Slowing China GDP Boosts Scope for Easing
Comment of the Day

January 17 2012

Commentary by David Fuller

Slowing China GDP Boosts Scope for Easing

Here is the opening for this topical report (PDF also provided) from Bloomberg:
China's economy expanded at the slowest pace in 10 quarters as Europe's debt crisis curbed export demand and the property market weakened, sustaining pressure on Premier Wen Jiabao to ease monetary policy.

Gross domestic product rose 8.9 percent in the fourth quarter from a year earlier, the statistics bureau said in Beijing today. Growth exceeded the 8.7 percent median of 26 estimates in a Bloomberg survey, staying above the 8 percent that signals a "soft landing" for China, according to SinoPac Financial Holdings Co., which correctly predicted the GDP number.

Asian stocks rose on speculation policy makers will ease lending curbs and increase fiscal spending to bolster the world's second-biggest economy. Liang Wengen, China's richest man and chairman of Sany Heavy Industry Co., told Wen this month that construction-machinery demand is weak and called for more infrastructure investment.

"Decelerating GDP growth will provide more room for policy makers to shift towards a pro-growth bias after an extended tightening cycle," Jing Ulrich, chairman of global markets for China at JPMorgan Chase & Co., said in a note after the data. "At this juncture, the challenge for policy makers is to implement measures that boost domestic demand without setting back progress made in curbing inflation."

The Shanghai Composite Index (SHCOMP) climbed 4.2 percent today, the most since October 2009, on expectations for more monetary easing and on speculation the government will support equities. The MSCI Asia Pacific Index gained 2 percent at 5:14 p.m. in Tokyo.

David Fuller's view Despite its impressive GDP growth rate, China's Shanghai Composite Index (weekly & daily) has been an underperformer since July 2009. This is mainly due to three reasons:

1) Monetary tightening to rein in a property bubble; 2) the largest increase in the supply of equity for any country over the last two and a half years due to government sales of previously non-tradable shares in a number of industries, plus secondary offerings by banks and other financial companies to raise their reserve requirements; 3) investor caution due the Eurozone's sovereign debt crisis and slower global GDP growth.

Needless to say, what happens next for China will have significant implications for Asia, commodity prices and global GDP growth. Currently, analysts' and investors' expectations regarding China are subdued, which is understandable given the stock market's lengthy medium-term downtrend. Discussions have mainly focussed on whether China would experience an economic hard landing or just a growth slowdown.

I maintain that this negativity should be regarded as a contrary indicator at a time when China's equity valuations remain historically cheap (PER and Yield), and the government appears to be embarking on an incremental policy of monetary easing. Cautious sentiment regarding China' stock market is even reflected by the above article's headline because GDP growth was actually stronger that the median of estimates, as mentioned in the second paragraph. Against this background today's market surge of 4.2% looks like a wakeup call for investors who are currentlyunderweight Chinese equities.

You may not see this potential on the weekly chart for SHCOMP shown above, although it had returned to the upper portion of the 4Q 2008 to 1Q 2009 base. Also, it was recently more overextended relative to its declining MA than at any time since mid-2010. Today's upward dynamic on the daily chart, from a higher reaction low, indicates that the rally will continue.

Of course the Index still needs to break the progression of lower rally highs and also sustain a move back above the MA to signal emphatically the end of its cyclical bear trend. I will give this hypothesis the benefit of the doubt, provided the yearend lows continue to hold, as I expect.

While mainland China's indices have lagged, both the Hong Kong HSI (weekly & daily) and HSCEI indices (weekly & daily) show evidence of base formation development similar to what we also see from many other stock market indices. Both would need to move beneath their November reaction lows to question scope for upward breaks. Interestingly, HSCEI is currently testing its November high and the MA which may be flattening out.

I have mentioned a China leash effect in the past and this has been largely negative for over two years, representing a weight on other growth markets, including commodity producers. However, if this turns positive in 2012, as I suspect, emerging markets and resources plays in general are likely to have a better year than in 2011.

Using the metaphor of a supertanker for China, we know that it takes time to turn it around. Asia's speedboats are four ASEAN emerging markets which also supply commodities to China and other countries in the region: Indonesia (weekly & daily), Malaysia (weekly & daily), Thailand (weekly & daily) and The Philippines (weekly & daily). They remain among the global leaders in terms of stock market recovery. All four indices are above MAs which are rising once again and The Philippines is the first market to reach a new all-time high.

Increased investor interest in China will also lead to a bullish reappraisal for many commodities, not least industrial metals which weakened in 2011. In my recent Audios and a chart review in Comment of the Day last Thursday I mentioned that they showed initial evidence of support building.

Copper (weekly & daily) is once again the upside leader among industrial metals. Should it continue to recover, as I expect, analysts who regard it as a lead economic indicator will take notice and upgrade their currently very modest outlook for GDP growth. There is a familiar downside to all this - a stronger global economy eventually leads to commodity price inflation.

Therefore we should keep an eye on the unweighted Continuous Commodity Index (historic, weekly & daily). This remains in a medium-term downtrend and last week's sell-off in grains and beans has helped to keep the recent rally in check. Nevertheless, it would be premature to conclude that the commodity supercycle is over.

The main threat to global GDP growth is not the western sovereign debt crises - it is the next spike in the price of crude oil. We are in the second consecutive decade in which the energy supply / demand balance is too close for comfort. Surges in the price of crude oil weaken our economies, as we saw following 1H 2008 and to a lesser extent after 1Q 2011. (See also Eoin's review of crude oil below.)

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