By Douglas R Terry, CFA
Headlines a few years back were about China's need to re-balance their economy away from a heavy reliance on exports and toward domestic demand. The thesis says that self-reliance will lead to a less volatile economy and lower cost of capital. China is succeeding with this goal, but the path is initially a very bumpy road. The MSCI China index is down nearly 20% in the last 3 months, but is flat year-to-date; that is some volatility.
As their economy continues to evolve, important proxies for economic activity will change. Steel production and electricity usage will become less reliable indicators of overall economic health. The old guard indicators have certainly shown sign of tiring, but continue to look more and more at the service side to get a more vivid picture of the Chinese economy.
Also remember the following:
- Excess capacity will continue to be a problem in the industrial sector.
- Financial activity will become a bigger part of the economy; and, this factor is likely a primary cause of volatility.
- The emergence of domestic markets for securities like municipal bonds will lead to investment.
- Later this year, the IMF is expected to decide if the yuan will be included in its SDR basket of currencies. Expect the yuan to be stable.
Looking at the bigger picture in China, the economy should still be expected to grow 7% this year. But, expect some continued volatility in asset markets.