China: Worse Economic Time

by: Enzio von Pfeil

Currency support worsens China's Economic Time. Avoid this market for a year.

1. Monetary Economy Convulsions

According to research house Capital Economics, China's capital outflow in 3Q15 was a hefty $221 bn; Capital reckons that this figure must have swollen in the subsequent quarter. And recent stock market convulsions must have magnified such capital outflows even more. Of course, those outflows have wounded the RMB/dollar exchange rate, as we all know. Just last week, it tumbled by 1.5% - or by 10.8% annualised. In order to stem the bleeding, Beijing has stepped up its currency support mechanism: it has been selling dollars and thus buying RMB. Our Economic Clock suggests that this is a bad omen.

2. Real Economy Paralysis

According to the Financial Times (FT) of 8th January, p 6, "The main goals of December's Central Economic Work Conference were to reduce excess production capacity, work off unsold inventory in the property market, and reduce the operating costs of companies. While such reforms - as well as the strenuous ongoing anti-corruption campaign - are crucial to China's longer-term economic health, they do not pack much of an expansionary punch." Does this sound like Greece, or does it sound like Greece?

3. Worsening Economic Time

Boiling these two developments down to their essence, Beijing has exacerbated China's already bad Economic Time. In the monetary economy, intervention to continue supporting the currency means that China's excess demand for money is tightening: in order to support the RMB (which fell by 12% annualized last week alone), Beijing must buy RMB, thus reducing domestic currency supply. (When buying such RMB, Beijing has to sell its forex reserves: on an annualized basis, these fell by US$435 bn in December alone.) Students of our Economic Clock will recall that whenever there is such an "excess demand for money," there is no spare cash that possibly can go into assets such as stocks. And in the real economy, two engines are depressing demand: firstly, enforcement of measures adopted by that December Central Economic Work Conference which were cited in said FT quotation above, and secondly, the stock market crash of 50% annualized since the end of 2015 has wiped out the consumer confidence of that 85% of the stock market's owners: retail investors. Summa summarum, China's Economic Time - an excess demand for money and an excess supply of goods - has worsened on account of government responses to the recent skids in the stock markets and RMB. This means in plain talk: even less spare cash with which to buy ANY assets, and no reason at all now to expect corporate profits to improve when turnover and margins must wilt.

4. Political Poker

Here comes the wild card. An old friend of his Hong Kong days, Jonathan Fenby, wrote on the selfsame FTpage: of President Xi Jinping's aspirations: "After three years in office, his aim is quite clear: to increase the concentration of authority on the party, strengthen his personal control, keep the military on a short leash, run the internal security apparatus, suppress dissent, make China the global political equal to the US - and to try to move a new economic model while retaining state dominance. Oh yes, and to pick his eventual successors at the next party congress in 2017." Such hardline centralization is not without its risks, ones that will make the Chinese stock market even less attractive to foreign fund managers.

5. Investment Implications

If your horizon is the next four quarters, then don't touch the dangerous Chinese nor our floundering Hong Kong stock markets. If you can afford to buy into weakness due to your much longer time horizon (i.e. exceeding a year), then this protracted market slump represents a marvellous way to get stock on the cheap. Don't touch the RMB: we reckon that Beijing will allow it to slide 10-15%. Allowing it to slide like this would allow for looser monetary policy, which is what the place needs, given its excess demand for money.