Opportunity to Sell Into China's Illusory Stimulus Package

As the Monday morning bullishness in Asia continues to impress traders in Europe and North America, buying interest in China shares (ACH, GSH, SNP), China indexes (CHXN) and China ETFs (FXI, PGJ, CAF) is certain to gather momentum today. But, on closer scrutiny, the $586 billion Chinese stimulus package which is triggering all the positive sentiment appears to be an illusion of the highest order.

Chinese government officials stated that the stimulus package will focus on housing, infrastructure and post-earthquake construction over the next two years. And bulls seeking feel-good stories are making a number of assumptions on the back of that announcement. Some anticipate that China's stimulus spending will boost copper, gold and oil prices. Others see a brighter future for Japanese building conglomerates and auto makers. Yet others are forecasting a turnaround in China's domestic consumer demand. IMF Chief Dominic Strauss-Kahn thinks that the stimulus package will have a positive impact on the World economy. So far so good.

However, the bullish calls on China uniformly fail to take into account that fact that hardly any of the designated stimulus dollars (or yuan) will be spent in the foreseeable future, or even in the medium term.

In the transportation sector, for example, Chinese lawmakers have already legislated on a comprehensive 5-year spending plan way back in March 2006. The plan included (a) six new railway systems and the upgrading of five others, (b) fourteen expressways, including one from Beijing to Hong Kong and Macau, (c) the modernization of transit facilities at twelve Chinese ports, (d) dredging deepwater channels at the mouths of China's major rivers and (e) expansion of at least ten regional airports. In addition, the Chinese government allocated spending for flood prevention measures, the development of water resources and gas pipelines from Russia and Central Asia.

As of today, each component of the legislation is well under way, albeit along uniquely Chinese timelines. Moreover, as far as post-earthquake rebuilding is concerned, city authorities in Chengdu (Sichuan's capital) publicly acknowledge that the delays in implementing the relief agenda have more to do with bureaucratic hurdles than with a shortage of funds.

So, when, how and where will the stimulus money be spent? There is obviously no clarity from Beijing, and sceptics are already suggesting that the Chinese announcement is designed simply to stave off pressure at the G-20 Summit in Washington later this week. But whatever Beijing's intentions may or may not be, equity markets are desperate for a dose of optimism, and there is no doubt that China-based shares, indexes and ETFs will attract robust buying over the next 48 hours.

Until, of course, reality dawns. The impending short window will not only be restricted to the China matrix. Copper and oil should also be ready for a pullback by Wednesday, if not earlier, once traders realize that China's stimulus is not going to result in real orders any time soon. The biggest beneficiaries of Monday's bullishness in Shanghai, Baoshan Iron and Steel (SHA 600019), Anhui Conch Cement (SHA 600585) and China Railway Construction (SHA 601186), should perhaps be avoided in the event that Chinese and Asian investors maintain their belief in the integrity of the Beijing announcement for a while longer.

Stock position: None.

Comments

[Pipo:]

Many famous investors including Jim Rogers are buying China right now. Shanghai`s composite is 65% down from the top.

jimrogers-investments....

2008 Nov 10 06:14 AM

[James Wilson:]

Let's see China is cash heavey and holds futures in almost every country's currency around the world.
Talking down China does not change the last 10 years of advancement and trade deficts other countries hold with China.

2008 Nov 10 09:18 AM

[David Martin:]

The package is said to include social stimulus programs too, which could presumably be front-loaded as they are an easy way of disbursing money.
An interesting question, I would have thought, is that if these funds are disbursed, taking China from a position of budget surplus to slight deficit, that would mean that around $300 billion a year would no longer be available to buy US Treasury bonds.
Any expert comment on the consequences of this?

2008 Nov 10 09:30 AM

[20smoney:]

China is a great buy right now

2008 Nov 10 09:49 AM

[huangthomas:]

How much funds are available to purchase US treasury depends more on the trade imbalance between two countries, and not on Chinese national budget. It is an open secret that US treasury always arm twisting Japan, South Korea, Taiwan, China.......to purchase US treasuries. To China, infrastructure construction is a better investment for the future than buying US treasuries.

Of course planning takes time. You don't take a map, choose two points and draw a straight line for the rail system construction. The social welfare spending takes much shorter planning time. As long as they plan to spend so much money for the next two years, it will help to lift Chinese economy, which is in dire shape.

Chinese dislike the fact that the West expect China to contribute to save the world financial crisis without much saying in the decision making process. Chinese always say "it is unfair".

2008 Nov 10 11:06 AM

[Rakesh Saxena:]

On Nov 10 09:49 AM 20smoney wrote:

> China is a great buy right now

Dear 20smoney: I am not making an overall bullish or bearish case on China. The short window I am focusing on has to do entirely with the real impact of the stimulus package on the stock markets, i.e. a single-purpose trading opportunity. Many thanks - Rakesh

2008 Nov 10 11:54 AM

[HaavBline:]

Mr. Saxena’s observations may be good, but probably far from complete, and maybe incorrect. Depending on how sharp the short term market response may be, he may risk a very good buying opportunity if he attempts to profit by selling or shorting China plays under current depressed market conditions.

