J.P. Morgan Funds: China's Slowing Growth - Who's In The Driver's Seat?

Includes: FCHI, FXI, GXC, PGJ, YAO
by: J.P. Morgan Funds

Anastasia Amoroso

Global Market Strategist, J.P. Morgan Funds

After three decades of double-digit GDP growth, China has recently been expanding at a rate much closer to its five-year plan's established target of 7%. As the pace of growth has changed, so has its composition and trajectory. The focus is shifting away from growth at all costs to a preference for quality over quantity that increases the wellbeing of an average Chinese consumer. The government is intent on rebalancing the economy away from commodity intensive infrastructure spending and towards supporting the middle class by increasing urbanization, private consumption and affordable housing.

Slide 51 of J.P. Morgan's Guide to the Markets, for example, shows that while aggregate growth has slowed due to smaller gains in investment spending, consumption has held steady and now contributes more to China's growth than it did in 2008. To achieve this transition, in addition to fiscal measures, Chinese authorities can pull on several monetary policy levers, including interest rates, interbank liquidity, loan quotas and their composition. These tools are aimed at stimulating or slowing down credit growth, which finances many infrastructure, manufacturing and property development projects included in fixed asset investment (FAI).

Oftentimes, FAI and GDP respond to credit growth with a lag of several quarters, making credit growth a key leading indicator. Exceptionally strong credit growth of late 2012 may yet to translate into additional investment, helping the economy in the short-term, although further acceleration of credit is likely to be hindered by future regulation. Persistent real estate price appreciation and the proliferation of non-standard means of project financing while circumventing regulation (known as shadow banking) are two of the key concerns that policymakers are aiming to address.

GDP growth in China has been slowing, with focus shifting from investment spending to stimulating domestic consumption. The Chinese government has several monetary policy tools to achieve targeted GDP growth, amongst them credit growth, interest rates, and reserve requirements.

To support the quality of life and affordable housing for the Chinese middle class, authorities are focused on reining in the surge in home prices seen since 2007. This helps explain a series of property regulations that were introduced in 2010, 2011 and again in March 2013 (as seen on slide 52 of J.P. Morgan's Guide to the Markets). These attempts to curb speculative demand, seen as the source of rapid price increases and potentially imprudent real estate development, have so far produced only temporary results while exerting a yo-yo effect on home prices, Chinese economy and codependent commodity-exporting emerging economies. Judging from recent data, more housing restrictions may be forthcoming to slow down surging prices. Longer-term structural reforms are needed to promote a greater supply of housing especially in less developed cities and to support the urbanization trend. Introduction of a nationwide property tax (which is now piloted only in select cities) could help curb speculative property demand.

Residential real estate prices have surged in China, prompting authorities to enact measures aimed at curbing speculative property demand, albeit so far with only temporary results.

The Chinese government is right to step up its efforts to control credit growth and property price appreciation to prevent a larger problem down the road particularly given the build-up of leverage amidst deteriorating profit margins. However, this process could create a headwind for the Chinese equity markets. Looking past the short-term regulatory pain (which brings welcome relief to financial instability risks in the medium-term), better growth in the United States, stabilization in Europe and a recent spike in Japan's GDP could support exports, which combined with low valuations could serve as a catalyst in spurring a rebound in Chinese stocks. The China story is far from over, but it is a different kind of story and long-term investors need to be prepared for a highly differentiated performance in sectors of the Chinese markets and in codependent emerging market economies.


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International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the United States can raise or lower returns. Also, some overseas markets may not be as politically and economically stable as the United States and other nations.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by Anastasia Amoroso, Global Market Strategist, J.P. Morgan Funds, and submitted on her behalf via the J.P. Morgan Funds' Seeking Alpha profile.