19th October 2015
Douglas Turnbull, head of Chinese equities at Neptune Investment Management takes a look at what the latest statistics from the world’s second largest economy means for investors…
As investors, we are all looking at the same information, whether corporate numbers or economic data; how we differentiate from one another and come to hold conflicting positions is how we interpret that information.
That is challenge enough anywhere in the world but in China there is an oft-mentioned second level of complication – a question of whether we can even trust the data itself, never mind what conclusions one should draw from it.
China’s GDP for the 3rd quarter was released on Monday, showing that year-on-year the economy grew by 6.9%, broadly in-line with Bloomberg consensus estimates and a decline on the previous quarters’ readings.
This will come as no surprise to most, not just because it met market expectations but because a chorus of cynics will tell you that the Chinese Government control both the goalposts and the players. It’s therefore all too easy for goals to be scored, expectations to be met and governmental promises to be delivered. In short, Chinese data cannot be trusted.
And cynics will no doubt point to the speed at which this data was collated and compiled with supposed final accuracy as being implausible, taking a mere fortnight.
At Neptune, we confront this long-running scepticism with real world, on the ground research. This leads us to the conclusion that whilst the absolute levels of the headline GDP data announced may not be gospel, they are broadly accurate. Indeed, we see that the most volatile thing about the Chinese economy is investor sentiment towards it.
The reality on the ground is far more sanguine. Using techniques at the forefront of academic debate, our in-house economics team’s cutting-edge real time economic growth indicator compiles numerous economic data points – most of which are entirely free from any political oversight or possible interference – and triangulates what we believe is the best possible current reading for the overall level of economic activity.
Whilst we concede that growth at between 5 and 6% is slower than what the official headline GDP statistics say, we believe the more important points are twofold: first, we do not think it is anywhere near as weak as bearish voices would have one believe, and second, that it is currently improving, recovering from a weaker-than-trend moment earlier this year.
Crucially, this is a message reinforced by our regular trips to the People’s Republic of China (PRC) and speaking to companies there. It is also supported by various other complementary indicators – the strength of the housing market, cement pricing, the rate of approval for fiscally expansion infrastructure projects, and so on.
On the second question, of what to make of the data, here too we differ from the crowd and draw different investment conclusions. Those who tell you to doubt the data will no doubt go on to tell one of a myriad narratives of endemic weakness in China, most likely presaging imminent collapse – all variants on a trope that have perennially been rolled out since China’s economic advancement began. In our view, what all these hardy perennials have in common is that they are grounded in market-driven neuroses rather than the real world, and that they have thus far always ended in postponement.
In our opinion, this year has revolved predominantly around a trifecta of false indicators based on a misinterpretation of China’s reality. First, the nature of the economy: the market continues to look myopically at indictors fit for the manufacturing and exporting powerhouse that China once was but is rapidly moving on from.
Second, concerns have been heightened by a precipitous fall of the domestic stock market. But unlike in most other major economies (given its predominantly retail and very narrow investor base) this market is neither reflective of nor reflexive on the economy; rather than signalling or even causing real world difficulties for companies, listed or otherwise, this is no more or less than a price correction after an extraordinary short, sharp run-up, exacerbated in both directions by leverage.
Thirdly, the Renminbi (RMB) has recently weakened versus the US Dollar, and the market has feared that a devaluation is an emergency measure being pursued as a last resort to prop up an ailing economy. In our view it is not. The very notion of devaluation is scoffed at by most domestic companies- unsurprisingly so, given they have seen a mid-teens appreciation of the RMB year-to-date versus almost all major trading partner currencies, save for the super-Dollar.
The reality is that the US-Dollar peg has been altered in favour of taking a basket of currencies and market supply/demand to account, a vital long-term step towards a free-floating currency, and a vital short-term step to allow Chinese monetary policy to ease whilst the Fed tightens (which would otherwise be impossible to achieve whilst maintaining a hard Dollar peg and a closed current account, without running down foreign exchange reserves at a potentially alarming rate).
At Neptune, our focus is squarely on the real world and correct interpretation of it, not these shifting vagaries of market sentiment. The story the data tells of a controlled decline in growth rate should be unsurprising to those with such a focus. It should be understood that the longer-term trend of slowing is inevitable, not least due to the law of large numbers, but more importantly due to the process of economic rebalancing.
Whilst the broad trend is indeed to a slower economy over time, the government stands willing and able to manage that decline with substantial fiscal and monetary firepower yet unused at its disposal, and a unique political economy which allows for pre-emptive action to see off potential crises, most crucially in the financial system.
But the rebalancing that will most likely drive China’s growth and wealth-creation through the next decades continues nonetheless – witness, whilst the (old economy) manufacturing PMIs have been declining for many quarters now, their (new economy) service counterparts have held up well; witness that services are now almost 50% of the Chinese economy, and responsible for almost 80% of GDP growth.
This is the real China: one of a continually evolving consumer benefiting from around 10% p.a. real urban income growth; one of fiscal expansion and monetary accommodation now; one ultimately of slower but better quality GDP growth – that Neptune sees.
As such, our confidence in China’s systemic stability and this growth environment allows us to continue to position for good Global Growth unencumbered by fears of an exogenous Chinese shock, albeit in a world of diminished incremental demand for commodities.