- China's GDP growth for 1Q15 is worst in the last six years and I expect economic weakness to continue.
- In my view, expansionary monetary policies are blunt and only contribute to speculation in asset classes.
- China's real estate sector is also slowing down and can potentially contribute to further GDP growth downside.
I have been negative on the Chinese economy and the stock markets since the second half of 2014 and the latest economic data from China comes as yet another disappointment. For the first quarter of 2015, China's GDP growth slowed down to 7.0% from 7.3% in 4Q14. The quarterly GDP growth is the weakest in six years and I expect this weak trend to continue through 2015 and potentially through 2016. This article discusses some data points that indicated continued weakness in the economy and the investment implications.
Before talking about some key growth indicators, I would like to quote the following point from an article in Reuters -
A series of cuts in interest rates, lower reserve ratios at banks and easing measures in the property sector look to have mostly flowed into stock market speculation without delivering much support to fundamentals. Still, the economy's persisting slowdown means more stimulus measures are expected soon.
If readers browse through my earlier articles on China, I had opined that lower interest rates or other expansionary monetary policy measures will not spur growth. Easy money will just result in speculation across asset classes and I maintain this view. I believe that easy monetary policies can spell further trouble for the economy through strain in the financial sector.
Coming to some key economic data, the first chart below gives China's non-manufacturing PMI and I wanted to discuss this data first as China's manufacturing sector is in a recession and that is well known.
However, China's non-manufacturing PMI also remains weak and after a marginal recovery in February 2015, the non-manufacturing PMI has again slipped to its lowest levels since March 2014. Therefore, the services industry continues to grow, but growth remains sluggish and further decline in the services sector activity can't be ruled out.
Other data that is important and I believe will continue to decline is the total investment in fixed assets. As the chart below shows, the growth rate of private investment and total investment in fixed assets has slumped in 2015.
The slump will continue as the country already has production and manufacturing excesses. The incremental value added through new fixed investments is minimal at this point in time and this also backs my point that easy money policies will not prop-up economic activity. At most, easy money will create further bubbles in different sectors of the economy as has happened in the recent past with the real estate sector. It is important to note that property investments have increased by only 8.5% in 1Q15, the slowest since 2009. This is an indication of another sector cooling off significantly besides the manufacturing sector recession.
Amidst all the worries, I believe that one of the positive factors is robust growth in retail sales of consumer goods. Retail sales increased by 10.6% on a year-on-year basis and I believe that the only factor that can revive growth in China is local consumption of goods and services. While manufacturing driven growth is likely to decline, this needs to be offset by consumption driven growth in the coming years.
From an investment perspective, the Shanghai composite index has surged by 26.3% in 2015. I would, however, recommend investors to stay away from the index. While easy money is taking the stock market higher, speculative money can also trigger a sharp decline once it becomes clear that expansionary monetary policies are doing nothing for the real economy.
I am negative on the Global X China Financial ETF (NYSEARCA:CHIX) and I am also negative on the Guggenheim China Real Estate ETF (NYSEARCA:TAO). As mentioned above, the real estate sector is slowing down and I believe that the financial sector can face headwinds due to excessive sub-prime lending. Among specific stocks listed in the US, I have written earlier on my negative outlook for Caterpillar (NYSE:CAT) and I remain negative on the stock with China being a major revenue driver for the company.
In conclusion, China equities can be avoided as the economy is likely to slow down further in the coming quarters. I remain underweight on China and I believe that the structural economic change will result in a relatively long period of sluggish economic growth. While easy money is taking China equities higher, continued weakness in economic data can translate into a sharp decline for equities. I expect that to happen in 2015.
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