4 Reasons to Like China

Thursday, July 12th, 2012

Last month, in my Investment Directions monthly commentary, I predicted that we’d see further stimulus from China this yearas officials try to keep Chinese growth at a respectable rate ahead of a fall 2012 leadership transition.

And as I suggested would happen, the Chinese central bank last week announced its second surprise rate cut within a month. The action from the central bank was an acknowledgement that the world’s second largest economy is slowing. In the first quarter, China’s growth decelerated to 8.1% year over year, the slowest pace since the summer of 2009 as a slowing United States and ongoing European sovereign debt crisis took a toll on Chinese exports.

Still, despite China’s economic slowdown, I continue to hold an overweight view of Chinese equities for the following four reasons:

1.)    Valuations: Chinese stocks are selling at a significant discount to both other Asian emerging market countries and to their own history, especially when you consider that Chinese inflation is decelerating. In addition, current discounted valuations appear to be already reflecting the risk of a hard landing, which I don’t believe is the most likely scenario for China.

2.)    Growth Expectations: While China is experiencing a slowdown, it’s important to put China’s growth in perspective. I expect second quarter Chinese growth to come in around 8%, a level consistent with a soft landing scenario, and not anywhere near the United States’ truly slow 2% growth. In addition, the preponderance of evidence – and the few bright spots among weak recent economic data — still suggest that China can engineer a soft landing and even if China ends up growing at 7% to 7.5% next quarter, Chinese equities still look cheap.

3.)    Economic Policy: That China lowered interest rates twice within a month suggests that Beijing is refocusing on, and is willing to go the distance to stabilize, growth. In fact, I continue to expect more stimulus from China as it tries to ensure a smooth upcoming leadership transfer and as cooling inflation in the country gives the government more room to focus on growth. In addition, the gradual liberalization of the financial industry is also a plus for long-term growth.

4.)    Relatively Low Risk: Based on my team’s analysis, China is not one of the 15 riskiest markets. In addition, China enjoys a relatively stable currency, which reduces the volatility of its USD returns.

To be sure, Chinese equities, along with other risky assets, are still vulnerable to the fortunes of the global economy, and an exogenous shock, such as a worsening eurozone crisis, could certainly knock China off of its trajectory. But in the absence of such an event, most evidence suggests that China can engineer a soft landing and its outlook seems more positive than investors may be discounting. I prefer to access Chinese equities through the iShares MSCI China Index Fund (NYSEARCA: MCHI) and the iShares MSCI China Small Cap Index Fund (NYSEARCA: ECNS).

Source: Bloomberg

Russ Koesterich, CFA is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country and investments in smaller companies may be subject to higher volatility.

Tags: Acknowledgement, Chinese Central Bank, Chinese Exports, Chinese Growth, Chinese Stocks, Debt Crisis, Economic Data, economic policy, Economic Slowdown, Emerging Market Countries, First Quarter, Growth Expectations, inflation, Investment Directions, Leadership Transition, Preponderance Of Evidence, Sovereign Debt, Stimulus, Surprise Rate, Valuations
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U.S. Equity Market Radar (June 11, 2012)

Sunday, June 10th, 2012

U.S. Equity Market Radar (June 11, 2012)

The S&P 500 Index rose 3.73 percent this week as the global equity markets bounced on global government policy initiatives or speculation of forthcoming stimulus. Financials were the standout performers this week on hope of some resolution in Europe. Defensive sectors lagged but even the worst performer rose more than 2.5 percent.

Strengths

• The financial sector took the lead, rising by 4.71 percent, with a diverse group of stocks leading the way. AIG, Invesco and Citigroup were the best performers in the sector, all rising by more than nine percent.
• The materials sector was not far behind with chemical names such as best performer Eastman Chemical, rising more than 9 percent.
• The best individual stock performer this week was Iron Mountain which rose 18.8 percent as the company announced it was converting to a Real Estate Investment Trust.

Weaknesses

• The industrial distributors were the worst-performing industry group, falling by more than 3 percent for the week. Following Fastenal’s disappointing May sales results, the company fell by 6.7 percent this week.
• The oil & gas services group also came under pressure this week as Halliburton fell by more than 6 percent as the company warned of lower profit margins.
• Alpha Natural Resources was the worst performer in the S&P 500 this week, falling 10.6 percent, as the company announced significant cuts to its production guidance for 2012 and 2013.

Opportunity

• The market feels like it may be at an inflection point as Chinese authorities enacted broad-based stimulus, essentially conceding the economic slowdown required decisive action. This is a very positive step and a change in tone for China. If Europe follows through in the near future it could be the catalyst for change.

Threat

• Stresses continue to build in Europe and missteps by policy makers could negatively impact the markets.

