Four Signs the China Growth Story is Cooling

by: Lou Basenese

After last quarter’s anemic GDP growth rate of 1.3%, it’s fashionable for financial pundits to knock the United States. But you know what? Our economy isn’t the only one flashing signs of a cool down. So is China’s.

Of course, we don’t hear much about a slowdown in China because so many people trumpeted the emerging market as the greatest growth opportunity of our lifetime. And thus, it’s heretical to even suggest anything to the contrary.

But as economic consultant Dr. Gary Shilling says, “China isn’t this juggernaut that’s going to grow forever without any interruption.” I agree. And here are four signs proving that interruption could be right around the corner.

China Warning Sign #1: Runaway Inflation

China’s annual inflation hit 6.5% in July, the highest mark since June 2008. And that’s well above the central bank’s annual inflation target of 4%. China’s been trying to cool down prices for almost a year. In fact, its central bank has raised interest rates five times since October 2010. Clearly, it’s not working. So more interest rate increases appear inevitable this year. And when any country keeps raising interest rates, it’s only a matter of time before it weighs on economic growth.

China Warning Sign #2: Auto Sales

Bulls love to champion China as a nation of 1.3 billion consumers with an insatiable appetite for modern conveniences, including automobiles. However, the latest auto sales figures hint that unmatched demand could be waning.

Sales of automobiles in July dropped 11.1% from June, prompting the China Association of Automobile Manufacturers to cut its annual sales forecast. Persisting weakness is a bad sign for China’s economy since the auto sector accounts for about 10% of GDP.

China Warning Sign #3: Bad Banking Fundamentals

We know firsthand how out-of-control lending can sap a nation’s economy and undermine stocks. And China’s banks appeared destined to repeat the sins of America’s financial sector. Over the course of two years (2009 and 2010), China’s banks lent out a record $2.7 trillion.

Mind you, such a rapid credit expansion exceeds the surges witnessed in the United States before the 2008 financial crisis, in Japan before its 1990 collapse, and in South Korea before the Asian financial crisis hit in the late 1990s, according to Fitch. And China’s clearly concerned about history repeating itself. It’s raised bank reserve requirements 12 times since the beginning of last year.

I’m sorry, folks. A government doesn’t increase the amount of capital that banks need to set aside to cover loan losses if they don’t anticipate a problem. When the credit bubble finally pops, Fitch estimates bad debt may jump to 30% of total loans.

China Warning Sign #4: Stocks

We all know that stock markets are forward-looking beasts. And the recent performance of the Shanghai Composite Index should be viewed as a flashing red warning sign. The Index is down 14% since April and almost 20% from its 52-week high hit in November 2010. In comparison, the S&P 500 index is only down about 1% since last fall.

Bottom Line: Although the world’s second-largest economy expanded at a 9.5% clip in the most recent quarter, the country’s not immune to a slowdown. And the latest signs point to one in the offing. So if you still have a significant amount of money invested in Chinese equities, take heed.