It's the question that comes up whenever a monetary policy induced boom becomes a bust: will Country X be able to create a soft landing and avoid the dreaded R-word. What I find interesting is that the definition of a soft landing is an ever moving target, especially depending on which country is involved in the discussion.
For a politically-important one like China that definition is pushed as high as GDP growth slowly below 7.5% while for the U.S. averting a cataclysmic depression and stuttering along for four years at less than 2% afterwards is considered a recovery.
So much of the discussion amounts to nothing more than people talking their book and their particular bias versus the country in question. As someone working outside of the U.S. this effect of reporting on the data and the situation is very obvious and clouds the creation of an investment thesis.
Bears Will Be Bears
China bears will see every move the Chinese make as bearish as that is their confirmation bias, but these recent developments tell me otherwise:
- 1st quarter GDP came in at 8.1% while China has guided for 7.5% for 2012
- Total Loan value is increasing faster than PBoC credit, meaning there is a market for new lending.
- The CPI has fallen from 6.5% in mid-2011 to 3.2% in March 2012
- The daily trading range for the Yuan was increased from 0.5% to 1.0% per day.
- Yuan quotas for outside investment, like ETFs, were raised to $50 billion
- China's current account surplus has dropped to 2.7% of GDP a good indication that the Yuan is close to fair value.
By making the moves to liberalize the Yuan for international trade and investment that indicates very strongly to the market that China's leaders are confident in the situation and no longer feel the need to protect the Yuan from appreciation. Chinese financials will be under a lot of pressure in the medium term as they continue to work through their construction excesses. But, with more than $3 trillion in foreign exchange reserves they have the capital to absorb a lot of external shocks as they transition their economy from export-driven to domestic consumption. Lower GDP growth rates are part of the future plan so any discussion of China's numbers should be viewed from that prism.
So, that said has China engineered a soft landing? If their longer term GDP goals are 5-7% as opposed to 8-10% and they are supporting monetary policies that will continue to wring the excesses of their property market while maintaining higher growth in their manufacturing sectors I would have to say yes. Is it going to be a difficult row to hoe? Of course, but when you are the world's largest net creditor gives you a lot more wiggle room, just ask Paul Volcker.
Looking at the Claymore/AlphaShares China Real Estate ETF (TAO), shares have risen 22% this year and seem to have found fair value near $17.50 per share. It is trading slightly above that near $18 on 4/25. The iShares FTSE China 25 Index (FXI) is trading on 4/25 at $37.37 per share and has seemed to found fair value as well. Investors at this point are comfortable with the valuations of China's real estate as well as their largest cap stocks.
Bulls Waking Up
The situation in Vietnam is more fragile but it is becoming more tied to China, Korea and Japan as each day goes by. The latest CPI numbers were just released by the General Statistics Office and they point out very strongly that the Volcker-like monetary policy of the past two years has popped the bubbles of the previous credit-induced boom. A year ago inflation was more than 23% as the dong was in free fall while gold and the dollar were in demand. Fast forward to today and CPI inflation for April was 0.05%. In March it was 0.16%. This takes into account a 15% rise in the price of most petroleum products which should have sent prices soaring.
They didn't. The reason is because of controls put on by the State Bank of Vietnam to curb the use of both the U.S. Dollar and gold while at the same time contracting credit slightly and offering extremely high rates of return on time deposits in dong. The SBV removed more than $6.3 billion in Dollars from the economy boosting foreign exchange reserves by more than 50% in the past nine months.
Mo. to Mo. change in Food prices
This dramatic slowdown in the CPI has given the SBV the room to begin lowering interest rates earlier than expected and stratifying the banking sector even further by lowering the deposit rate cap. Going inside the CPI figures for the year, since January food prices have actually dropped by 3.6% cumulatively. Since 2009 food prices in Vietnam have risen more than 52%, severely impacting disposable income. The trend in food prices is accelerating.
I'm focusing on food prices because this is a key driver for loan servicing which is the weak link in any thesis involving a soft landing for Vietnam's economy. The banking system is extremely fragile, as are a number of industries still struggling under very high interest rates. M&A activity and bankruptcies are increasing across most sectors and yet, GDP growth still came in at 4.0% for the 1st quarter while achieving a modest trade surplus of 0.7% of GDP. The bearish case for Vietnam is based on inflation not getting tamed quickly enough.
That argument is over. If anything the contraction of total credit, 1.96% in Q1, is signaling that price deflation is actually taking place. It is happening in real estate, finally. For example, major conglomerate HAGL announced a massive price drop on villas and apartments as the company re-focuses itself into a rubber and sugar manufacturer.
That said, the SBV has not contracted the money supply, but it has radically reshaped it in a very short period of time, injecting dong into the economy at a slightly faster rate than it is removing dollars. Gold is being relegated to a savings instrument either through time deposits or physical hoards.
The Vietnamese equity market bottomed in early January and since then has gone on a 35% run which looks technically very strong. The Market Vectors Vietnam Index Fund (VNM) has risen similarly and seen AUM expand more than 16% since early March. The early adopters of the thesis for Vietnam's recovery have been well rewarded.
What is happening in Vietnam would be considered a hard landing in China and vice versa. The important takeaway in both of these analyses is that definitions of such a slippery nature are irrelevant to the present and the future. Both countries took extreme measures to correct their excessive speculation and should reap the benefits of it going forward. The markets told us back in October that the worst of the projections for China had been accounted for and similarly for Vietnam in January. Looking at today's policy decisions will tell you where they will be in 2013.