More signs of a bumpy Chinese landing

So, the many meetings of the leaders of China have came to an end and the Shanghai stock market celebrated by falling 2.6% yesterday. There are a few things wroth noting from the past two days.

As mentioned early on, Wen Jiabao has made it clear that GDP growth target for the year would be 7.5% instead of 8%.  And just to recap, the inflation target is 4% yoy, and the M2 target is 14% yoy.  Curiously, even though we have long known that the growth target will be lowered, the market did not like this.  Bear in mind that 7.5%, if achieved, would be a very decent growth.

There is a possibility that China is already growing less than 8%. J.P. Morgan certainly is declaring that a hard landing has already begun, via Bloomberg:

“If you look at the Chinese data, you should stop debating about a hard landing,” Mowat, who is based in Hong Kong, said at a conference in Singapore yesterday. “China is in a hard landing. Car sales are down, cement production is down, steel production is down, construction stocks are down. It’s not a debate anymore, it’s a fact.”

Contrast that with Jing Ulrich, also from JPMorgan, proclaimed earlier this month, also via Bloomberg:

The “worst is behind us” for China’s real-estate market and property prices and transaction volumes will begin to improve in the second half of the year, Ulrich said. Still, high inventories in steel, cement and other materials will continue to put pressure on construction stocks, she said.

I believe that there is a good possibility that China will undershoot the inflation and money supply growth target as the economy continues to slow.  I also hold the view that cutting RRR is not real easing, and the probability of significant interest rate cuts on both lending and deposit sides is small for the moment (though I hold the view that the lending rate might be cut more than deposit rate if rate cuts do happen).

Yesterday, Wen Jiabao said the real estate market regulations will have to be continued because real estate prices are still far from reasonable.  That more than anything spooked the markets. Why, I don’t know. It is well known that real estate prices are ridiculous, and the government is determined to ring them to heal.

Meanwhile, there are a few more signs that policy tightness is hurting. Hang Lung Properties (101.HK), the operator of various commercial properties (notably shopping malls), said in its annual weakening retail sales. I believe that is consistent with the overall slowdown, and the disappointingly slow growth in retail overall:

In Shanghai we detected a weakening of retail sales.  As a result, growth in rent, while continuing, has slowed.  Office rental has improved somewhat.  Margins remain high and again we are basically fully occupied.  The mall in Plaza 66 has seen several major tenants expanding their shops, so some space is temporarily taken out of the market.

This is consistent with some of the observations made by the team of analysts at J.P.Morgan mentioned above:

Softer sales in October: Most of the retailers that we visited during the tour recorded different degree of sales growth slowdown in Oct compared to the first nine months, attributing this to 1) increasing macro headwinds, 2) warmer weather, as well as 3) higher base last year during the World Expo. Nevertheless, most retailers seemed reluctant to call it a “slowdown trend” and anticipated potentially strong year-end sales, given the much earlier Chinese New Year (end of Jan 2012). In addition, most retailers were comfortable with current inventory levels and suggested no urgency for heavy discounts. Separately, no retailers have encountered funding issues due to the credit tightening.

A slowdown trend forming? Softer sales in Shanghai seem to us to be early signs of a slowdown and suggest moderating growth of consumer discretionary sector in the near term, especially toward 1H 2012E when the sector has a tough base to beat. We have built in a new lower earnings base for 2012, reflecting SSSG slowdown and margin contraction. We currently look for 15% y/y sales increase and c.13% y/y earnings increase for 2012 (ex-sportswear), which are still on average 3% and 7% below the consensus respectively. Therefore we expect more consensus downward revisions.

Another sign of ongoing stress was the news yesterday that Bank of Communication is raising RM 56.6 billion in both A and H shares. Ministry of Finance, National Council for Social Security Fund, Shanghai Haiyan, Yunnan Hongta and HSBC will be among the subscribers.  HSBC, for instance, will be paying HK$13.3 billion to buy 2.36 billion shares. As I’ve said before, I don’t like Chinese banks as the economy slows and the real estate bubble is popped.  Assets on the banks’ books will be worth much less than they appear because of non-performing loans.