Tags: Alpha Natural Resources, Chemical Names, China, Chinese Authorities, Decisive Action, Eastman Chemical, Economic Slowdown, Estate Investment Trust, Fastenal, Global Equity Markets, Global Government, Government Policy Initiatives, Industrial Distributors, Inflection Point, Invesco, Iron Mountain, Market Radar, Materials Sector, Profit Margins, Real Estate Investment, Real Estate Investment Trust
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China Joins Global Easing Party By Cutting The Lending And Deposit Rates By 25 bps

Thursday, June 7th, 2012

Update: 9:00 am has come and gone… and no global bailout unlike November 30, 2011. Not a good sign for those expect a central-bank D-Day.

While minutes ago the Bank of England followed in the ECB’s footsteps, it was the China central bank that stole England’s thunder, announcing an unexpected rate cut moments before 7 am, and thus finally joining the global easing party: this was the first Chinese interest rate cut since 2008. As a reminder, hours before the global central bank intervention on November 30, China announced its first (50 bps) reserve requirement cut since 2008. Is today’s PBOC move, which is the first cut of deposit and 1 year lending rates also since 2008, a harbinger of something much bigger to come any second now?

From the PBOC:

The People’s Bank of China decided to cut financial institutions RMB benchmark deposit and lending interest rates since June 8, 2012. One-year benchmark deposit rate cut of 0.25 percentage points, year benchmark lending interest rate cut by 0.25 percentage points; other deposit and lending interest rates and individual housing provident fund deposit and lending rates be adjusted accordingly.

 

Since the same day: (1) the upper limit of the floating range of interest rates on deposits of financial institutions was adjusted to 1.1 times the benchmark interest rate; (2) loans from financial institutions interest rate floating range of the lower limit was adjusted to 0.8 times the benchmark interest rate.

And from Bloomberg:

China Cuts Interest Rates for First Time Since 2008

China cut interest rates for the first time since 2008, stepping up efforts to combat a deepening economic slowdown as Europe’s worsening debt crisis threatens global growth.

The benchmark one-year lending rate will drop to 6.31 percent from 6.56 percent effective tomorrow, the People’s Bank of China said on its website today. The one-year deposit rate will fall to 3.25 percent from 3.5 percent. Banks can also offer a 20 percent discount to the benchmark lending rate, the PBOC said, widening from a previous 10 percent.

European stocks and U.S. index futures extended gains as China’s move fanned optimism that policy makers around the world will do more to bolster growth. The announcement, two days before China is due to report inflation, investment and output figures, may signal that the economy is weaker than the government expected.

“This will be the beginning of a rate cut cycle and there will be at least one more reduction this year,” said Shen Jianguang, a Hong Kong-based economist with Mizuho Securities Asia Ltd. “The data to be released over the weekend must be very weak and inflation must have eased sharply.”

The MSCI All-Country World Index added 0.8 percent at 7:30 a.m. in New York. The Stoxx Europe 600 Index jumped 1.2 percent, extending yesterday’s biggest rally in six months, while the Standard & Poor’s 500 Index futures advanced 0.7 percent.

Slower Growth

The central bank last reduced benchmark interest rates in late 2008, when the government unveiled a 4 trillion yuan ($586 billion at the time) stimulus package to counter the effects of the global financial crisis. Interest rates have been unchanged since an increase in July 2011.

Industrial output in China, the world’s biggest producer of steel and cement, probably rose 9.8 percent last month from a year earlier, close to the slowest pace in three years, according to the median estimate in a Bloomberg News survey of 27 economists ahead of a National Bureau of Statistics report due June 9.

Inflation may have moderated to 3.2 percent in May from a year earlier after a 3.4 percent rate in April, a separate survey showed, the fourth month consumer prices have risen by less than the government’s 2012 target of 4 percent.

Today’s move signals policy makers are concerned that the cost of borrowing is crimping companies’ spending and holding back expansion in the world’s second-biggest economy. Three bank officials told Bloomberg News last month that the nation’s biggest banks may fall short of loan targets for the first time in at least seven years as demand for credit wanes.
Slowdown Worsening

The PBOC cut banks’ reserve requirements in November for the first time in three years, and again in February and May, to spur lending.

China’s manufacturing expanded at the slowest pace in six months in May, a government report showed on June 1, adding to signs the nation’s slowdown is worsening. A separate purchasing managers’ index from HSBC Holdings Plc and Markit Economics pointed to a seventh straight contraction, the longest stretch since the global financial crisis.

Premier Wen Jiabao and the State Council, or Cabinet, pledged last month to place greater emphasis on stabilizing growth after data showed April industrial production, new loans and exports all increased less than economists forecast. The data prompted banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. to cut their economic-growth estimates.

