Slow the Bloat To China
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
According to the IMF, China’s contribution to global economic growth has increased to an average of 31% from 2010-2013, up from just 8% in the 1980s, making it the world’s largest single contributor to global GDP. China’s GDP growth in Q1 2012 was 8.1%, a three-year low.
With the Eurozone on the brink and the US still treading water, the world is again looking to China to keep things under control and prevent further chaos. But with China now showing signs of a slowdown of its own, there are concerns that if the global financial crisis falls off the cliff there might not be anyone there to catch it this time. With the global economy on life support, the last thing anyone wants is to hear China sneezing.
By the Numbers
Slowing demand for Chinese products overseas coupled with a decline in imports to China have raised concerns that the world’s second largest economy may be feeling the strain of the ongoing crisis. China’s exports in April totaled just over $163 billion, growing just 4.9%, down almost a third from the annual growth rate of 7.2%. Analysts at HSBC have attributed the decline to weakening demand for Chinese products overseas as well as slowing demand for goods at home. China’s manufacturing sector, further exacerbating the problem, registered a PMI at 49.1, the weakest reading this year. Manufacturing output in May was the lowest since November 2011.
HSBC (NYSE: HBC) China’s manufacturing PMI, which tracks smaller private sector firms declined to 48.4, down from 49.3 in April, marking seven consecutive months of contraction. The employment sub-index fell to 48.1, the lowest mark since Q1 2009.
In addition, the slowdown will likely hit China's construction sector, which accounts for more than half of steel consumption in the country. Last year China exported 7% of its total steel output totaling 48.9 million tons, while it exported 10.6 million tons of cement, representing just 1.1% of output. The result of this has been big decline in the Shanghai Index,
Macau, the Las Vegas of China, has also felt the pinch. Gambling revenue from the island’s casinos increased just 7.3% in May to $3.3 billion, a substantial decline from the 27% growth it enjoyed just a year earlier. This was reflected in Wynn Resorts’ (NASDAQ: WYNN) first quarter results that saw revenue in Macau grow at just 9% year over year.
Around the Region
For Japan, the slowdown in China is damping demand for exports, causing its current account surplus to fall more than 21%. South Korea has seen a decline in exports to the US, Europe and China as well. Australia has proven to not be immune from the contagion but the China accounts for the largest proportion of iron used. The price of 62% iron ore delivered to Qingdou declined 12% down to a low near $131 per ton as reports of Chinese steel firms refusing to take delivery were circulating. It has since recovered pushing back above $136.
Australia is the biggest supplier of iron ore and coal to China and slower growth from China sent their trade deficit plunging in March to $1.3 billion. It recovered in April to just $203 millon as coal and iron demand have picked up. This has created a ripple effect in the Australian Dollar along with the unwinding of the carry trade due to a series of rate cuts. So, China’s slow down putting pressure on commodity prices plus tight central bank policy equaled a bursting of Australia’s credit markets which the RBA is now trying to reflate.
Looking at the iShares MSCI Australia Index ETF (NYSEMKT: EWA) and its heavy exposure to financials and materials it has been caught in a broad range between $19 and $25 per share for nearly 3 years; paying a 5% dividend and currently trading at a multiple of 5.7 and may be a worth a contrarian play if one believes the China story lands in a pillow of cotton rather than rocks.
A Policy Decision
The current situation in China stems from monetary policy and their need to deal with the structural imbalances in housing and construction. The latest party 5 year plan has set a target of 7.5% GDP growth which means the world will have to get used to China growing a lot slower than they have been. But, it will also have to the opportunity to sell things to China in exchange for the Yuan as that same 5 year plan is more focused on building internal consumption. While the capital markets in China mature, Hong Kong and Japan will play major roles in internationalizing the Yuan while weaning the entire Pacific Rim off of the U.S. Dollar.
That said, however, while China does have more monetary, fiscal and administrative options available to it than the U.S., Japan or the E.U. do, in reality, with the size of the bubbles created and the state they are currently in China is as constrained as everyone else is. It’s not like they can cut the benchmark lending rate to 3% from the current 6.31% and create an economic miracle. That would create an even bigger mess than the world is in right now. The recent rate cut, and reserve ratio requirement cuts are more symbolic than anything, a sop to the U.S. and Europe to stabilize the situation in the capital markets while they continue to accumulate real capital, like copper, steel and oil reserves, while deploying their enormous current account surplus around the region.
The effect has been to continue to see Chinese equities underperform the Dow Jones Industrials, since the current situation is the culmination of a 5 year crash in the Hang Seng and Shanghai indices. But, like EWA above, the iShares FTSE/Xinhua China 25 Index (NYSEMKT: FXI) is trading at very low multiple near the low end of its trading range delineated by the early October 2011 low close of $31.04.
The Great Mall of China
Consumers in China account for roughly 33% of GDP, with government spending contributing more that 50%. China is now in the process of implementing a 30 year plan to move from an agrarian-based society to an urban consumer economy, which will further fuel long term demand for more consumer goods, including automobiles and housing. If there was a dominant theme from the latest earnings season it was that U.S. multinational consumer discretionary and communications companies saw the lion’s share of their growth from China or the Asia-Pacific region.
Be it Apple, Intel, Starbucks or KFC, they all saw their business grow fastest in 2011 and the first part of 2012 in China. Moreover, China is where they are continuing to deploy their capex budgets. While the current turmoil in Europe and coming soon to the U.S. casts a huge pall over the markets, especially the commodities, one could make the arguments that equity markets like the Hang Seng and the Nikkei 225 (NYSEMKT: NKY) are far closer to the respective bottoms than either the Dow or the S&P 500.
The Aftermath
While China has a property and construction bubble that has not been completely dealt with, they have not embarked on the same path blazed by Japan for the last twenty years, which is what the U.S. and Europe have done, replete with zombie banks, huge deficits, negative interest rates and high unemployment. There can be no recovery in the U.S. and Europe without taking China along for the ride at this point, and the question then becomes which market offers the most attractive risk-to-reward in this scenario.
PeterPham8 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.
