Summary conclusion
To be clear; not will/may hard land but is hard landing. For several years I swatted away the notion that this was going to happen; because it didn’t. Indicators are now though pointing unequivocally in this direction and only the trajectory and speed of descent are moot. This will rattle some but for value investors it shouldn’t affect the way they manage their China investments.
First, a look at how we know this is happening
In the past doomsters would point to some potential problem(s) on the horizon with analysis based on what would happen if predictions came true. Today we don’t need to scan the horizon; there’s a whoop of 800lb gorillas in the room. Here, in no particular order, are just a few.
Property – According to the National Bureau of Statistics property sales for Jan.-Aug. this year were down 9% from the same period in 2013. Residential property sales were down 11% and offices down 20%. New home prices fell countrywide for the fourth straight month in August, by 1%, accelerating the 0.9% drop in July. In aggregate they’re nearly back to where they were a year ago. The authorities have been relaxing Home Purchase Restrictions and developers are cutting prices to shift inventory. Facts, not predictions.
M2 and lending data – M2 rose by the slowest amount in five months in August and although it’s still off the March low of 12.1% appears to have resumed a downtrend that the May mini-stimulus seemed to have taken it out of. July loan growth collapsed (seasonal factors said the PBOC) and although August saw some recovery something must be amiss as the central bank decided unexpectedly to inject Rmb500bn into the system earlier this week. Pushing on a string perhaps?
PMI, Power, Imports – The HSBC/Markit Purchasing Manager’s Index fell to 50.2 in August, a three month low. The official data showed a fall to 51.1 from July’s 51.7 but the breakdown was more revealing with falls in output, new orders, employment and raw material inventories. Power consumption dropped in August by 1.5% (maybe a one off?). August imports fell 2.4% and that was after an unexpected fall in July. Individually nothing here to vex too greatly over; but when combined a clear picture emerges.
Anecdote – I usually put little store by this; but when the pile gets high enough? I wrote in an earlier posting about disappointing first half reports from the corporate sector. More troubling was any sign that things were improving. This week I attended the CLSA forum in Hong Kong and ALL the companies I met were glum on H2 progress. Most telling was China’s #1 instant noodle maker who talked of consumer’s ‘conservative behavior’ persisting into H2. Their best seller is an Rmb1.5 pack for goodness sake!
Now for the good news. Why, for stock investors at least, this doesn’t matter (much)
Valuation – From an economics professor a long time ago comes this rather lame one. Did you hear about the parrot that knew all there was to know about economics? Its owner had taught it just two words; ‘supply’ and ‘demand’. Boom-boom. My parrot, if I had one and wanted to teach it all I knew about investing, would know just one word; ‘valuation’. My point? As anyone who follows the China stock market closely is acutely aware (apart from a slight rush of blood to the head in July) the market remains one where animal spirits and consequently valuations are (mostly) crushed.
No hype to correct – China stocks haven’t been pumped up by either crazy-cheap money or over-hyped expectations of reform. Even the flurry in some parts of the market in anticipation of the Shanghai/HK connect is a pale, pale imitation of the Through-Train excitement that drove it to all-time highs in 2007. Sure, we’re some way off March lows (18%) but at last night’s close the HSCEI was virtually unchanged from its December 31st 2013 level. So the news isn’t great? So what? Neither is the market particularly.
Growth – Despite headwinds companies are managing growth. The consensus forecast for HSCEI earnings growth this year is 5% and for next, just under 10%. That’s on top of growth of 12%, 4% and 14% for 2011, 2012 and 2013 respectively. For the five years 2011 to 2015 that’d add up to cumulative growth of just over 50%; and the HSCEI was where in January 2011? Around 13, 000 or 17% above last night’s close. Forget GARP, this looks very much like GAWP; to me at least.
Cheap – Perhaps not without reason China stocks remain some of the cheapest listed on the world’s major stock markets. How cheap? The consensus earnings integer for December 2015 (last time I checked) is 1,570. Simply divide the current index level by this number and it reveals an AVERAGE valuation of 6.9x earnings. To stress, that’s the average. Within the market you can find great franchises with solid track records trading at much lower multiples; and don’t get me started on yield?
In conclusion
From bao ba (保八) just a couple of years ago when the slogan was to protect 8% GDP growth at all costs we’re entering a new era, one in which the central government may have given up targeting top line GDP growth altogether (that won’t be admitted of course). Investors hate uncertainty and as the realization grows that old rules no longer apply some volatility can be expected. However, a look at present valuations suggests investors are braced for a lot of uncertainty already.
The bigger and more complex question now is if pedal-to-the-metal top line growth is no longer the yardstick by which the Party are going to judge cadres’ efforts, what’s replaced it? I wish I knew.