With a possible summit of President Xi and President Trump approaching to sign “the trade deal of the century,” the Chinese stock market has zipped higher – rising from under 2500 to over 3100 on the Shanghai Composite in 2019, before the chilling export data hit last week causing a sharp reaction lower.
This rally on rising trade deal hopes is a rally for the wrong reasons. I believe that the recent sharply decelerating economic data in China is not because of trade friction and tariffs, which in this case act only as a catalyst. It’s because the Chinese economy was slowing down due to China’s authorities clamping down on unregulated lending and overall credit growth that had gone out of control in the last five years.
Apple (NASDAQ:AAPL) is a good indicator for China, as they cited the mainland as the main reason they missed estimates last quarter. If you watch the interview CEO Tim Cook gave to CNBC’s Jim Cramer, he clearly stated that Apple saw the Chinese economy slowing down on a rational trajectory before the tariffs hit, at which point the pace of deterioration picked up. My point is that the removal of tariffs will be no magic wand that makes the Chinese economy perform much better, despite the fact that they are pressing the accelerator pedal on lending quotas and reserve ratio cuts in order to spur the very credit growth that they were trying to clamp down on – which led to the slowdown in the first place (for more, see MarketWatch, January 14, 2019, “China’s hard landing? Watch prices on these 3 things, not economic data”).
Navellier & Associates does own Apple in managed accounts and in our sub-advised mutual fund. Ivan Martchev does not own Apple in personal accounts.
When it comes to economic data, February exports fell 20.7% from a year earlier, the largest decline since February 2016. Consensus estimates were looking for a 4.8% drop after January’s unexpected 9.1% jump. What makes matters worse is that imports fell 5.2% from a year earlier, where the consensus was looking for a 1.4% fall accelerating from January’s 1.5% decline. Imports of major commodities fell across the board, raising an interesting question about the direction of the CRB Commodity index and the price of oil, which fell precipitously in 2014-2016, the last time there was a major economic deceleration in China.
When the price of oil fell from $77 to $42 in the fourth quarter of 2018, I had a sneaking suspicion that it was not only due to hoarding crude stockpiles because of the coming Iran sanctions, but also a dramatic fall in demand from China, the largest driver of oil prices on global markets. The rapid deceleration of economic data in China of late supports that view (see MarketWatch, November 14, 2018, “China’s coming recession has pushed oil below $60”).
A Nikkei reporter saw the above article and called me, centering her questions on the very important issue of when China’s hard landing may arrive. As you may know, Japan has its own issues of too much financial leverage backfiring in epic deflation and economic stagnation for over two decades now, so a credit bubble like the one we have seen in China today is near and dear to their hearts.
You might call this “the trillion-dollar question” since that is the amount of foreign exchange reserves that have been lost since China’s reserves topped out near $4 trillion in 2014. How many trillions more will leave China if the hard landing actually arrives? I think we will find out soon enough.
The challenge with timing a hard landing in the Chinese economy is the fact that we have never had a situation in a major world economy where the majority of lending is done via government-controlled entities. Every time the economy weakens, they accelerate lending via quotas, adjust the reserve ratio requirements for banks, and exert control over the exchange rate in order to prevent such a hard landing.
The Economic Cycle Cannot Be Eliminated
Such draconian interventionist monetary policy has worked for at least 25 years and has created an elongated economic expansion. I do not believe such long economic cycles could have happened in a pure capitalistic economy with an open capital account, where the majority of the financial sector is in private hands and only the central bank acts as a regulator. Capitalistic economies are cyclical because of how savings and investment cycles work. Can a hybrid economy like China, with such government control over the financial sector and a large part of the economy – namely the energy sector – eliminate the economic cycle? I believe the answer is “no.”
There has never been a case in the history of capitalism of an economy without economic cycles. I think such extreme interventions end up creating non-productive uses of capital and over-indebtedness that ultimately makes the coming hard landing a lot worse than it would have otherwise been.
The unproductive uses of capital can be seen not only in the numerous empty cities that have been built in China, but also in the performance of the Shanghai Composite, when compared to India’s Sensex Stock Market Index. India is much less developed today but similarly to China, had to do numerous reforms to liberalize its economy by reducing government control. But there is no such thing as forced lending in India, and there are numerous large financial institutions that are for-profit enterprises.
As the Indian economy grows, profits in the overall economy grow and so does the Sensex Index. As the overall economy in China grows, profits in the aggregate do not necessarily grow, other than for some well-known Chinese privately-held companies many of whom have ADRs listed in New York. This lack of rising aggregate profits can be seen in the erratic performance of the Shanghai Composite.
The cycle of rising GDP with rising indebtedness and lack of rising profitability will be China’s downfall.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
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