True, you can extend and pretend, but that doesn’t make banks stocks attractive. Investing in banks stocks with shrinking assets is like investing in out-of-the-money call options on bank assets. Everyone should expect that Chinese banks will have to raise more capital in the years to come.

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Comments

  1. “In Shanghai we detected a weakening of retail sales.”

    I thought bulls said they were moving to consumption and it was increasing….. There isnt any rebalancing going on here.

  2. Lets be honest – the USA is recovering and importing more already.

    Sure growth will slow in China, it just can’t stay at double digits, and a slowing to a rate of 6% to 8% is still phenomenal growth.

    Talk of a hard landing is grossly overrated.

    • Peter,

      Most of China’s growth comes from investment not net exports. What happens in China’s construction sector is much more important to overall GDP growth than exports, and construction is certainly much more relevant to Australia.

      Besides, its probably fair to say the recession in peripheral Europe offsets much of the growth in the US.

      In the longer term China needs to rebalance its economy away from investment and towards consumption. China already has the highest investment share of GDP than any country ever, way higher than Japan or Korea at the peak of their development. With investment still growing at 21.5% and consumption in the mid-teens there are two ways to achieve this rebalancing; either grow consumption faster than investment, or slow investment growth.

      Growing consumption rapidly requires rapidly rising wages, which has obvious implications for China’s competitiveness, so its unlikely to happen. Besides, with no social safety in place, the Chinese are notorious savers. Also, much of China’s wealth gets funneled into SOEs, local government authorities, Party officials, and property developers. All of these things have to change to grow consumption rapidly.

      By far the easier option is slow investment growth, probably into the single digits. There is some suggestion (above) that construction related sectors are already in recession (steel, cement etc). Now given that Australia is not only highly-leveraged to China, but highly leveraged to a single sector in the Chinese economy — construction — this has obvious implications for us, and our glorious 100 year mining boom.

      Looking forward to your response.

      Yours negatively, Lorax.

      • Lorax – to show that I am not a one eyed all the way with China guy who does not look at the facts, here is what Greg Canavan says about China;
        Massive internal imbalances
        -An epic credit boom
        -Fragile financial system
        -Blocked currency
        -Run by the party for the party
        -Horrible demographics
        (care of Money Morning conference -After America.)
        and Dylan Grice said this about Europe;
        The facts say the western welfare state has huge unfunded liabilities that cannot be paid. The idea that the core of Europe is sound and the problems are contained to the periphery is wrong.

        We do live in a highly uncertain world and the MM team say that only 3 options are available; 1. A new Order 2. Disorder or 3. Chaos. Sobering stuff indeed.

        • Well said. There is a widespread assumption here at MB that if you support resources you are a one-eyed blinkered China Fanboy!

          My experience is that those in resources are well versed in potential problems with China (and globally, interlinked) but recognise that the only sensible option, if resources are your thing, is to run with it for as long as possible.

          China gloomsters have been foretelling of collapse for years now. Pro resources readers here at MB have suffered great focus on the impending China collapse and the corresponding plummet in commodities, particularly the glorious one. Indeed, if all these spruikers of ‘we’ll be rooned’ hang around long enough, one day they may be right. Inevitable, it’s all a cycle.

          In the meantime, the boom has been very very good indeed. Anyone listening to the collapseniks a couple of years ago would not have ramped up production – and not reaped the very substantial reward.

          It ain’t over until it’s over!

          Cheers
          ChinaFanboy

          • Were you invested in US tech stocks in 1998, because those arguments sound awfully familiar.

