There’s no reason why views of the future need be timed to coincide with either the moon’s rotation about the earth or the earth’s rotation about the sun. Nonetheless, fund managers write monthly letters and seers in general think loudest about the future around this time of year.
Having noted the above, and because it’s that time of year, I’m going to have my own swing at some futurology; but instead of trying to play the doomed-to-failure game of guessing what events the coming year may bring I thought it might be more useful to consider some things, we can say with 99% certainty, won’t happen any time soon.
In the process, by assigning a Neutral (0), Positive (+1) or Negative (-1) rating to each of these likely non-events we may be able provide a better sense of the base-case environment investors will be navigating, in the early part of next year at least.
Summary Conclusion
Of the seven highly likely non-events relevant to investors in China stocks in this note one is negative, two are neutral and four are positive. The cumulative score, which could have between -7 and +7, is therefore +3 indicating a benign, if not compelling, investment climate ahead.
This conclusion chimes with my own default that one is usually better off in rather than out of markets. The notion is reinforced at this time by the valuations of China stocks that, relative to their history and global peers, remain close to all-time lows. Not a slam-dunk case for participation I’ll own; but not a reason either to keep mattresses as stuffed as many are at present.
Let’s now have a closer look at these forthcoming non-events in more detail.
Not Happening Soon #1 – US Monetary Policy Will Not Ease Further (-1)
Some are suggesting a QE4 may come along in Q416; well, maybe. For now though, and for the foreseeable future, investors will have to deal with a US monetary policy that is either not easing further or tightening; with very short odds on it being the latter.
Personally, I’m not convinced of the straight-line relationship drawn by many between QE and rising asset prices. Many asset prices, I’m thinking of commodities particularly, have collapsed in the last couple of years. What matters though is the majority of market agents do believe in a relationship and if the QE punch bowl is finally being taken away that’ll be a sentimental headwind for asset prices globally.
Not Happening Soon #2 – China Monetary Policy Will Not Tighten (+1)
The speed, methodology, mechanics and implementation of monetary policy in China will always be impossible to predict. What we can, with a high degree of certainty, predict though is that monetary conditions in China are unlikely to be tighter in six months’ time than today. Most likely, they’ll be easier.
A manager marginally longer in the tooth than me summed this up recently: ‘Since Deng these guys have been in QT mode [Quantitative Tightening, I believe]; deflation’s on their tail now and QE is an inevitability’. Not being a macro-guy I can’t critique the analysis. It makes intuitive sense though and recent CPI data is supportive of the argument. Whatever, tightening is extremely unlikely from here.
Not Happening Soon #3 – The Chinese Economy Will Not Stop Growing (+1)
Premier Li Keqiang told us in early November to expect 6.5% GDP growth between now and 2020 and he, and his Party, have the wherewithal to make this happen. As noted above monetary policy has room for considerable easing and if that doesn’t work? Bring out the fiscal cannons; it’s been done before.
This is too short a note to go into the unreliable relationship between corporate profitability and top-line economic growth. Let’s play a game though. Imagine GDP fades from here by 1% per annum to zero; so 6.5% goes to 5.5% and so on. Q. How much bigger would the economy be at the end of the process? A. A little under 30%. That may not work for everyone but it’s not a bad environment to be doing business in.
Not Happening Soon #4 – The China Property Market (And/Or It’s Banks) Won’t Collapse (+1)
Reports of the demise of the Chinese property/banking complex have been greatly exaggerated. If it was going to happen, a property market collapse that is, it should’ve happened already. What do we think the chances are now in the context of observations above on the likely course of monetary policy? Quite.
That there’s something not quite right about the China property market is in no doubt. There’s a bit too much supply and a lot of vacancy. The former though is a problem confined to smaller cities and the latter, given how little credit there is at the personal mortgage level, a cosmetic not systemic blight. China will remain, in many parts, an ugly building site for the rest of all our lives. Get used to it; get over it.
Not Happening Soon #5 – Corporate Profits Aren’t Going To Collapse (0)
Discussions about aggregate corporate profits in China are always parried with an ‘Ah-but’ from cynics about how the picture would look if you were to exclude financial stocks (they usually mean just banks). Take them out or leave them in; my point here would be the same either way.
Not collapsing is not the same as growing robustly; but this is to miss an important point. Earnings persistence is growth in terms of firm value over time. To the long term investor a company that produces a steady dollar of earnings year in year out is worth much more than a company with just a shot of doubling earnings over the next 18-months; and China has more than a few of these steady-Eddies.
Not Happening Soon #6 – The Anti-Extravagance/Anti-Corruption Campaign Won’t Stop (0)
I’ve assigned a zero to this because there are benefits doubtless down the track, but the here and now is that it’s undoubtedly retarded a lot of decision making. We can’t begin to quantify the economic impact, but it must be negative; and, if it continues, it must continue to be negative for the economy overall.
Studies have contrasted China’s level of corruption with (most notably the US) other economies at roughly the same level of development and found, as repugnant as it is, nothing unique about China’s experience. Corruption works like alcohol, a little helps a party along but too much leads to boorish addiction. Abstinence is the only sure way out and China seems to be taking the cure; but it’s not fun for anyone.
Not Happening Soon #7 – Wholesale SOE Reform (-1)
Of all the Not-Happenings above I really, really hope I’m wrong about this one; but I fear I’m not. One of the propellants of the domestic stock market surge in 2014 and the first half of this was the notion that SOEs might at last be brought to heel; but it didn’t happen. I think the chance has now been lost.
There was a notion in 2014 that SOE ownership would be migrated from SASAC to some kind of Singaporean-like Temasek structure. This body, it was imagined, would have hire and fire power over SOE management and a firm hand on dividend levers. That would have been an awesome development; but, for reasons we’ll never know, the initiative seems to have been buried. A darned shame indeed.
In Conclusion
Few commodities have a shorter shelf-life than predictions; and for that reason, as a rule, I try to avoid making them. There are predictions though and predictions.
‘The End is Nigh!’ is a particularly narrow-tail forecast; but a view that one’s sock drawer contains a clean pair is a far less risky call. What I’ve tried to do above is concentrate on what’s not likely to surprise us in the next few months and by so doing consider whether this presents a world in which we are happy to assume or shun risk?
For me at least the picture seems, at worst, a dull one. Couple that outlook with near record low valuations for China stocks now and the advice ‘..it’s probably better to be in than out..’ seems rarely to have been more appropriate.