No hard landing for China

Predictions about a possible hard landing in China have cast a shadow over equity markets during the past few months. And with market gurus such as George Soros and Nouriel Roubini predicting that growth of the Chinese economy could slow dramatically, the concern is gaining momentum.

One worry for investors is inflation, which has more than tripled since the start of 2010 and is up by 30% this year. The government has been increasing the benchmark one-year lending rate since 2009, up to a peak of 6.31%, as it seeks to control rising prices. But this move has brought its own set of concerns that the rate hikes could put the economy into recession.

Last month we published an article, China’s coming collapse in which we presented the viewpoint of Societe Generale strategist Dylan Grice on why the bailout by China of its local banks was a cause for worry. But not everyone is worried and strategists are citing different data to corroborate their viewpoints. Francis Cheung, head of CLSA’s China and Hong Kong strategy team, who spoke at a media briefing last week is one of the optimists.

“A hard landing is highly unlikely,” is the view of Cheung, based largely on the growth in fixed asset investment (FAI) which currently stands at 25%. Despite the fact that the growth of total money supply has declined to a low of 16% and loan growth has fluctuated, investment in fixed assets has been rising by more than 25% a year since 2003, he said. This growth is primarily from the manufacturing, infrastructure and property sectors.

Statistically, investment in fixed assets has a higher correlation with economic growth than industrial production. So, despite slower industrial production in April and May, the continued growth in fixed asset investment suggests the economy is not in danger of a slowdown. Further supporting Cheung’s hypothesis is the fact that the consumer price index to producer price index has started to trend up indicating that company profits are improving.

Cheung predicted inflation will peak in June and stay high until August. The wholesale spot price of pork, another key inflation indicator in China, has increased by 80% since May last year, but Cheung said it will peak by the third quarter of this year. He attributed the increase to both supply-side constraints and a scare over tainted pork supply. Reserves are expected to recover later this year, bringing the inflation rate down to about 3.7% by the end of 2011, from 6.4% now.

Data released by the Chinese government, however, suggests that monthly pork supplies have increased by around 5.4% after May last year, when pork prices started to jump, and then dropped by 17.4% in February this year, which suggests pork prices might be driven by money supply, among other things, rather than availability.

Cheung also touched on the Hong Kong property market, where prices have increased by 80% during the past 10 years while real wage growth has been almost nil. The price increase is mainly due to the low cost of debt and buying by mainland Chinese, said Cheung, somewhat stating the obvious. He highlighted that trades of properties worth more than HK$3 million ($386,000) have been relatively stable, but the volume of properties traded at a value less than HK$3 million, which are the homes that most Hong Kong residents live in, has plummeted by 46.7% to around 4,000 units in May, down from 7,500 units in September last year. Against this backdrop, Cheung is more bullish on investing in stocks that he said are at the low end of the valuation cycle, rather than property.

Despite the current levels of inflation and slowing industrial production in China, Cheung said that the situation is under control as the economy is not as overheated as in previous years. Rather than the hard landing many strategists are forecasting, Cheung suggests that equity markets currently offer attractive opportunities to value investors. “I don’t know what will happen next year, but you want to buy something when it is cheap,” he said.

Finance Asia

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