks to invest in increasingly low-returning assets.
  • The growth in the off balance sheet banking, such as wealth management products, is of particular concern. Many of the trust loans have financed cash-strapped property developers. If you're thinking that this has a whiff of U.S. subprime about it, you'd be right.

For these reasons, China's latest stimulus package has only succeeded in delaying a day of reckoning.

Investment implications

If I'm right, there'll be some significant investment implications for the second half of this year.

A mild economic rebound would see the China stock markets also rebounding from current depressed levels. It wouldn't take much for these markets to run given the pessimism surrounding them at present. You'd see the beaten-down cyclical sectors take the lead.

You could well see a turnaround in the depressed industrial commodities. Again, it wouldn't take much for a turnaround given the negative sentiment towards these commodities.

Countries and currencies reliant on China could also see a surprising rebound. Think the likes of Australia and Canada. 

More broadly, you could see renewed hope of a global economic recovery, with China leading the way. That may be reflected in stock markets outside of Asia, depending on the circumstances in other major economies, such as the U.S. and E.U.

But let me stress that as a long-term investor, you'd be taking on significant risk if you choose to participate in any China-led rebound. If you want to speculate and trade it, fine. Be fully aware though, that you likely to be picking up proverbial nickels in front of a steamroller as the long-term picture for China remains dim. 

This post was originally published at Asia Confidential:

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MythicalFish's picture

Great article, thank you. Your warning reminds me of August 2007 when all China bears got slaughtered because of liquidity before the reckoning came. This mistake is unlikely to be repeated (and China is in worse shape), but your caution in my opinion is very valid nonetheless. Also, China will not be kind to the bears, so unless people can access the convexity of CDS like Hugh Hendry et al, its gonna be a tough game to beat. What strikes me as an interesting trade is long dated banking calls which are quite cheap and may be converted into synthetic puts in the case of a short squeeze. If the market falls too far, single stock futures are not the place to be in either though.

JOYFUL's picture

The point of transition in which China finds itself right now is open to considerable differences of interpretation... along the lines of glass half empty... or half full. But something apparently makes it necessary for some to insist that all interpretations must lead in the end to bearishness ...due to something which they call the 'china bubble.'

Why is it a 'bubble'? Why, because they say it is! That's why...nothing else make sense! And indeed... it doesn't... till one stops tilting the table!

Here is a country crossing out of a 3 decade long period of building up it's exports - and trade surplus' - into a totally different part of it's cycle... in which ODI, growing at a rate of over 20% per annum, will overtake foreign direct investment in less than five years. Those harping on 'falling exports' will simply refuse to take this in -doesn't fit with the script.

That China's overseas investments grow exponentially at the same time that overall global investment is stagnant or shrinking can be dismissed, of course, as meaningless data. That China can and will use it's massive foreign reserves to back Chinese companies in overseas expansion will not occur to these same uber-bears amongst us. This massively significant shift from production for export models to a much more profitable... but time lagged ownership of foreign production model is simply beyond their ken. All the matters is that Chinese is or is not replicating the patterns of development expected of them in MBA studies or repeating the theoretical models of failed western economics. Hilarious!

The joke is repeated when one moves to the domestic scene. Housing investment is falling apart. BUBBLE BUBBLE BUBBLES! That upwards of 2\3 of China's total fixed investment is going to infrastructure - long-term, durable public infrastructure investments including subways, railways, highways, urban public facilities and the national water system ...must be treated as another 'meaningless statistic' one gathers! This at a time when public infrastructure(as in...long term investment in things necessary for future growth!)in the west is falling apart!

Ok. So let's get with the program here, and change the title of this article to what it should read to meet our bearish bretherns expectations: Misery loves company - Why China's decoupling from the west's pending doom spells big trouble in lil Chinatown!

I'll say it one more time... Great, balanced piece of writing by the author...

which seems to ruin some peoples day!

williambanzai7's picture

Here is a bit of interesting China reading I stumbled across this week:

One of the first things I learned when I came out here 10 years ago is the absolute disconnect between people who think in 24 hour data/news cycles and Central Planners who seriously believe they can and actually try to plan in grandiose increments of 5, 10, 25 and 50 years.

The shallow analysis of many MSM China pundits seems to be driven by their insatiable thirst for some kind of hot and spicy schadenfreude.