Slowdown Worsening

The PBOC cut banks’ reserve requirements in November for the first time in three years, and again in February and May, to spur lending.

China’s manufacturing expanded at the slowest pace in six months in May, a government report showed on June 1, adding to signs the nation’s slowdown is worsening. A separate purchasing managers’ index from HSBC Holdings Plc and Markit Economics pointed to a seventh straight contraction, the longest stretch since the global financial crisis.

Premier Wen Jiabao and the State Council, or Cabinet, pledged last month to place greater emphasis on stabilizing growth after data showed April industrial production, new loans and exports all increased less than economists forecast. The data prompted banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. to cut their economic-growth estimates.

Tags: Bailout, Bank Of China, Bank Of England, Benchmark Interest Rate, Bps, Central Bank Intervention, China, China Cuts, D Day, Debt Crisis, ECB, Economic Slowdown, Financial Institutions, Footsteps, Global Growth, Gold, Harbinger, interest rates, Pboc, Percentage Points, Provident Fund, Reminder
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Our House: Is the United States the Best House in a Bad Neighborhood? (Sonders)

Wednesday, June 6th, 2012

June 4, 2012

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• The June 1 employment report was a dud, but other economic reports were a bit rosier.
• The eurozone debt crisis and slowing global growth remain the greatest risks.
• A muddle-through economy continues to be the most likely path.

I won’t try to put lipstick on the pig that was last Friday’s May jobs report, but I will try a little lip gloss. Somewhat lost in the mire of the dire reaction to the report were several other more-positive readings on the economy. That’s testament to the likelihood that there are many more drivers to today’s malaise than just jobs growth, or lack thereof. It seems clear we’re in the midst of the third consecutive mid-year economic slowdown, driven by similar forces, most dominantly the eurozone debt crisis.

Questions about recession risk are as rampant now as they were last fall, but I remain in the camp that believes we will avoid one in the short-term. Part of the reason is not rosy: as the saying goes, if the plane never got off the runway, a crash is much less likely. It’s the “blessing” and the curse of a muddle-through economy. I wouldn’t bet the farm on a recession being avoided and I have as cloudy as crystal ball as anyone, but that remains my view.

First, the lip gloss

The weakness in the employment report was largely across the board. Payroll employment was up a meager 69,000, about half the consensus expectation, while the unemployment rate ticked up a tenth to 8.2%. The weakness was largely concentrated in three areas: business services, leisure and hospitality, and construction.

The weakness in construction probably reflects a “give-back” from the exceptionally strong, warm-winter-weather period in the beginning of the year. The other two segments tend to see their hiring lag movements in energy prices, and given their surge during the first four months of this year, the weakness is not terribly surprising. The good news is that energy prices have plunged since then.

There are some other caveats, too. The household measure of employment, from which the unemployment rate is derived, showed an increase of 422,000 and an increase in the number of participants in the labor force. The latter explains why the unemployment rate ticked up, but may also show some increased confidence about landing a job. However, it also points to expiring unemployment insurance benefits, which is forcing some participants back into the labor pool.

It’s not all bad

We also know that many of the leading indicators for job growth remain healthy, including:

• Employment components of the Federal Reserve’s regional manufacturing surveys
• Hiring plans, sales, profits and jobs-hard-to-fill at multi-year highs
• Jobs-hard-to-get at multi-year lows
• Job openings (JOLTS survey) at a four-year high
• Average hours worked at a 20-year high
• National Federation of Independent Business plans to hire at a cycle-high

Friday also brought the latest Institute for Supply Management (ISM) manufacturing index, which registered a reading of 53.5—still well above the 50 reading that separates an expansion from a contraction, and consistent with economic growth remaining comfortably above recession territory. On top of that, the new-orders component of the ISM index (both the index overall and the new orders component are key leading indicators) is not only at a cycle-high, but the “prices paid” component, measuring inflation, has collapsed in the past month. As noted by Wolfe Trahan, the best US gross domestic product (GDP) readings have generally come in the wake of large declines in inflation. And stocks generally do well when leading indicators of growth (new orders) are stronger than inflation pressures (prices paid).

Wall of worry is back

Sentiment has also improved markedly over the past month, thanks to May’s weakness. When I last wrote about sentiment in early April we highlighted the market’s elevated risk of a correction due to overly-optimistic sentiment (a contrarian indicator). As you can see below, that sentiment has reversed and is approaching territory that’s usually supportive for stocks. But frankly, I’d feel better if sentiment got even more pessimistic. We may need to see a little more capitulation before the market can find its legs.

Enough Pessimism?

Source: FactSet, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2012 (c) Ned Davis Research, Inc. All rights reserved.), as of May 29, 2012.

