Over the past few months I have found myself in the unusual position of coming to the defence of the Chinese economy. I say it is unusual because I used to be the biggest China bear out there. During the past decade, when the market pundits were falling all over themselves with adoration for the Chinese “economic miracle,” I was firmly in the skeptic’s camp. I took solace with other China bears like famed short seller James Chanos, and refused to believe that it was as rosy as the China bulls claimed.
But even I am amazed at how the quickly the tide has turned against the Chinese. Today it is as fashionable to be bearish on China as it was to be bullish a few years ago.
One of my co-workers recently challenged me about my statement that “everyone is bearish on China.” He didn’t believe that the consensus was as negative as I claimed. So I started keeping a record of the “bearish China” research pieces. Here are just a few:
You get the idea… The overwhelming consensus is that China is screwed from all the mal-investment of the past decade. The bears now claim that we had been fooled into thinking that China was “different this time.”
Of course China was never different. It was never as miraculous as the bulls claimed, but on the flip side, neither is it as bad the bears now believe.
Today it seems to be taken as a given that China has checkmated itself into a situation where they cannot grow without inflation, and if they cannot grow, their massive debt will overwhelm their economy.
I am part of the consensus that believes that the China “economic miracle” of the past decade has to a large extent being fuelled by a massive credit bubble that has resulted in some incredible examples of epic misallocations of capital.
But where I now part ways with all my new found bearish friends is in their belief – no… their certainty… that this credit bubble has to come to a crashing end starting this quarter.
The Chinese government has recognized that their economy is unbalanced. They have started the shift away from export and investment led growth. Their focus is now towards a more sustainable balanced economy with a much stronger domestic component. This shift is far from painless. But neither is it the end of the world.
As this rebalancing works its way through the economy, the Chinese growth rate has slowed. The market, which is not good at doing anything except extrapolating the recent past, cannot understand any response except more of that which previously created growth. So when that response does not come, market participants get increasingly bearish.
Have a look at this reporting from Reuters:
Li stressed on Thursday that job creation was the government’ policy priority, telling an investment forum on the southern island of Hainan that it did not matter if growth came in a little below the official target of 7.5 percent.
“We will not take, in response to momentary fluctuations in economic growth, short-term and forceful stimulus measures,” Li said in a speech.
“We will instead focus more on medium- to long-term healthy development.”
His comments are among the clearest yet on the government’s plans for the economy, which has rattled global investors this year with a surprisingly lackluster performance.
The almost unabated run of disappointing data this year has fuelled investor speculation the government would loosen fiscal or monetary policy more dramatically to shore up activity.
This lack of panic from the Chinese government has emboldened the China bears. The bears are convinced that there is only one way for China to grow, and if the government doesn’t follow through with this sort of growth, then the whole Chinese economy will come crashing down.
There is of course the occasional financial analyst that is not part of the bearish herd. This article from the Pivot Farm author highlights the other side of the argument far better than I could ever hope to do:
So, China’s growth rate is the slowest it has been for the past 18 months in the first quarter of 2014. So, the Chinese government may not reach their target of growth for this year set at 7.5%. So, there was a drop from 7.7% in Gross Domestic Product in the last quarter of 2013. So, in comparison with last year there has been a year-on-year increase of 7.4%. It’s a lot better than some were predicting, hailing a massive drop to 7.2%. That was wishful thinking by the West, wasn’t it? Less for them and more for us? Errhhm, maybe that’s the way it went in the past. But, it hasn’t been MOAR for the West for a long time now. Less for China will just mean more for other countries like India or Russia or Brazil.
Chinese industrial production increased last month by 8.8% year-on-year. That was above the Februaryfigure of 8.6%. Economists had been targeting a 9% increase. Isn’t it always funny that the figures that are provided are always forecast lower than they really are for growth and yet higher than they ever could be for industrial production? You don’t have to look very far as to why.
Retail sales for China grew by 12.2% in March year-on year and in February that growth stood at 11.8%.