It is true most of the components in the 4 Trillion Yuan package consists of projects that were already included in other longer term plans. The emphasis is on the expedited approval and funding of those projects already in the current 5 year plan, to be expedited into 2009 and 2010. So the short window of planning delay expected by the author may not materialize at all. In fact, today, the expedited START of two railroad projects were announced, in addition to 2 others started in the last two weeks.

The bureaucratic hurdles that delay project starts surely exist in China as much as any other country, especially when those hurdles remain under the radar screen of the central government. However, in China, when the central authority is knocking on the door of local officials, those ‘bureaucratic hurdles’ has a way of disappearing instantly. So again it is very risky for Mr. Saxena to bank on those illusive hurdles.

The author also neglected to mention the numerous other policies in addition to the stimulus package. These include interest rate cuts, tax cuts, duty wavers, removal of loan reserve requirements, as well as concessions and stimulus packages at local levels in Guangdong, Shanghai, and Beijing.

If all of these is still not enough, China still have plenty of ammunitions to ensure the targeted 8% growth.

At current levels, China plays are excellent medium and long term buys.

2008 Nov 10 09:53 PM

[fawnpass:]

This author, it seems, can't see the forest through the trees. He is correct in saying that the stimulus package is largely illusury, but his conclusion is faulty. The stimulus package is illusury in the sense that many of these projects, as the author stated, are already works in the pipeline. So, in essence, the Chinese government has labeled infrastructure projects that have already been planned as stimulus. This functions to reassure the world that the Chinese government will continue to invest large amounts of money on future growth even amidst a current downturn of manufacturing. It also serves to reassure investors in the chinese stock market, supporting the index. You must also keep in mind that as governments around the world infuse money into systems where large amounts of "paper" capital have vanished, in order to insure ongoing operations, the Chinese government's money spent is going into real concrete products, that will serve to create even more capital in the future.
Of course, short term rallies will offer opportunity for profit taking in such a volatile market, on this point the author is also correct. However, it would also be wise to take a long term investment position as well as a trading position in China at this time.

2008 Nov 10 10:01 PM

[HaavBline:]

China excels at central planning, and the national transport and energy infrastructures are tools for managing a smoother economic growth. There are long term plans and then there are 5 year plans. The plans are not rigid as many may think. When face with 12% GDP growth and overheated commodity markets like those of 2007, the central planner may slow down the funding and scheduling to planned projects to avoid overly stressing the economy. When faced with sub-par growth and subdued commodity markets, China can expedite those projects. The money and the construction capacity are in good supply.

2008 Nov 10 10:09 PM

[Tony Petroski:]

I don;t understand how an economy growing at 8% a year, down from 12%, needs a "stimulus," nor how such a country can have stock values down 75% and more. Can we trust the word of the communists or not?

2008 Nov 10 10:18 PM

[HaavBline:]

China is the the urbanization / industrilization phase of national development. It has a very large rural population that will need to migrate to cities to find productive work. Most economist believe China need to maintain 8% GDP growth in order to create enough jobs to assorb those new workers, or else China will face social chaos.

Some economists are beginning to predict as low as 5.5% GDP growth for 2009 due to global recession. The 4 Trillion Yuan stimulus package are calculated to provide a 2% to 3% boost in GDP growth in order to ensure China gets the 8% growth it needs. Additional measures are also being applied.

This package are almost unanimously prasied and admired by various commentators on CNBC today. Even long-time China basher Peter Navarro had to praise it, saying that it is 'ironic' that China is showing us the way forward, or something to that effect. For people who know Navarro, this is a shocking U turn.

Finally, China's domestic stock market is notorius for failing to predict or even reflect economic reality. Slowing from 12% to currently supposed 9% is also quite a shock.


On Nov 10 10:18 PM Tony Petroski wrote:

> I don;t understand how an economy growing at 8% a year, down from
> 12%, needs a "stimulus," nor how such a country can have stock values
> down 75% and more. Can we trust the word of the communists or not?

2008 Nov 10 10:34 PM

[Rakesh Saxena:]

On Nov 10 10:18 PM Tony Petroski wrote:

> I don;t understand how an economy growing at 8% a year, down from
> 12%, needs a "stimulus," nor how such a country can have stock values
> down 75% and more. Can we trust the word of the communists or not?

Dear Tony: Your concerns are genuine. Why does China need a stimulus package in the first place? Economists should be asking that question. And why did stocks tank when the GDP is still at record levels, relatively? These are fundamental questions which need to be answered before making any longer term case on China, bullish or bearish. Many thanks - Rakesh

2008 Nov 11 01:08 AM

[bassmaster17:]

China wants to be the economic jugernaut in ten years and the financial capital of the world...this will probably happen, but the US will recover and the twin giant scenario will take place, but we may have to get through some pretty painful inflation in the intermediate term. I was reading something about how Pemex will have no oil in two years..Mexico...our second biggest exporter, the next few years will be very interesting. Recessions come and go, there are some great long term ops out there.

2008 Dec 26 11:23 PM