      • “Most of China’s growth comes from investment not net exports. What happens in China’s construction sector is much more important to overall GDP growth than exports, and construction is certainly much more relevant to Australia”

        I think the figures are like 60-70%
        GDP comes from this (maybe even 50-60%, ill be conservative). Only 5 – 10% is export now it might be higher but not much. Still thats alot for construction. The other thing to consider is how much of the construction is dodgy and will need a lot of money to fix it plus how many properties (commercial and residential) is sitting empty and not creating any capital (rents, cash etc…) You can tell me this is going to end good.

      • +100

        Some numbers from the excellent Satyajit Das article.

        China’s investment boom may also be exacerbating industrial overcapacity. The greater portion of investment has been in infrastructure, rather than manufacturing.

        A 2009 report prepared for the European Chamber of Commerce outlines the over-capacity. In its analysis of six major sectors, the report identified the following capacity utilisation rates: steel 72%; aluminium 67%; cement 78%; chemicals 80%; refining 85%; and, wind power 70%.

        In 2008, China’s steel capacity was 660 million tons against demand of 470m tons but the difference is similar to the European Union’s total steel output or the combined output of Japan and Korea.China’s excess in cement is larger than the total consumption of the US, Japan & India. Yet China continues to add capacity.

        If China be unable to absorb this new capacity domestically, then it might seek to increase exports, in order to maintain production and growth. This would increase a global supply glut. To the extent that Chinese growth is driven by such spending on unproductive investments, it is both wasteful and ultimately economically destructive.

        • This sounds like a rehash of his article in Drum.

          A 2009 report …

          In 2008, China’s steel capacity …

          He knows that it is 2012 now right? If he wants to make a case to support whatever opinion he has why not use current data?

          This reads as either being too lazy to source current data or current data doesn’t fit the narrative.

          • If we want to use 2008/2009 data we can conclude that Australian consumers are going to face high prices for imported goods because the Aussie dollar is at 65 cents and spiralling downwards.

            We can also conclude that base metals, iron ore and coal are finished due to collapse in prices. Steer clear of these.

            …and so on.

            3-4 years of data makes a big difference in how you view investments in this country. I’d imagine it is the same in China. Pundits too lazy to source current data should be asked why.

          • Why do I need to prove anything?

            You’ve quoted from an article. I drew attention to the fact that to make his case he uses 3-4 year old data, at the height of the GFC meltdown.

            I’m thinking that circumstances are a tad different now to the bottom of the GFC meltdown. Just sayin’, …but I know that is not consistent with the collapsnik narrative which seems to have very little quality control in the data cited 🙄

          • Well, you just made some lazy assertions of your own:

            This reads as either being too lazy to source current data or current data doesn’t fit the narrative.

            Anway, You seem to just taking the piss, so not interested in continuing this thread. Ciao.

      • Sure demand for our ore will drop off when the structural work has been completed – but that isn’t the case yet.

        Calling 7.5% GDP Growth a hard landing is an oxymoron in any language.

        We both know that the boom will end at some point, but we won’t be shutting all of our mines down.

        • Yes it is the case – demand has massively dropped off, so has the price.

          Whats more there is no real growth in the US, beyond the stock Markets – the US economy took a 25% smashing across the board, when we see 25% regained you can claim recovery, 2% on top of last years falls is not a recovery.

          • Well we can only grow from where we are at the moment, and pretty much everyone accepts that the USA is now growing again.

            I’ll change my tune on that if and when the outlook changes.

        • Calling 7.5% GDP Growth a hard landing is an oxymoron in any language.

          Pettis has been predicting 3% growth for a while now.

          We both know that the boom will end at some point, but we won’t be shutting all of our mines down.

          No, but both prices and volumes are likely to fall significantly, which will have a big impact on national income. And as you know Peter, when market sentiment turns, markets tend to overshoot on the downside.

          Outside of the iron ore space I think our LNG investments will be in trouble with gas prices at record lows and US gas production at record highs.

          Unlike iron ore, we are a high cost LNG producer, so it won’t take much for Aussie LNG production to become uneconomic. It will take an absolute catastrophe for our iron ore mines to become uneconomic, but they will be vastly less profitable if (when?) Chinese demand collapses.

