What happens to the world’s economy should China sneeze?
China’s economic adjustment challenges are as well-known as they are challenging, but I feel sufficient policy flexibility exists to steer the economy to a lower equilibrium in a managed, ordered way.
Should China sneeze, would the world catch a cold? Or catch the flu? Or something worse?
I ask, because over the past few months, the flow of economic data from the world’s second-largest economy has been underwhelming to say the least.
Just in the last week, a whole slew of industrial, consumer, property, trade, and forward looking sentiment indicators posted either year-on-year declines, or missed analyst expectations, or did both.
Inevitably, this has prompted questions about whether China is experiencing a mid-growth cycle wobble - from which it will soon emerge unscathed - or whether the weakness is a portent of something more worrying; specifically an end-of-cycle inflection point.
It’s only right to take the deceleration in China’s macroeconomic momentum seriously, but it’s also important not to read too much into the wailing and gnashing of teeth that routinely accompanies the publication of major economic data from China.
I’m sure we’ve all noticed a faintly ridiculous asymmetry at work, whereby China bears will dismiss positive data as inaccurate or falsified; but will leap on negative data at face value proclaiming it vindicates their cautious stance.
Psychologists call this behaviour cognitive dissonance, being inconsistent thought relating to behavioural attitudes. I call it wishful thinking, plain and simple. And it has absolutely no place in investment decision making.
But concern over the veracity of China’s data is a genuine issue. My take is that the quality of data generated by the National Bureau of Statistics is almost certainly better than many of its counterparts in emerging markets, but that the sheer scale, complexity, and rapidly changing nature of China’s economic rebalancing makes an accurate point-in-time print almost impossible.
If it takes the United States – the largest and most sophisticated economy in the world - three revisions to finalise America’s gross domestic product (GDP) numbers, how can we expect similar levels of accuracy from China?
And the idea that there’s a small army of rogue statisticians tucked away somewhere in China, falsifying the estimated 250 separate data sets published daily, is just plain silly.
But it is true that accurately measuring China’s economic pulse is challenging given the limitations of existing data, and it’s equally true that China watchers follow their own particular indicators.
Premier Li Keqiang, famously, has his own Li Keqiang Index (comprising loans disbursed by banks, railway cargo volume, and electricity consumption). Every investment bank will have its own proprietary activity index, which the bankers believe more accurately reflects momentum in underlying growth.
Personally – as a proud and long-standing member of the Credit Geek Club – I often gauge economic activity with a payment delay index, which measures the average number of days it takes a company to collect payment after a sale has been made, otherwise known as the days of sales outstanding (DSO). As you would expect, across an entire economy, where deteriorating payment delays usually denote solvency problems, a quick glance at the chart underscores its reasonably close relationship with GDP growth.
But whatever economic measurement is used, the prospect of a regime change in sentiment towards China is concerning for the private bank community, not least as it relates to the allocation of risk. I exaggerate slightly, but the average private bank client in Asia is typically conservative in their investment outlook and as such, surprisingly equity shy. These clients much prefer the safety and consistency of fixed income instruments, particularly investment grade credit. Only after meaningful evidence of sustained performance will a client accede to equity in their portfolio, and even then only grudgingly.
Year to date, China has been the single best-performing major equity market in the world bar none, and indeed, has largely shrugged off recent signs of decelerating growth.
But would you allocate your investments to China equities right now, possibly at the top, fearing we’re at such a critical inflection point?
It is a difficult challenge, and the only way to meaningfully address the question is to revert to the strategist’s decision-making architecture: fundamentals, valuations and technical indicators. If all three drivers suggest the growth, earnings, and multiples-driven rally is likely to endure, then allocate we must.
Personally, I do not believe China’s growth is at an inflection point; nor do I think the slowdown we are seeing is necessarily temporary.
Rather, I think the manufacturing-to-services adjustment, which inevitably entails a slower growth trajectory, remains firmly on track, and that the occasional soft patch is entirely to be expected. China’s economic adjustment challenges are as well-known as they are challenging, but I feel sufficient policy flexibility exists to steer the economy to a lower growth equilibrium in a managed, ordered way.
As such, I remain positive towards the economy and positive toward the markets, albeit more selectively.
Rather than simply buying into a directional trade, I’m now suggesting clients consider overlooked opportunities; in that regard, China banks represent value, in my opinion.
John Woods is the chief investment officer of Asia -Pacific at Credit Suisse.