The big difference with the stimulus plan that the Chinese state is implementing and the Quantitative Easingof the Federal Reserve is that the latter just printed money aimlessly that took flight as far as it possible could from the USA to emerging countries to make the investment bankers richer. The Chinese are putting their money into projects including spending on railways and support for small companies. Say what you will, but if the Federal Reserve had had the common sense to invest at home rather than throwing the money to the banks, then we wouldn’t be in the sorry state that we are now. We might have actually improved the US industrial sector, given jobs to people and boosted the growth of the economy. The Chinese in their mini-stimulus will provide:
• Tax-breaks for small and micro companies (extended until 2016).
• 6.6 thousand km (4.1 thousand miles) of new railway (an increase of 1 thousand on 2013’s figure). Yes, massive engineering projects will boost their economy and increase employment and at the same time better infrastructure.
• A railway fund will be created of 200–300 billion Yuan ($32–48 billion) every year for development projects.
• There are plans to boost domestic consumption and employment (to be announced later in the year).
It’s not a patch on the $586 billion that was invested in the economy to stimulate it in the aftermath of the financial crisis. Of course China’s growth is slowing down. It’s an economy that is out of the dizzy stages of youth and now entering maturity. It would be impossible to sustain growth of the levels that were experienced in the period prior to the financial crisis.
Why should we expect more from them when we are doing nothing for ourselves?
Is it such a “certainty” that the Chinese rebalancing won’t work? Let’s not forget what has been happening with “real savings” over the past decade. On the government level, China has been accumulating savings and the US has been accumulating debt.
The accumulation of real reserves during the past couple of decades will allow the Chinese much more flexibility for navigating their way through this rebalancing.
And even though I am skeptical of the massive amount of mal-investment that has occurred in China, I can’t help but wonder if the situation might resemble the Dotcom bubble in the US. Even though there was a great amount of wasted resources, the Dotcom bubble laid the infrastructure for the next stage of the US economic development.
Has there been mal-investment in China? For sure – without a doubt.
Does that mean that it is doomed to fail? No – the skeptics are now too bearish.
Whereas a few years ago, China and all the associated China plays were priced for perfection, it has now swung too far the other way. Too many trades are priced for the “certainty” that China is doomed.
China SCHOMP Index vs S&P 500</a> </div>
And in a fit of brilliant timing, these same brokerage firms that were all bulled up on China 5 years ago, have now concluded that the never ending demand from China for commodities was not as never ending as they thought. So they are now closing their commodity operations. From the FT:
Barclays, one of the world’s biggest commodities traders, is planning to exit large parts of its metals, agricultural and energy business in a move expected to be announced this week.
The shake-up comes as commodity trading suffers a sharp slide in revenues and attracts greater scrutiny from regulators, which has already led to the withdrawal of several big banks from the area.
For me, there couldn’t be any better bull signal than Wall Street giving up on commodities by closing their operations.
Although I am not nearly as “certain” about the direction of the Chinese economy as the analysts who are now convinced about the imminent Chinese collapse, I think that the risk reward now favours the bulls.
Could the bears be correct and the China bubble unwind only begun? Of course. You always need to be cognizant of the fact that these cycles move to extremes in both directions.
However, I am willing to make some bets that these newly minted bears are just as wrong as they were on the bull side a few years ago.
If I am incorrect, I don’t think the damage will be that great as there is a fair amount of pessimism built into the prices. But if I am right that China manages to navigate through this rebalancing better than the bears believe, then there might be a squeeze that is quite profitable for those who didn’t give up on China.
I am going to play this theme by buying copper.
The speculators have more outstanding short positions in copper than anytime in the past decade:
Copper Speculative Shorts</a> </div>
The hedge funds have piled on the short side of the copper trade as it the perfect vehicle to play the collapse of China and the ensuing global economic slowdown.
A few years ago I would never have imagined myself saying this, but the hedge funds are too bearish on China.. I bought some copper on Friday.
Copper price</a> </div>
I also sold some precious metals. My P&L has been swinging a little too wildly with the moves in gold and silver, and given my new found copper bullishness, I don’t want to be too long metals in aggregate.
I am not going to buy Chinese stocks as equity longs still scare me, but if I were forced to choose between the US and Chinese stocks, then there wouldn’t be a moments hesitation. China in general is too beat up. The risk reward favours the bulls.