Talking Points: GDP slowdown

PUBLISHED : Monday, 15 October, 2012, 12:00am
UPDATED : Monday, 15 October, 2012, 3:10am

Any landing you walk away from is a good one, but does that apply to China? It's an important question as the country risks a deep economic slowdown. The consensus view now holds that growth will be 7.7 per cent for 2012. Yet the definition of a "hard landing" is a moving target. Two years ago, it was defined as less than 8 per cent growth.

Since then, it switched to growth of less than 7 per cent and even 6 per cent expansion, or growth last seen during the Lehman crisis.

So let's turn orthodoxy on its head and assume China growth decelerates into 2013. Let's stay positive about China's long-term outlook, but accept the chance the economy is heading for this crash landing. The good news is that there are ways of trading into, and profiting from, this worst-case scenario. Read on.


Resource-rich Australia became economically entwined with commodity-hungry China 15 years ago. Its share of total exports to China has grown by a factor of six since 1995. Economic dependency, naturally, has also increased.

This can be observed in a number of ways: we can compare the performance of the commercial yuan - known as a non-deliverable forward - with the Australian dollar.

Bearing in mind that these are in fact two entirely separate currencies, their co-movement is striking. Indeed, it begs the question, who has more influence over the Aussie dollar, the Reserve Bank of Australia or the People's Bank of China?

If there is slowdown in China, the impact will be obvious in Australian exports and a falling Australian dollar. This suggests one course of action: sell Australian dollars.


China's equity market over the past two years has been disappointing. While the MSCI Asia ex-Japan Index has generated positive returns of almost 15 per cent year-to-date, China's Shanghai Composite Index lost 5 per cent - Asia's only major market to achieve such a loss.

Yes, China is cheap. The MSCI China Index trades at a price/earnings ratio and price-to-book multiple of 10 times and 1.56 times respectively - with both measures well below their 10-year averages.

But investing in China is more a momentum than valuation play. Any investor buying equities in China because they appeared cheap - at least for the past three years - would have lost money.

China's equity story is of domestic rebalancing and weak exports to developed economies. So who benefits from this? The domestic-demand-orientated economies of Indonesia, Vietnam, Thailand, Malaysia and the Philippines, for starters. These will benefit from the erosion in China's cost-competitiveness and become the "new" manufacturing hubs.

Meanwhile, the prospect of years of weakened demand from developed markets is forcing governments to reassess Asia's export-driven growth model and look towards growth driven by local consumption.

I suggest investors focus on a mix of consumption stocks, such as those involved in agriculture, food processing, food retailing, clothing, car sales and gaming.


But why buy China's equities when you can buy its bonds? Its US dollar-denominated bond market has returned almost 14 per cent in the year to date.

China's bond market differs in that, unlike other sovereign markets, it has a good spread of both high-grade and high-yield issuers. It offers choice.

As of early October 2012, China's diverse ratings mix was equivalent to a blended yield average yield of 4.1 per cent, and its high-yield US dollar bond segment offers average yields of 8 per cent to 12 per cent.

But can it continue? Are bonds too expensive? We don't think so. Credit spreads since the global financial crisis in 2007 show spreads at 3.36 per cent, just below their six-year average of 3.4 per cent.

More tightening is possible, even before spreads get anywhere close to the 15-year average of 2.3 per cent.

From a supply viewpoint, a hunt for yield among developed-market investors has seen large amounts of liquidity entering the Asia market in search of investing opportunities.

Asia's bond frenzy represents an unusual mix of risk-off, bearish political and macro trends affecting the global economy, which is not going away soon.

John Woods is chief investment strategist, Asia Pacific, for Citi Private Bank