The ongoing slowdown of the Chinese economy is based on the fact that China failed to switch from an export/investment-led economy to a consumption-led economy (said differently, authorities may have been too optimistic on the rate at which this would happen).
1. Higher wages have reduced the competitiveness of low-end products. In the meantime, most of the increase in income has been saved, driving the share of consumption below 40% of GDP.
The new pattern of international trade is no longer based on the exchange of goods and the offshoring of production lines (thanks to lower transportation costs) but on the optimization of the global chain (thanks to lower communication costs). As a result, ramping up the value chain of goods manufactured by one country no longer reflects the old theory of the innovation cycle (technology first developed and used in advanced economies then sent abroad to low-income countries). Countries that host the assembly line may never have access to the technology embedded in the goods produced.
The internationalization of the value chain can also distort the perception of economic power. China may be a strong exporter, but the value-added content of its exports is very low. The best way of showing this is the chart below that crosses the bilateral trade balance between the U.S. and China and the ratio of Apple to Foxconn valuation.
2. The depreciation of USD/CNY could ease the rise in the real exchange rate triggered by higher wages, but it should not help the expected demand switch, as domestic demand is inversely related with a weaker currency.
3. For the official GDP growth target to be reached, an efficient stimulus would be required. Unfortunately, it all depends on local administrations whose resources are linked to the sale of real estate. Real estate prices are flattering, while banks are forced by the PBOC to reduce their margins (the purpose being to avoid the emergence of non-performing loans).
China's long-term objectives are challenged by the short-run necessity to stimulate economic activity. On one hand, cash-strapped local governments are reluctant to invest too much, and if they did, they would raise the share of investment in total GDP (not that the capital stock is too high in proportion to GDP, but its growth pace must decelerate). On the other hand, higher wages would likely be saved and hurt competitiveness further.
So, even though Shanghai stocks my lay look very low and cheap against their European or U.S. counterparts, I would not recommend any long position for the next few months.
Disclosure: I 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.