Everything You Need To Know About China

| About: iShares China (FXI)

Summary

The Chinese economy is expected to continue slowing in the following years and will probably undershoot the government's average annual target of 6.5%.

Due to the ongoing structural reforms, government policies and global economic conditions, certain sectors within China have surfaced as winners while some are surprisingly becoming losers.

Monitoring how Beijing is managing China's slowdown and whether it will be able to rebalance its growth are highly important as weakness in China will weigh on US stocks.

Overview

China's economy grew 6.9% in 2015, which was the slowest expansion rate in the last 25 years. The Chinese economy is expected to continue slowing in the following years and will probably undershoot the government's average annual target of 6.5%.

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Source: World Bank

And while the authorities are implementing reforms needed to rebalance growth in favor of consumption and services, weak companies have been hit on profits margins. Nevertheless, it is expected that the Chinese government will continue to introduce "favourable" policy initiatives concerning supply side reforms, even though the monetary relaxation is proving to be ineffective and the volatility of the financial markets could undermine confidence levels among investors and consumers.

Due to the ongoing structural reforms, government policies and global economic conditions, certain sectors within China have surfaced as winners while some are surprisingly becoming losers, which give long-run investing opportunities.

Winners

Among winners, there are automotive (NYSE:ATHM), information communication technologies (ACTS, CNTF) retail (ATV, ATAI) and transportation sectors, which will continue to benefit from the positive demand outlook, supported by the rising middle-income class and stronger government emphasis on consumption. Companies in these sectors are expected to continue investments in fixed assets, which will further be boosted by government incentives for targeted industries, such as electric vehicle and aircraft engine manufacturing. On the bright spot is pharmaceutical sector as well (NYSE:WX), whose net profit margins remain very stable. While enterprises within this sector are enjoying steady profit margins, they are at the same time less dependent on borrowing for their ongoing operations. Looking ahead, pharmaceutical sector is likely to enjoy an increase in structural demand, with the continuing expansion of the middle classes and the ageing population.

Losers

On the other side, former champions of Chinese economy chemicals (DQ, SHI) and construction can be classified as sector losers. These sectors have been suffering from significant overcapacity, falling demand and lower support from the government. In addition, companies within those sectors have cut back on investment projects, as reflected by slowing growth in fixed asset investment. Moreover, many of them are assigned with high risk ratings, indicating a higher default probability and insolvencies due to challenging business conditions. Metals sector is another sector to likely face challenges as its two key segments, steels and non-ferrous metals, have been suffering from muted demand and significant overcapacity. Followed by gloomy outlook for the construction sector, China's official PMI has been around 50 for the most of 2016 showing little improvement. This points to a lackluster demand for steel and non-ferrous metals (aluminum, copper. magnesium, nickel… ). Besides, authorities in China plan to reduce capacity in steel sector, which is evident from the steel production data from 2015 that shows a decrease of 2.3% from 2014 levels. These actions can affect a variety of steel companies worldwide (X, ACH, OSN, AKS, STLD, NUE, MT) as China still accounts for 49.5% of global production.

Neutrals

There are also those that do not benefit directly and nor are harmed directly by the structural reforms; however, they are affected by other specific factors. They can be classified as neutral sectors which include: textile-clothing sector (affected by rising labour costs in China that lead to the relocation of manufacturers to other emerging countries with lower labour costs such as Vietnam); paper-wood sector (which is likely to be affected by an increase in import costs) and agricultural sector.

At the end…

The Chinese economy is set to slow down in 2016 and 2017 and being the world's No. 2 economy, a slowdown may have a big impact on developing countries and global economy in general. The combination of weakness in China and other developing economies and the potential that they could send the global economy into a recession are the real problems that will weigh on US stocks. Thus it is highly important to constantly monitor how Beijing is managing China slowdown, and whether it will be able to rebalance its growth.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.