Bears Found in China?
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It is difficult for me to fathom the bear case for China. I get the worry over Europe and the U.S. I get the credit-created real estate bubble. I even get the wary eye cast over the Chinese government statistics released for our consumption. What I don’t get is how it is possible to look at a slowdown over a few months and call it a crash. But, that’s what the China bear case is based on. And they’ve been making it for 4 years while the U.S. and Europe come apart at the seams. The PBoC cut the reserve requirement ratio from 20.5% to 20% on Friday and this set off a bevy of calls that China is even worse off than the worst bear case had made things out to be.
The U.S. economy has cratered and is bouncing along a bottom that cannot be reflated by any amount of monetary or fiscal stimulus. For me to make a bearish case for China going forward based on a further devolution of the U.S. economy has to be attenuated by the knowledge that it has already shrunk, in real terms, significantly since The Lehman Moment. I say that having looked at the quarterly results of a number of U.S. multinationals recently who have all posted earnings from the solid, Intel (NASDAQ: INTC) to the spectacular, Apple (NASDAQ: AAPL), on the back of massive growth of their business in China. If China is crashing then why is everyone’s business there up 15-20% year over year?
China has surged from 23 to 29% of Intel’s total revenue since 2008 while China now accounts for 20% of Apple’s revenue. In China the iPhone sells for a 35% premium over its U.S. sale price and they still haven’t cut a deal with China Mobile and its 500 million plus subscribers.
Cutting the reserve ratio was a telegraphed move by the Chinese to provide liquidity to the banks and the real estate market choked off by tight monetary policy, not to stimulate loan growth. Numbers of new loans have been rising; those loans are smaller, a point underscored by falling M2 growth and further supported by tax cuts to small and medium enterprises. China has made it clear that they are looking at a slower rate of growth in this next five year period than in the past. Monetary policy will reflect this and a lot of pain will be involved.
But, fundamentally, this means that the growth of M2 is going to slow. It does not mean that China has reached its credit limit like the U.S. has. The Federal Reserve is attempting to reflate a credit bubble that has burst because the U.S. is fiscally broke; having reached debt saturation at nearly all levels of the government and finance. I would not be surprised to see China’s M2 growth slow to 5-6% over the next 18 months and stay in that range.
Opening up the liquidity locked in bank vaults is a management tool to soothe the interbank market and the increased demand for Yuan without inflating the core money supply. Money velocity goes up even if credit growth slows. But, remember, the China bear argument has to start and end with a credit deflationary scenario. 20.0% RRR and 6.5% benchmark rates are, by definition, credit deflationary at 9% GDP growth rates. Hence, the drop in GDP growth and slowdown in imports is not surprising. So, again, why anyone should be surprised or alarmed by this is beyond me. It all looks like it’s been engineered this way.
The Fatal Conceit
The only way this bearish argument makes any sense is if one truly believes that the people in charge at the PBoC are incompetent. I may disagree with many of the mechanics of central banking but to assume that they’re idiots is dangerous.
China’s trade growth numbers year over year have been slowing since coming out of the 2009 global recession but that also tracks with a number of factors:
- The natural decaying growth function
- Europe and U.S. falling back into recession in real terms.
- Aforementioned tight monetary policy intentionally slowing domestic growth to fix the real estate market.
All of this said, I don’t believe China will emerge from this situation unscathed. Trade growth may not be impressive in the short term. That is not a hard landing, all rhetoric notwithstanding. If the European periphery falls off the vine and the powers that be in Brussels give up on their dream of United Europe the Euro will come out the other side stronger as a Northern Europe currency block. The economies of Greece, Spain, Italy and the rest really cannot get much worse, and if they do how big an impact will they truly have on China’s economy?
A Value Play
The Shanghai Index is trading at 10 times earnings. The S&P 500 (SPDR S&P 500 (NYSEMKT: SPY) is at 22 and the ratio of it to the Greenhaven Continuous Commodity Index (NYSEMKT: GCC) is at a 3 year high. GCC has crashed 24% in the past year which is telling me that much of the turmoil in Europe is priced in and we’re reaching the lower bound of broad commodity prices.
On the other hand the Shanghai ratio to the CCI, as evidenced by the iShares FTSE CHina 25 Index Fund (NYSEMKT: FXI) is just coming off a three year low. Even a frontier market like Vietnam only fell to a multiple of 8 and their credit bubble induced imbalances are far worse relatively speaking than China’s. So, if you are going to park your investment funds somewhere are you going to do so in a low growth expensive market or a medium growth cheap market?
The U.S. will muddle along at near-zero growth with their companies repatriating some of their profits made in China while the Fed continues to play firefighter around the financial system. Meanwhile, capital flight from the West will continue East and China will be there with its enormous pile of money to pick up what it needs with a steadily appreciating Yuan.
And the China bears will continue to be confused.
PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Intel. Motley Fool newsletter services recommend Apple and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.