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CommentInsight & Opinion

China to see slower growth, tight liquidity in 2014: research head

Bank of Communications' Managing Director of Research Hao Hong previews its predictions for next year

PUBLISHED : Friday, 06 December, 2013, 2:15pm
UPDATED : Friday, 06 December, 2013, 2:35pm

2014 themes: US Federal Reserve tapering; China reform and slowdown; significant macro risks.

China’s reform has jolted the market into action. At a time when risk appetite is fanned by liquidity and the China Dream, the dejected cyclicals are rejuvenating. Yet on the horizon, the Fed’s tapering looms, and will soon set off a significant reversal in global capital flows.

US investment return has long peaked and has been declining, auguring ill for the emerging markets and global cyclicals’ relative performance. Indeed, EMs' relative performance has double topped in mid 2010, after its first peak in 1994. Further, falling investment return also hints at slower US growth in the second half of 2014, and hence a defensive investment posture.

In the near term, however, growth looks fine and thus bolsters the case for tapering - most likely in the first quarter of 2014. The US 10-year yield will likely shoot up soon, inducing a risk-off event and heralding a switch into defensives.

To explain this through a different prism: the US household balance sheet has largely been repaired through a surge in savings. An improving US current account, or a mirror of rising US savings, spelt trouble for global markets historically.

In the past few years, the puzzle was that growth in the developing countries was stronger, but their markets lagged seriously

Low interest rates in the developed world, as a consequence of the heavy debt load, have worked for the developed markets, and will continue to give incentives to keep rates low. If so, the secular underperformance in EMs and cyclicals will continue.
         
China’s growth is set to slow; macro liquidity likely remains tight.

China has well passed a recovery phase that started around the third quarter of 2012. And the structural reform, with a lower growth target and a mandate to avoid stimulus during a slowdown, will mean slower growth at around 7 per cent in 2014.

Indeed, a real test of the market reform is whether the government could sit tight if growth ever falls below 7 per cent in 2014. So far, financial reforms and the anti-corruption campaign have demonstrated the government’s resolve.

Macro liquidity will remain tight in 2014, with further curbs on shadow banking. China’s total debt is about 110 trillion yuan, or 200 per cent of GDP at about 58 trillion yuan.

Applying a 6 per cent interest rate and 10 per cent nominal growth, we can see the 5.8 trillion yuan new GDP growth will not be enough to offset the 6.6 trillion yuan interest cost. Of course, this is a macro sketch, but it demonstrates why China’s dramatic credit expansion has translated little into real growth.

As such, we believe that slower growth and tight liquidity are likely, and thus argue further for a defensive stance after early 2014. That said, stock market liquidity can be temporarily boosted by introducing the government investment arms and expanding QFII quotas.
         
Valuation is cheap; bullish for primary markets and restructuring plays; winners in SOE reform, defence, agriculture and environmental protection.

For now, sentiment is elevated but not yet at its extreme in China, and valuation is cheap, especially in the dejected cyclical sectors where SOE reform is the most intensive. As shadow banking activities will be suppressed, the target of reasonable growth means that direct financing through bonds and equities must flourish – bullish for primary markets and restructuring plays.

Also, defence, agriculture, consumer staples and environmental protection will likely produce "dark horses" in the coming year. While we believe that the final outcome of the reform will deviate from its current interpretation, a shift in the crowd’s expectation itself, coupled with international fund flows, may be just enough to sustain the rebound momentum for now. We would not argue against a strong tape.

That said, slowing growth and tight liquidity are not the recipe for a secular bull market. Indeed, after five years and four rounds of QEs, the Hang Seng has gone nowhere, while Shanghai has indeed plunged. Instead, the effect of QE has largely shown up in property froth.

Hong Kong property is now particularly vulnerable as tapering looms, while China is not immune. As global liquidity ebbs, significant systematic risks will be exposed in 2014. The year will be one of 'dark horses' from China’s reform and 'black swans' from the Fed’s tapering. Sit tight, and we wish you a Great Year of the Horse.

The Bank of Communications complete outlook for 2014 will be published this coming Thursday.

The author is managing director for research at Bank of Communications. Follow him on Sina Weibo.

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singleline
Every country in the world just intends her own gain.
The Feb has just the United States (US) in mind when engaging in various rounds of quantitative easing (QE). One of the unintended (or intended) consequences of the QEs is propping up various property bubbles all over the world.
Now it seems the US is stuck in a liquidity trap. You can pull a string, not push it. Monetary policy is easier to stop an expansion than to end a severe contraction.
The US (and European) government should responsibly use expansionary fiscal policies to kickstart quicker economic recovery. Any possible Japanese-style lost decade must be avoided at all costs.
People like Joseph Stiglitz, Lawrence Summers and Kenneth Rogoff all argue that the US government should spend more on useful self-liquidating real investments, such as ‘fixing bridges and roads, updating badly outmoded electricity grids, and improving mass-transportation systems’.
The ‘big’ US budget deficit is of no concern here. (Read chapter thirteen of the book ‘The Little Book of Market Myths’) ‘US debt as a percent of GDP … (is) still well below peak levels.’
I don’t think President Obama the democrat will lower the tax rates.
The coming potential stalmate between President Obama and the Republicans is a matter for concern. I’m afraid the debt-ceiling may not be extended further enough early next year.
Bad politics often causes bad economics. Economics remains a dismal science.
singleline
Some of the so-called ‘emerging markets’ are, to a large extent, now fully emerged.
Financial repression in China (and particularly in Japan), represented by too low a yield curve, leads to wasteful real investments and overcapacities in some areas. This perhaps explains why China’s dramatic credit expansion has translated little into real growth. China should learn from her Japanese counterparts. (You may visit ****noahpinionblog.blogspot.hk/2012/08/financial-repression-japanese-style_13.html).
The possibility of Asia’s capital flight can’t be overstated, as was shown by what’s happening in June this year.
As a responsible emerging power in Asia, China should imitate the West and set up swap lines with her Asian neighbours as a precautionary measure, so as to counter the coming global liquidity ebbs. (Please read ****www.project-syndicate.org/commentary/katharina-pistor-crticizes-the-new-great-divide-in-international-monetary-management).
It’s time to use China’s rich US$ reserves in a more productive way.

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