I remember what I thought 10 years ago on my first trips to China and I can assure all what has happened subsequently is not what I expected back then. 

Of course, much of China's evident successes can be attributed to the short term myopia of it's rivals as much as it's own ambitions. 

I find the linked article interesting not because I am eager to judge the Chinese people, but because it hints of the immensity of the task that the Chinese government deals with in managing China's rapid modernization, a tall tall order indeed.

There are two things I am pretty sure about at this time: the days of state chronys (pun) wearing Patek Philippes are over and the days of planning an exit to suburbs of Los Angeles and NYC or Vancouver have begun in earnest. When these kinds of  chrony-watch collectors depart, they will NOT be affectionately remembered as "sea turtles" who are welcome to return.

Element's picture



" ... For instance, the first quarter of 2009 stimulus didn't result in a rebound in economic activity until the third quarter of that year...."

Not really, Australian iron ore had cranked production back into high-gear by June 2009, demand had exploded by then. You are also discounting that oil and coal was still at very low levels, and commodity currencies were in the toilet, and the industrial commodities themselves were at historic discounting levels.

That is not the case now.

Element's picture



" ... If the Chinese government wants loans to reach the real economy, it's going to get it. It controls the banking system and key players in vital industries. By contrast, the West can print money all the money that it likes, but it has little say about whether banks lend that money out. ..."

I'd say that CHI-GOV 'benefit' is not a good thing, it's more of a landmine, that lends itself to dangerous abuse, as the market is not involved in moderating the debt excess and affect on prices. Recipe for serious dislocation ... on a long enough timeline.

RagnarDanneskjold's picture

China's export numbers are fake and now people who are faking it are talking. The story was out this morning in China. Exporters are broke and can only earn profits by doing currency arbitrage (now that the real estate market is burnt out). Since there is cross-border settlements of yuan, they only do a one-way trade in USD and settle in yuan. So whatever % of GDP that trade is overstated, it represents the one-way inflow of USD into the Chinese banking system as part of a massive arbitrage scheme by the export sector. This is why the government is targeting banks and exporters because they can't shut it down without reversing currency reform or pushing ahead and opening it further to let USD flow out freely. 

Yuan Arbitrage Replaces Trade as Exporters Go Bust; Endgame Begins for China Bubble


Tyler Durden's picture

You may want to read on the surge and accumulation of bad loans, something you didn't mention once in your piece, in the Chinese economy: Credit Shock Dead Ahead: China Money Formation Soars To 2-Year High As Delinquent Loans Surge By 29%

As for your simplified view of the delay in response to money injection, i.e., credit inertia, another place to start getting an informed opinion would be here: The True Chinese Credit Bubble: 240% Of GDP And Soaring

Asia Confidential's picture



Thanks for the comments.

Yes, I agree with both of your points. Where I differ with fellow China bears is on whether a sharp economic slowdown happens now or 18 months down the track. I've tried to present a basis, some of it admittedly simplified, for why the odds may favour a delayed crisis.

On your second point, I think my admittedly simplified view presents a similar case: that China has become credit dependent and that it has to push more credit into the system but is getting less bang for its buck, so to speak. It doesn't mean that there won't get some bang for its buck and very soon. No doubt though, it will make their predicament worse.

I suppose the key issue is whether current stresses in the system are such that a near-term crisis appears inevitable? No one can be certain of the answer but the evidence doesn't appear so clear cut to me.

JOYFUL's picture

How legacy! An actually balanced piece of reportage... which has the grace to flat out admit...

China... is not "the West" ... and therefore... "Western" measuring sticks are clumsy instruments for gauging it's condition. After CHS cut n paste jappery, and the raft of self-anointed experts who have breezed through the turnstiles here of late... it's great to have an antidote at last!

btw... just one thing... your inflation stats seem suspectly benign... source?

Asia Confidential's picture


Of course, the inflation stats are government ones, making them inherently unreliable. However, agriculture is a large component and we know where agricultural prices have been heading lately. Also, it's clear that many Chinese industries have been saddled with overcapacity issues, which has put downward pressure on prices. That's why the ppi figures of the past week were negative for the 14th straight month. These points gel with what I've been hearing from Chinese colleagues on the ground about inflation.

Thus, at least in this instance, the stats appear to be close to the mark.