Despite some resounding economic successes since the middle of last year, asset allocators have remained highly sceptical of China’s boom.
Of the major emerging market (EM) fund allocations, China is the only country to experience net portfolio redemptions in the year to date, even though the mainland total equity return has offered a premium to the EM index, at 14.4% versus 12.8%.
While the tractor-beam pull of the People’s Bank of China’s monumental recent easing – with the bank’s balance sheet expanding at an annual rate of 6% over the past six months and credit up an annual 14% since January – has powered a regional trade, it has yet to lure overseas buyers to Beijing.
Following five years of managed slowdown as the country’s policymakers tried to correct the excess of the previous stimulus, the state-led catalyst for the rally may go some way to explaining the scepticism. But are investors allowing reflexive bearishness to blind them to a winning trade?
The momentum of the recovery is real, but also partial and highly selective, according to research house MRB’s Asia ex-Japan specialist Adam Wolfe. Six months after producer price inflation broke above zero for the first time since 2012, popular measures of activity in the real economy are similarly breaking multi-year highs but offer limited insight into its durability.
While popular, non-official proxy measures of activity such as the Li Keqiang index were designed to offer alternatives to easily manipulated official output indicators by drawing on harder-to-falsify rail freight and power data, that may be as much a weakness as a strength, Wolfe added.
‘[The] index is a useful tool for assessing activity in China’s resource sector, and it tends to lead related commodity prices and financial assets.’ However, he said the growing importance of services and rising credit intermediation means proxy numbers offer an increasingly distorted picture and fail to capture the scope of the economy.
‘We continue to believe that China’s economy is leading with its chin,’ he added. ‘A blow from weaker housing demand will knock the economy back into structural slowdown and rebalancing by mid-year.’
Following a full-year 2017 forecast that went long on the risk to South East Asia of a stronger US dollar and an interventionist US president, Nomura’s chief economist Rob Subbaraman admitted last week that the house had been blindsided by China’s recent strength.
The company lifted its Q1 China growth forecast from an annual 6.6% to 6.8%, although it left its 2017 prediction unchanged at 6.5%.
While admitting to some ‘humbling’ revisions, China remained the odd one out in a series of upward full-year revisions. Subbaraman’s Hong Kong figure was marked up from 0.5% to 2.2% and Thailand went from 2.8% to 3.2%, for instance. He said he had limited faith in a bounce powered by China alone.
‘There are several reasons why Asia’s export recovery may be short lived,’ he added, including the volatility of the semiconductor businesses, which has led growth, and the one-off step change in commodity prices, which has inflated price indices.
With leading exporters reporting sales to China up 25% in 2016 versus a 4% change in onward sales by China to the developed world, a lot appeared to depend on a small source of demand. He linked China’s accommodative policy to political optics ahead of a significant Communist Party Congress.
‘In essence, there is a “Beijing put” in play: if growth slows, policy will be quickly eased; if defaults rise, the state will come to the rescue; if capital outflows increase, more controls will be imposed,’ Subbaraman said.
‘[But] China’s oversized financial cycle is vulnerable to snowballing defaults or accelerated capital flight, perhaps sparked by an external shock, such as a trade war.
‘Perhaps most worrying, the much-needed rebalancing from investment to consumption appears to have stalled, with massive fiscal stimulus driving infrastructure spending, along with a revival in property investment.
‘This, plus credit growth continuing to outpace nominal GDP growth, could be storing up greater risks of an economic setback in 2018 when the market may no longer perceive the “Beijing put” to be in play.’