The Great 'Fall' of China?

On Thursday, China announced its economy grew at a 6.8% in Q4. This is not very good news at all. China’s GDP growth is inching perilously close to 6% economic growth, which is viewed as the minimum necessary in order to keep the lights on. It’s a critical level that the world is watching, closely.

Say what you want about the validity of China’s “official” numbers, but it’s bad and it’s probably going to get worse. As you can see in the table below, the downtrend is still accelerating.

click to enlarge

The U.S. is Sneezing…

At this rate, China is on its way to a full-blown crisis. A few months ago, when the first wave of manufacturer shutdowns in China swept through the country, we felt that there would be a lot more to come. After all, about one-third of China’s economy comes from production, manufacturing, and exports and about one-third comes from expanding export and production capacity.

That’s why China’s economy takes a double hit during tough times. When toy factories are shutting down, the economy loses the jobs. Of course, there’s no need for new toy factories either, so the production expansion sector of its economy is hit too.

The old saying, “when the U.S. sneezes, the rest of the world catches a cold,” certainly seems to be a proven fact in China. China Daily estimates that:

A drop of 1 percentage point in the economic growth of the US and Europe would send the Chinese exports falling by 4.75 percent, and the exports of electronics and textiles down by 0.5 percent respectively.

Now, we’re starting to see the impact on GDP growth. Of course, the quickest way to get China back on track is to get exports rolling again, but as we saw a few weeks ago, that’s not going to happen anytime soon. This was when China announced that its exports had fallen the fastest in over a decade.

This is the first time that China has had to deal with all three of its top customers – U.S., Europe, and Japan - being in recessions at the same time.

What does this mean for China stocks?

Well, since November, there’s still a lot of interest in China stocks. It’s pretty tough to make a case against the long-term opportunities in China, as the country’s economy is showing signs of change. For instance, last month retail sales increased more than 17%. Internal demand is growing, but it still has a long way to go. The short-term outlook, however, isn’t very strong at all.

One indicator I look at is the volatility component of long-term options on the iShares FTSE/Xinhua China 25 Index ETF (NYSE:FXI) which tracks 25 of the largest publicly traded Chinese companies. The volatility on the FXI is the equivalent of the VIX (CBOE Volatility Index, or “Fear Index,” for the S&P 500). Although it has a bigger exposure to mining and energy stocks than the S&P 500, it’s the closest thing to a “China VIX” as you’re going to find.

Basically, the VIX is a way to value the cost of downside protection. It’s the cost of insurance. When the market is falling, the VIX goes up and vice versa. Today, the China VIX ticked up to 80 (for the January 2010 FXI 25 Put option). Compare that to the S&P 500 VIX of 50 and it shows there’s still some strong demand for “insurance” against Chinese stocks, but it’s not near crisis or panic levels.

Combine a steadily declining economy, and growing fear, and it’d be a pretty safe bet there will be an opportunity to “buy China” down the line at a noticeably better price. We’ll keep you posted in our 100% Free e-Letter, the Prosperity Dispatch. Remember, China’s economy is built for booms and no one knows how well it’s going to fare during a downturn. So far, it hasn’t fared well, at all.

Disclosure: None

Comments

[Lonestar1:]

While many think that US will be the FIRST in and FIRST out of the crisis, it is more likely that China will be the one LAST in and FIRST out. The monetary, fiscal and currency tools are only employed at moderate levels, compared to US or Europe. They have a lot more room to maneuver than any other country. The only question is when to jump in in terms of stock investment. My own bias is the same time as in the US. i.e., sometime in the Summer.

Jan 25 10:37 AM

[ajit:]

This is because of export down.

Creation of china inbuilt demand is not possible to that extent ?

so market will be down

but when demand show up china will start first to come up and also India

Jan 25 10:50 AM

[Ricard:]

When there's an earthquake in which the foundation of a building collapses, what happens the 10th story? Guess what...it falls, and damages every story underneath it as it falls. Developed country consumption has been the foundation of China's growth. Now, China's 10% GDP growth is falling, and it will take out everything underneath, and further damage the foundation as well.

Central banks around the world are trying to reinforce what's left of the foundation so that the building does not fall. What you would probably have afterward is probably a building that is uninhabitable.

Jan 25 01:03 PM

[Firat Ünlü:]

You are aware that China will be the of the rare economies to still grow in 2009 and that its fundamentals (solid manufacturing base, increased infrastructure spending, better-educated workforce each year, increasing knowledge, working its way up the value-ladder etc...) remain sound, aren't you?

The problem is that growth at less than 8% means that the private sector does not create enough jobs, however, they have ample room to maneuver and come up with short-term solutions.
Any information on how stocks are affected by market sentiment would be much more lucrative considering the Chinese market tanked by 60% despite much better fundamentals than those of most 'developed' economies.

Also, exports didn't fall by that much, did they?...

Jan 25 01:15 PM

[applesauce:]

They have cash and lots of people willing to build out their infrastructure. Expect mass projects in roads, rail, and energy infrtastructure spending the next five years . Currently short thru FXP but will change soon.

Jan 25 02:32 PM

[fairguy:]

for china growing at 5-8% per annum is much better than boom rates of 10%+ per annum. Americans shouldn't tell how china run their country when they themselves are so screwed up.

Jan 25 04:07 PM

[Boriga:]

Again, more utter rubbish about some magical growth figure meaning China is in meltdown. What all these armchair China watchers do not seem to see, as Yamu mentions above, is that China is still growing and at rates that Europe or even the US could now only dream about.

China is suffering change, as it has for the last 30 years, but there is so much going on in the domestic economy, particularly the very significant construction and real estate sectors, which can very easily be rekindled, particularly with the way the banks are prepared and now can lend. The real estate slowdown was inevitable when the government, unlike UK or US, had been restricting lending by the banks and charging 10% tax on transactions to try and cool the market. They have started reversing these policies and its already kicking in.

China will be last in, first out. In fact, the signs are already there and the recovery will be domestic consumption driven and so the global recession and decline of export markets will not affect this turn around.

Jan 26 09:33 AM

[huangthomas:]

Chinese official data show export falls 2.8% and import falls 21% in December 2008. Since global economy is still sinking, this is not the end of the story for China.

Jan 26 10:56 AM

[seneca:]

Silly silly stuff -- magic mushroom magic 6%....this near-sighted writer is standing outside of a very large pachyderm and making predictions based on what his fingertips can touch. Beware of this superficiality.

Jan 26 11:56 AM

[Gedankonomist:]

Yes, thanks to your tax money, we have the Export-Import "Bank" giving incentives for companies to relocate to China. Perhaps the US may never get out.


On Jan 25 10:37 AM lonestar1 wrote:

> While many think that US will be the FIRST in and FIRST out of the
> crisis, it is more likely that China will be the one LAST in and
> FIRST out.

Jan 26 02:43 PM