The Beijing authorities need to act carefully to avoid both being overly generous with stimulus and fuelling an asset market bubble, or being too restrictive and pulling the rug out from under the Chinese economy.
The latest batch of economic data vindicates our assessment that Chinese GDP growth bottomed in Q1 2019 amid signs of stabilisation in Q2. Q1 real growth came in at 6.4% year-on-year (YoY), beating market expectations. Major indicators including industrial output, retail sales, property sales, fixed-asset investment growth and car sales, showed signs of recovery. We continue to expect a mild bounce in the second half, with an upside risk to our forecast for full-year growth of 6.2% YoY.
Slower Chinese growth, less inflation, but green shoots nevertheless
Onshore stocks had a muted reaction to the data, reflecting investor concerns that an improving economy might prompt an early end to policy easing or even a return of the debt reduction measures that delivered the slowdown in the first place. The green shoots have yet to turn into a solid recovery.
Q1 nominal GDP growth slowed to 7.8% YoY from 9.2% in Q4 2018 as the GDP deflator fell sharply to 1.4% YoY from 2.9% in Q3 and 2.7% in Q4. However, we believe the People’s Bank of China is not done easing yet since the expected growth recovery will likely be modest as Beijing aims at keeping growth at between 6.0% and 6.5%. While this recovery is expected to be strong enough to stabilise the labour market, it will not set off any economic overheating. Inflation is being kept firmly at bay – the recent supply shock that pushed up pork prices and the headline consumer price index should not last – and core inflation is anchored at below 2.0%. Accordingly, we see little risk of a shift to monetary tightening.
A favourable constellation
Non-inflationary growth is still favourable for risk assets. With GDP growth expected to bottom out and recover in the second half – without any inflation threat – the near-term environment also looks bond positive. But Chinese yields may soon trough as liquidity and the economy continue to recover. Onshore credit spreads are stabilising and will likely roll over soon.
Risk-on trades on Chinese stocks should prevail, although the headwinds to stock-price advances remain. They include
- weak profit growth in the near term as the decline in the producer price index (PPI) crimps industrial (large-cap stock) profits
- the tail-risk of Sino-US trade negotiations going bad
- the risk of regulatory tightening to reduce stock punting, which has been on the rise.
To ease or not to ease
The Chinese authorities are facing a delicate balancing act. Any continued liquidity rebound may fuel an asset market bubble. We believe the last thing Beijing wants to see is a property market bubble. On the other hand, if Beijing tightens too soon, it could pull the rug from under the economy.
In summary, an expected recovery should translate into upward earnings revisions, but this has not yet been priced into Chinese equities. The market is only starting to discount the impact of policy easing. This implies that there is still upside momentum for stocks, albeit not without volatility.
Near-term risks include 1) trade war escalation and 2) policy risk from a clamp-down on stock punting.
Medium-term risks include 1) a microeconomic policy mistake that leads to credit events which could degenerate into a systemic shock and 2) a policy error whereby Beijing stops easing, or even starts tightening, too early, which could hit the economy severely.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
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