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Is China Bottoming?

THE ESSENTIAL

We think the Chinese economy is bottoming in the near term, at least over the next few quarters. Bottoming can be said to be taking place when there is marginal improvement, or when the economy is simply stabilising around the current level with no further deterioration, and bottoming can also take place within a narrow range.

We also predict that China is likely to be more of a stabiliser for the global economy in 2016 and 2017 for the following reasons: (1) deterioration of the current economic situation takes time to mature – at least another two years; (2) lagging policy effects from stimulus initiatives in 2015 might start to show from mid-2016 and further stabilise the economy; and (3) further sound policies can change the path of the economy, and China is not lacking in policy tools.

 

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Why China’s bottoming is very important for global markets?

We believe that whether China has bottomed in the fourth quarter of 2015 or in the first quarter of 2016 to be the single most important question for global markets in the near term. If we simply reflect back on a series of events that took place since 11 August 2015 when China unexpectedly depreciated the CNY sharply, this was an obvious acknowledgement of an economic slowdown, and hence the market interpreted this as a rise in the risk of a Chinese hard landing. Global markets capitulated in August to September 2015, after which the US Federal Reserve deferred its initial rate hike in September. In addition to all of the domestic reasons, concerns over China were taken into consideration in the Fed’s calculation this time, by proving the simple analogy that the ultimate outcome of a hard landing in China is global recession. We should reiterate that the Fed hike delay had been a very non-consensus call, especially before China depreciated its currency back in August.

After the August and September 2015 market corrections, any near term China bottoming would fundamentally determine, as an external factor, whether the Fed would hike in December and where the global markets were heading in the fourth quarter of 2015, and the quarters ahead. Hence whether China is bottoming is critical for global markets. Bottoming can be said to be taking place when there is a marginal improvement, or the economy is simply stabilising around the current level with no further deterioration, and bottoming can also take place within a narrow range. If this is the case, these are big positives for the global markets. It is in stark contrast to extremely bearish sentiment on China back in August and September in 2015.

If we are fortunate enough that the Chinese economy stabilises, then the next question we should ask ourselves is how long this stabilisation and improvement can last – one month, one quarter, or two quarters and more? These scenarios certainly have very different implications for global markets in the near term.

Why is China’s bottoming a very difficult macro call?

If we look back at what has happened here as well, by the end of 2014, when markets released their forecasts for 2015, it was predicted that the Chinese economy could bottom as early as the second or third quarter of 2015. However, the markets were wrong and the Chinese economy extended its deterioration into the third quarter of 2015, hitting its lowest real GDP reading of 6.9% since the Great Financial Crisis (GFC). The general pattern of second or third quarter bottoming for the Chinese economy was completely broken in 2015, as the prior practices adopted over the past four years were not repeated. Markets are puzzled and, as such, are losing confidence and fortitude in issuing early macro calls on when the Chinese economy is bottoming.

Back in early October, we were brave enough to call a bottoming of the Chinese economy, by showing the initial signs that we were monitoring. We are at least two months ahead of some – but still very few – market participants who are calling for sluggish stabilisation in December 2015. With China’s bottoming having been one of the most difficult macro calls, it is now becoming increasingly challenging to gauge the upside and downside of the Chinese economy while the overall trend is definitely declining.

Our call two months ago was, also, if the Chinese economy indeed bottomed in the fourth quarter and initial signs of stabilisation were strong in early November/December 2015, we could foresee a December Fed hike – even a small one – as a high probability event for global markets. And we were proven right.

What are further signs of bottoming?

It is time to update further signs of bottoming on top of the initial signs we saw two months earlier in October 2015. These are data we are tracking closely and which are the most telling in judging China’s current economic stage and direction.