          I think (themal) coal will do ok though, with Japan and Germany shying away from nukes, the world will demand more of our black death.

          • Lorax, you amaze me – you know about peak oil but don’t see a future for gas????

            What gives – do you think the world has unlimited oil reserves?

            How can you move from macro on one commodity to micro on it’s replacement. How much solar power do you think we can generate in the next few years, and I know that you are aware of the current limitations with solar power.

            Yours truly,

            A realist.

          • MsSolarFelineAU

            Just to go off-topic, may I venture that LNG stocks *may* go up if the Middle-East blows up? Just a thought…

          • Peter,

            Have you noticed that oil is pretty close to is post-GFC high, but gas is at 10 year lows?

            Fracking has changed the gas game in the US, but they’re still not producing much oil.

            Is there a long term future for gas? Sure, but there’s also a global gas glut ATM, and (unlike iron ore) we don’t have the luxury of being a low-cost producer.

            Yours realistically, Lorax.

          • yes lorax, i did notice all of that. When the fleets convert the lift to GDP from a more economic fuel will be dramatic.

          • I think you need to distinguish between domestic gas used largely for domestic industrial heat and electricity production and LNG which is a liquid fuel that can be exported and used in transport as a replacement to oil.

            In order to get a better deal for their gas, the US will build LNG export terminals.

            Judging by the price of oil and inability of conventional oil production to meet rising demand, I’d expect the price of gas to rise in the US more than depressing the price of global LNG prices.

          • When the fleets convert the lift to GDP from a more economic fuel will be dramatic.

            But Peter, there’s no distribution infrastructure for natural gas. You can get LPG at most servos nowadays, but not CNG, and if LPG is any guide, the switch from petrol to CNG won’t happen in a hurry even if there’s a huge price differential.

            The fact is, gas is a less energy-dense, less convenient fuel than petrol or diesel, and that’s probably the main reason Australians didn’t switch to LPG years ago. People don’t want a big gas tank in the boot, and they’re wary of using LPG bowser.

            Contrast this with the rapid take up of diesel powered vehicles in recent years. Who’d buy a petrol engined 4WD these days? You can buy little diesel hatchbacks that will do 60mpg in the old money, and have more torque than a V6 Commodore.

  3. For noobs (like me, who had to look it up)

    RRR = Required Reserve Ratio

    A pet peeve of mine is authors who use abreviations (acronyms and initialisms) without defining them.

  4. In comparison to China boosters such as Pascoemeter, Wen Jiaboa actually sounds like a pragmatic collapsenik!

    In last year’s session, he talked about working hard to avoid stagflation. And this year, he seems intent on deflating the housing bubble. I don’t know on what basis do China booster push the “millions more to urbanize” narrative.

  5. I agree with you that U.S. shale gas will have a much bigger impact on the LNG market than most commentators believe. The arbitrage between North American gas prices and Asian gas prices is just too large to be maintained in the long term (once sizeable exports out of N.A. begin).

    Having said that the LNG projects that have signed offtake agreements already are in a better position than you give them credit for. Unlike iron ore contracts which are now repriced quarterly (I believe) pretty much all of these LNG contracts have oil linked pricing for the life of the contract (typically 20 years).
    As such projects already underway will only be hurt:

    1) If the price of oil globally is severely impact by the gas glut; or
    2) If the buyers default on their contractual obligations.

    On point 1) I think gas will depress oil prices to some extent given there is some substitution potential + liquids rich shales are being very aggressively developed. I suspect the change won’t be anywhere near as large as for Asian spot LNG cargoes however.

    On point 2) I’d note that I understand most of the agreements are under Australian law and that most of the buyers have equity interests in the projects (that is they have something to lose if they default and are sued in court).

    I would be very cautious about LNG projects that have yet to sign an offtake contract though.