By Bryce Coward, CFA
The last two days have been met with the usual monthly slue of Chinese economic statistics including retail sales (+10.4% YoY), auto sales (+11.8% YoY), industrial production (+5.6 YoY), fixed asset (infrastructure) investment (+10.1% YoY), and bank loans (+15.6% YoY), among others (charts below). The fact that retail sales, auto sales, and bank loan growth have all accelerated in recent months has spurred some commentators to suggest that the Chinese economy has found its footing and the growth scare is behind us. From our perspective growth in the Chinese economy has indeed stabilized on a cyclical basis, but we disagree that this stabilization marks the end of the more structural slowdown for at least three reasons.
First, the Chinese government has managed to cobble together various stimulus projects that by some estimates amount to about 2.8% of GDP in aggregate. With this type of stimulus, mostly directed at infrastructure projects (as if China needs more rail lines, airports or highways after almost two decades of building them out!), we should certainly expect the economy to stop slowing on a cyclical basis and the bank loans to pile up (which they have). The problem is that juicing infrastructure investment to keep the growth rate up just delays the rebalancing process from an investment led economy to a consumption led economy. In the months and quarters ahead this same fiscal stimulus will turn into fiscal drag at which point growth will slow dramatically.
Second, the economy is on a structural, not cyclical, slowing path. Investment as a share of GDP will eventually fall from about 50% to closer to 35% over the next decade as the composition of China’s economy begins to more accurately reflect its stage of economic development (chart below). This implies that annual growth in fixed investment must fall into the low single digits or even turn negative, which in turn implies a much, much slower aggregate growth rate for the economy.
Lastly, the behavior of market determined prices from things like copper, oil and shipping rates (all very sensitive to economic growth rates) indicate a slower China is on the way. Today we observe copper making a new cycle low and plunging to levels not seen since the middle of 2009. Both Brent crude oil and the Baltic Dry Index (an indicator of shipping rates) are near their cycle lows and will break to new lows with one more bad day. This is price action indicative of weaker Chinese growth, not stronger.