Objective & Preface:
This article aims to equip investors to evaluate China's economic landscape & its effects on cross-asset international markets, assessing risks and opportunities presented by current challenges. Actionable trading ideas are provided, though China often warrants a nuanced approach. Long-term investors may prefer next week's piece on US fiscal policy.
China will likely pursue reforms, targeted stimulus, and oversight to achieve stable, sustainable growth. Markets may continue to be underwhelmed, as massive stimulus appears counter to China's strategic goals. The focus for investors should be gauging whether potential measures could succeed, not anticipating their timing.
Current conditions make major stimulus probable, but not guaranteed effective. We will explore the context, key indicators to monitor, and trades offering asymmetric risk/reward. While perspectives abound, objective analysis of both bull and bear cases is most valuable for trading China's crossroads. China is, virtually always, a trade – if you’re here for long term investments wait until next week’s article on US Fiscal Primacy.
China's approach to the myriad challenges it currently faces will likely include a mix of structural reforms, targeted stimulus measures, and regulatory oversight, all aimed at achieving a stable and sustainable economic path. All of these measures will likely continue to underwhelm investors – this has been planned for longer than the market realizes, and a “firehose” stimulus would defeat the entire point. The only way the bazooka is coming out is if something goes seriously wrong, which is looking more and more likely, so the best skill an investor can have now is not to be able to anticipate when the stimulus is coming but whether it will work. It’s not guaranteed this time. Let’s explore the basics and then delve a bit deeper into both the background, what to watch going forward to identify opportunities or catalysts, and a few plays that may present asymmetric risk/reward.
Thanks to Steve Hou for translating Chinese language source & Alexander Campbell for his excellent 8 years’ worth of Chinese Property Developer Research.
Figure 2. The 3D's: China's Economic Crossroads
The 3D’s: Deflation, Debt and Demographics
The intersection of these three factors creates a complex and potentially precarious situation. The resolution requires careful policy calibration to navigate the conflicting pressures. For instance, easing monetary policy to combat deflation might exacerbate debt levels, while aggressive deleveraging could depress growth and reinforce deflationary trends
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Figure 3. China's Slowing Growth Trend
A debt-deflation loop looms, yet China is still a massive economy that has pulled off “economic miracles” in the past.
China's economy took a sharper-than-expected downturn in July, but the “bad news is good news” dynamic often witnessed in Developed Markets has yet to emerge due to doubts that the current government of Xi Jinping will decide to engage in sufficiently supportive economic stimulus measures.
The decline encompassed various sectors, with a few bright spots, but the alarming drop in bank lending to its lowest point in 17 years, paired with a negative GDP Deflator, YoY PPI & YoY CPI for the first time in over two decades, are particularly concerning.
In what should be news to no one, the property market, a central pillar of the economy, is showing significant signs of strain. Declines in sales, increased financial strain among developers, and a notable reduction in new projects signal broader economic distress. These issues could further intensify deflationary trends and disrupt local government funding. While declines in sales don’t seem all that horrible, consider that they threaten to evolve into an increase in fire sales that drives prices down significantly in the frozen market. This already begun in Hong Kong after mogul Eric Chu had to liquidate billions at 40-50% discounts following his wife’s arrest for securities fraud in Vietnam.