China stock market

Consumer staples back in favour as rally in China’s industrials runs out

A peaking of producer prices presages the end of the rally in China’s industrial stocks.

PUBLISHED : Sunday, 19 March, 2017, 9:00am
UPDATED : Sunday, 19 March, 2017, 11:41pm

If you’re wondering where the prices of China’s industrial goods will go, stock investors may already have an answer.

The fastest gain in producer prices since the global financial crisis in 2008 has led investors and analysts to speculate that the broader increase in factory gate prices may be ending, jeopardising the profitability of cyclical companies that rely on the strength of the economy.

The rally in Chinese stocks from commodity producers to steel and coal companies is already losing steam, with Jiangxi Copper and steel maker Angang Steel falling at least 5 per cent from this year’s high.

“Producer prices may already have peaked,” said Dai Ming, a fund manager with Hengsheng Asset Management in Shanghai. “The market is worried that this round of economic recovery that is mainly driven by the restocking of industrial goods is coming to an end.”

Investors did not cheer when China’s statistics bureau announced on March 9 that the country’s producer prices jumped 7.8 per cent.

The benchmark Shanghai Composite Index responded with a 0.7 per cent loss that day. Jiangxi Copper is down 11 per cent from a February high, while China Shenhua Energy, the nation’s biggest coal producer, has dropped 7.6 per cent from its November high.

China’s industrial stocks were benefiting from six months of consecutive increases in producer prices as the government unveiled a campaign last year to eliminate excessive capacity in industries from steel and commodities to coal.

The drive, dubbed “supply-side reforms” by policymakers to bolster economic growth, has proved an immediate success, ending an almost five-year deflation in industrial goods. Industrial companies’ profits grew 8.5 per cent last year, reversing the previous year’s decline, according to the statistics bureau.

China’s economic growth accelerated to 6.8 per cent in fourth quarter from 6.7 per cent over the past three quarters.

Gains in factory gate prices may have already peaked and growth will peter out in the following months, brokers say. February could be an inflection point for producer prices because of a higher base, and as supply increases with some upstream companies starting to raise output, Citic Securities analysts Zhu Jianfang and Wang Yupeng said.

“The rally in cyclical stocks since the fourth quarter last year has already priced in an economic recovery and the gains in producer prices,” said Wu Kan, a Shanghai-based fund manager at Shanshan Finance. “The market is now becoming cautious when good news materialises and some investors have chosen to sell to pocket decent profits for safety sake.” Wu said he has cut some of his holdings in cyclical stocks including commodity producers and cement makers as they were rising too fast.

After the rally, cyclical stocks are already expensive compared with the key stock gauge. Jiangxi Copper is valued at 55.3 times estimated earnings while Baoshan Steel is 14.3 times, compared with the multiple of 13.8 times for the Shanghai Composite Index.

With last year’s success, the government is lowering its 2017 targets for weeding out output in industries with excess capacity. The coal industry aims to cut 150 million tonnes of capacity this year, after slashing 250 million tonnes in 2016.

While investors are finding cyclical stocks more expensive and selling them on concern an economic recovery will falter, smart money is starting to chase consumer staples that are less reliant on economic swings.

Kweichow Moutai, the brewer of China’s best known rice liquor, rose to a record in Shanghai on March 16, leading the gain among consumer staples stocks on optimism that sales will continue to increase amid growing affluence of Chinese consumers.

The price of Moutai liquor, which is often used by Chinese leaders to fete foreign guests during state banquets, has rebounded to more than 1,200 yuan (US$174) per bottle, reversing the price decline during President Xi Jinping’s clampdown on extravagance. Other liquor makers also gained, with Wuliangye Yibin and Luzhou Laojiao climbing at least 19 per cent this year.

“The market may shift focus to consumer and growth stocks amid fluctuations,” said the strategy team of Hua An Securities on March 14. “The increase in the risk appetite since February may come to an end as the economic recovery may prove to be a false one.”