Rudi's View | Aug 09 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck, editor FNArena
After a few weeks of heavy share market turmoil due to a global re-pricing of risk it would seem investors will soon have another “surprise” to focus on with economists and China watchers predicting a growth slow down for the Chinese economy. Given the current jittery state of investors’ nerves across the globe it is not inconceivable this news, once official, will initially be taken as a major negative.
China’s economy was never going to continue powering along at 12%+ growth. Last month a few China-based economists at international financial institutions such as JP Morgan and Credit Suisse already suggested China’s growth numbers would soon start trending down. That call turned out too early as July’s GDP growth figure surprised on the upside showing GDP growth beyond 12%. However, the number of China watchers who have joined the view of an economic deceleration for the Chinese economy has steadfastly grown over the past few weeks.
At first thought a deceleration for Chinese exports seems but logical. As happened in the past few years, changes in the Chinese government’s export rebates have caused a spike in activity in the weeks leading up to the official change in export regulations. A temporary lull afterwards is something to be expected.
But there is more.
Chinese manufacturing surveys are indicating the amount of export orders probably peaked in March/April. While interpreting economic data from the country is still more art than science, the monthly Purchasing Managers Index (PMI) for China has now declined four months in a row, indicating a slowing of activity is gradually taking place.
In fact, the so-called forward-looking new orders index for July came out at a 12-month low.
It’s not just exports that are to blame with some China watchers suggesting recent order flows suggest domestic infrastructure related machinery demand is declining. Others are pointing at the quickening appreciation of the renminbi/yuan and that the Chinese government has also been imposing export restraint measures, reducing tax rebates for some exports while introducing tariffs and quotas for others. These measurements are expected to (finally) start generating results in the second half of this year.
The good news is that none of these experts anticipate a sharp slow down, but a slow down nevertheless. Also Chinese authorities are likely to tread extra carefully in the light of slowing growth, even if domestic inflation is expected to rise. With a major national conference for the Chinese communist party to take place later this year it may well be that Chinese interest rates should be considered on hold for the time being. (Also keep in mind that China is hosting the Olympics next year).
As one would expect, there’s no consensus about how much the Chinese economy will slow, or for how long. Some experts talk about a weak quarter with growth likely to trend higher again from the final quarter onwards. Others believe the slow down could well last for six months, or even longer.
The difference between both views seems to be predicated on a different outlook for the US economy. Those who think Chinese growth will slow down for longer than just the current quarter seem to have taken into account that more problems in the US housing sector will ultimately lead to fewer orders for Chinese products from US consumers.
Interestingly, the Wall Street based team of economists at Citi suggested this week they now have a downward bias when it comes to US economic growth in the second half of this year. While the Fed may not necessarily jump into action, and cut interest rates, to prevent too many financial institutions from going under amidst the current global credit crunch, Citi believes it would seem but logic to assume the next move in US interest rates will be down, whenever that may be.
The ripple effect from the release of lower economic growth figures from China could be quite severe given it could well happen in the wrong place and the wrong time given that the global financial community is already coming to terms with widening credit spreads, less risk appetite and expectations of more negative news from the US housing market.
Recent market turbulence has hit share prices of mining and metals stocks exceptionally hard. Rio Tinto (RIO) shares are currently some 18% below their year high of $105 while shares of BHP Billiton (BHP) are some 10% off their high of $39.79.
The ruling view among asset strategists at major brokerages is still that resources stocks remain among the best shares to own. This view is also shared by the China watchers who are now anticipating slower Chinese growth.
Rio Tinto has a reading of 0.7 on the FNArena Sentiment Indicator with seven out of ten local securities experts rating the shares a Buy. Two rate the shares Hold. Credit Suisse is currently restricted from expressing a view.
BHP Billiton has equally a reading of 0.7 on the FNArena Sentiment Indicator with seven Buys and three Holds.
The metals, mining and minerals research team at Merrill Lynch summed it up as follows this week: using current spot prices for LME metals market consensus forecasts could potentially increase by 20-30% for 2008 and 2009 for Rio and by 20-50% over the same period for BHP (the difference stems from nickel and oil). These estimates already take into account further increased costs and a stronger Aussie dollar.
In addition, if iron ore contract negotiations would generate a price increase of some 30% from March next year this would boost market consensus forecasts by a further 20-40% for Rio and 30-60% for BHP. (This does not take into account that both major producers may also successfully bring the freight differential with iron ore from elsewhere to the table).
It seems but fair to assume that a Chinese slow down is not going to completely wipe away all this potential upside.
At the end of the day, the Chinese authorities have been cautiously trying to slow down their economy for years. Pure logic tells us they will ultimately have it their way: an economy that is growing at a controllable, more moderate speed. It may well be that this time has finally arrived.