Rudi's View | Dec 05 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
In global finance negative news is not always bad and equally positive news is not always a good thing. As investors have been able to witness over the past few weeks, deteriorating indications about the health of the US economy were only a clear negative as long as investors were in doubt whether policymakers at the Federal Reserve Bank would be willing to continue cutting US interest rates.
Now that the market has convinced itself the Federal Reserve will again cut rates at the December 11 meeting, more negative news about the US economy is actually a good thing as it increases the odds the Federal Reserve will move to stimulate the US economy appropriately. Depending on how economic data turn out between now and then there’s still a reasonable chance interest rates might be cut by 50 basis points instead of 25.
There’s more than just a fair chance that what you’ve just read will be the mantra for the first two quarters of next year as more and more experts have come to the conclusion that official interest rates in the US will be cut to 4.00% or lower from the current 4.50%. So the theme of Fed rate cutting is likely to continue dominating global finance markets well into 2008.
The principle I outlined in my opening sentence also applies to China. Part of the global investor community has drawn confidence over the past months from the fact the US economy is no longer as dominant as it once was on a global scale and maybe Asian economies, and China in particular, will be able to decouple from the US and continue growing on their own account when the world’s largest economy moves through a rough patch. This concept of de-coupling has been particularly important as investors wondered whether they should hang on to their shares in resources companies.
But as the number of experts who decided to look deeper into this thesis grew over the past weeks so did the number of experts who concluded the idea was nice and appealing, but unfortunately reality will be different. Investors received a timely reminder about this on Monday when an independent monthly survey by equity broker and investment banker CLSA into the Chinese manufacturing industry revealed a significant drop in overall operating conditions with the amount of incoming new orders having dropped significantly.
In early August already I pointed out that Chinese growth was likely to start trending down in line with the rest of the world (see Weekly Insights “Next Stop: The China Slow Down”, August 07, 2007). I repeated this conclusion a month later (see Weekly Insights “Asia Poised To Save The Day”, September 18, 2007).
It turned out my stories were a little bit early, with some economists arguing since then a weaker US dollar provided Chinese manufacturers with an extra stimulus -this kept their business going in other parts of the world while US orders shrank- but Monday’s release strongly suggests even Chinese manufacturers will be battling some serious headwinds from now on.
CLSA’s China Purchasing Managers’ Index for November fell to an eight month low of 52.8 after surging to a thirty one month high of 55.2 in the preceding month. CLSA cites a “sharp easing” in incoming new orders in combination with higher input costs such as for oil and steel, as the main factors behind the “marked slowdown” for the industry.
This is not necessarily bad news. As some experts have pointed out previously, US orders for Chinese products have been trending down for many months now, and China has been able to absorb these losses and still grow its economy at breakneck speed.
While exports to Europe, Hong Kong and Japan should slow down as the world’s key developed economies are each hitting their own specific growth obstacles, Chinese authorities will still have one major joker left: domestic infrastructure developments financed by the country’s humungous trade surpluses. It is this part of the Chinese economy that matters most for global steel and metals demand and it is this part that is believed will remain unaffected by problems elsewhere.
China needs new roads, ports, buildings, reservoirs, power stations, airports and rail roads and the authorities will not stop investing in the overall socio-economic development of the country and its 1.1 billion population. Emerging Markets experts at Credit Suisse concluded last week: “Beijing is well positioned to increase infrastructure investment, if necessary.” In addition, domestic demand in the country is expected to increase further as well.
That’s the good news.
The not so good news is that exports still account for about 40% of Chinese GDP and even though Chinese exporters have done their best to diversify, the US is still the largest export market, representing some 20% of all export sales. Hong Kong takes 15% of all Chinese exports, but most of this ultimately end up in the US as well. Europe nowadays attracts a little less than 15% of Chinese export sales, while Japan’s share has declined to some 9%.
It goes without saying that any slowdown in the US will further affect Chinese exports. Economists at ABN Amro put it as follows in a report on the matter this week: “Exports to the US were growing at an annual rate of about one-third, but are now up only 15% on a year ago, which broadly tracks the slowdown seen in US GDP growth. In 2001, when the US was last in recession, Chinese exports grew by about 2-3%. This suggests that a hard landing in the US would quickly slow Chinese export growth”.
In other words: China will feel the impact from less economic growth in the US -especially if Europe and Japan will show weakness as well- but this should cause no serious dramas, as long as the US avoids a hard landing.
Analysts at highly respected BCA Research reached a similar conclusion when they looked into the matter recently. BCA highlighted the fact that emerging Asia now surpasses the US as a percent of global GDP, implying domestic demand from Asia is rapidly becoming a significant and growing source of demand for global end products.
Alas, there is at this point in time no escaping the fact that 79% of Asian exports ultimately end up outside Asian countries.
Assuming the US Fed (likely joined by the colleagues at the Bank of England and the European Central Bank next year) will succeed in avoiding some of the world’s major economies to experience a recession next year, simple logic would have it that equity markets should all in all reflect the growth rates of their underlying economies.
Hence why strategists at BCA (and elsewhere) remain attracted to Emerging Asia as the differences in economic growth rates between the US, the UK, Europe and Japan on one side and Asian countries such as China and India on the other side should become even more pronounced in 2008.
And Australia? Luckily for investors in the Australian share market, the local economy has increasingly de-coupled itself from the US in favour of an increased focus towards China and other Asian markets. Also, growing domestic demand throughout Asia should prevent commodities prices to fall off a cliff at a time of a slowing global economy.