  1. China’s Manufacturing PMI stabilised in September and continued to improve. The first stabilising sign in Manufacturing PMI appeared in the September 2015 data. Though China’s Manufacturing PMI was registering only the smallest improvement of 0.1, the impact was significant, when we look at the figures from South Korea (+1.3), Malaysia (+1.1), Taiwan (+0.8) and Singapore (+0.6). We believe this marginal stabilisation in China is leading to broad-based improvement in manufacturing PMIs across Asia, a fact of which the market should not lose sight. 
    China’s Caixin Manufacturing PMI also extended its improvement from the trough of 47.2 in September 2015, unexpectedly jumping to 48.3 in October 2015 and then to 48.6 in November 2015. Even though the reading is still in contraction territory, the fact that it has been continuously improving since September 2015 is encouraging. We believe it will sustain this trend for at least another quarter, and the time it will take for the reading to return to expansion territory remains a source of uncertainty. Our best guess would be around mid-2016.
  2. China’s PPI first stabilised in September 2015 and extended the trend four months in a row. We think China’s PPI is the most important price indicator to which China’s market should pay more attention. We understand that China’s PPI at -5.9% is surely an ugly reading, and 51 months in negative territory is highly deflationary. However, in the near term, stabilisation around this level, but not drifting down further, is already a big achievement that market should appreciate, and is also a very important indicator when gauging the overall economic stabilisation. It is likely to take time to improve further from here given the overall overcapacity issue in China.
  3. Eastern China Cement prices in China are bottoming. The most leading commodity price would be Eastern China cement price, which bottomed during the week of 21 August with an 8% increase. Cement prices are leading as cement can only be stored for one month. As such, cement production will follow real cement demand closely, as cement is generally used in construction activities.
  4. Commodity inventory in China is in the destocking stage indicating economic recovery. Eastern China Cement inventory peaked during the week of 31 July at 80% and is down to 72% with a 10.5% destocking taking place. Similarly, steel (rebar) has also been destocking since the week of 26 June with a 41% destocking taking place, implying that construction activities are already accelerating, especially since July.
  5. Exports have stabilised since September. China’s export growth came in better than expected at -1.1% in September (vs. prior -6.1%) and stabilised around -3.7% in October and November. Similarly, South Korea’s export growth, a leading indicator in guiding global export growth, reached -8.3% in September (vs. prior -14.9%), and extended the improvement to -4.8% in November 2015.

How sustainable will the bottoming be?

We have been early in calling the near term Chinese economy bottoming. And we have been brave and early again in saying that China would likely be more of a stabiliser for the global economy in 2016 and 2017. The reasons for this are:

  • Deterioration of the current economic situation takes time to mature – at least another two years;
  • Lagging policy effects from stimulus initiatives in 2015 might start to show from mid-2016 and further stabilise the economy; and
  • Further sound policies can change the path of the economy, and China is not lacking in policy tools.
  1. Aggressive monetary policy easing in 2015 and beyond. China’s M2 growth has increased significantly from 10.1% in April 2015 to 13.7% in November 2015. Lagging monetary easing effects generally show 6 to 9 months later, i.e. from October 2015 to January 2016, and will last for at least a year. We continue to believe the aggressive monetary easing will extend into 2016, with at least another 300bp in cuts to the RRR, and 100bp in IR cuts to further help stabilise the economy.
  2. Accelerated FAI investment in late 2015. Above all, we believe the most important indicator to monitor and to judge the degree of economic stabilisation for this quarter and the next, would be Fixed Asset Investment (FAI) numbers. We have previously assumed that the 13th Five Year Plan projects might be brought forward to 2015, to achieve the real GDP growth target, which has proved to be true. Yoy YTD FAI has stabilised for three months since September; however, yoy FAI for individual months has seen big jumps for both October 2015 and November 2015 readings. And we believe this trend will continue.
  3. Even consumption picked up. Chinese retail sales picked up from 10% in April 2015 to 11.2% in November 2015. The pickup in consumption also helped stabilise the economy and supported the economy with further upside.

Conclusion

We think the Chinese economy is bottoming in the near term, at least over the next few quarters. Bottoming can be said to be taking place when there is marginal improvement, or the economy is simply stabilising around the current level with no further deterioration, and bottoming can also take place within a narrow range.

We also predict China would more likely be a stabiliser for the global economy in 2016 and 2017 for the following reasons: (1) deterioration of the current economic situation takes time to mature – at least another two years; (2) lagging policy effects from stimulus initiatives in 2015 might start to show from mid-2016 and further stabilise the economy; and (3) further sound policies can change the
path of the economy, and China is not lacking in policy tools.

 

Bottoming in a narrow range

 

2016-01-01-01

 

Why is calling China’s bottoming a difficult macro call?

 

2016-01-01-02

 

PPI stabilising is huge achievement

 

2016-01-01-03

 

2016-01-01-04

 

China, a stabiliser for 2016 and 2017

 

2016-01-01-05

 

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Cross Asset of January 2016 in English

Cross Asset de Janvier 2016 en Français

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JI Mo , Amundi Hong Kong Chief Economist
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