Manufacturing renaissance

Longer term, we remain optimistic about the prospects for both the US economy and stock market relative to the rest of the globe. As I’ve noted consistently, we have a “renaissance” story unfolding here in the United States; particularly within manufacturing and domestic energy. Housing is also becoming a major tailwind (more to come on that in future reports.)

I got back from a trip to China 10 days ago and my conversations in Hong Kong and Shanghai largely supported my view that even in the face of a “muddle through” economic-growth environment, from which this country is unlikely to exit any time soon, there are bright spots worthy of attention. In fact, maybe tellingly, nearly everyone with whom I had a conversation was more pessimistic than the consensus about China’s growth prospects but more optimistic than consensus about US growth prospects. And this was the sentiment of both local Chinese as well as US ex-patriots with business in China.

Tags: Bad Neighborhood, Blessing And The Curse, Charles Schwab, Chief Investment Strategist, China, Crystal Ball, Debt Crisis, Dud, Economic Reports, Economic Slowdown, Employment Report, Energy Prices, Eurozone, Global Growth, Last Friday, Liz Ann, Muddle, Payroll Employment, Senior Vice President, Unemployment Rate, Warm Winter Weather
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U.S. Equity Market Radar (April 2, 2012)

Sunday, April 1st, 2012

U.S. Equity Market Radar (April 2, 2012)

The S&P 500 Index rose 0.81 percent this week driven by the healthcare sector, which rallied on the prospect of a Supreme Court decision rejecting the Affordable Care Act.

Strengths

• Defensive sectors tended to outperform this week, along with healthcare, utilities and consumer staples were among the week’s best performers.
• Within the healthcare sector, managed care stocks were among the best performers with Wellpoint, Coventry Health and Aetna all rising by at least 10 percent.
• Red Hat was the best performer in the S&P 500 this week, rising by more than 15 percent as the company reported better than expected earnings and increased guidance.

Weaknesses

• With the likelihood of mergers and acquisitions disappearing for utilities, the sector was the worst performer in the S&P 500 this week.
• The energy sector was also weak as oil fell more than three percent on continued fears of an economic slowdown in China.
• Best Buy was this week’s worst performer on a stock-specific basis as the company announced disappointing results and closure of 50 big box stores.

Opportunities

• The market continues to grind higher on recent news and the “trend is your friend” until this pattern changes.

Threats

• The S&P 500 is arguably overbought in the short term and could be vulnerable to profit taking.

Tags: Aetna, Affordable Care, Amp, Best Buy, Care Act, Consumer Staples, Coventry Health, Economic Slowdown, energy sector, Fears, Healthcare Sector, Likelihood, Market Radar, Mergers And Acquisitions, Pattern Changes, Recent News, Red Hat, Sectors, Supreme Court Decision, Wellpoint
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U.S. Equity Market Radar (March 26, 2012)

Sunday, March 25th, 2012

U.S. Equity Market Radar (March 26, 2012)

The S&P 500 Index was down 0.50 percent this week as a growth scare is developing in China which led to the sell-off of cyclicals, particularly energy and industrials.

Strengths

• The S&P 500 consumer discretionary sector was the best performer this week, as brick and mortar and internet-based retailers rallied. Best performers included Netflix, Best Buy, Priceline.com, Amazon.com and Tiffany & Co. Tiffany’s reported earnings that were well received and the market liked Amazon’s purchase of Kiva Systems, Inc.
• Within the S&P 500 technology sector, Western Digital was the best performer, rising nearly 11 percent.
• Watson Pharmaceuticals was up nearly 11 percent for the week on reports the company is in talks to buy Actavis, a Swiss drug company.

Weaknesses

• The energy sector was the worst performer this week, as investors are becoming increasingly concerned about an economic slowdown in China. Compounding this was an announcement from Baker Hughes that pressure pumping is weak and margins have been negatively impacted.
• The industrial sector was weak for similar reasons, as Joy Global and Caterpillar were among the worst performers due to the China slowdown fears.
• Sears Holdings was the worst performer in the S&P 500 this week, falling by more than 12 percent. Going into this week, the stock had risen by 160 percent this year and it appears to be a normal pull-back after such a strong run.

Opportunities

• While the market was down modestly this week, the current bull market appears to be intact.

Threats

• The S&P 500 is arguably overbought in the short-term and could be vulnerable to profit-taking.

Tags: Amazon, Baker Hughes, Best Buy, Brick And Mortar, Caterpillar, China Slowdown, Consumer Discretionary Sector, Cyclicals, Economic Slowdown, energy sector, Industrial Sector, Industrials, Joy Global, Kiva Systems, Market Radar, Sears Holdings, Swiss Drug Company, Technology Sector, Watson Pharmaceuticals, Western Digital
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Are Best and Brightest Grads Turned Off by Wall Street’s Bad Press?

Friday, March 16th, 2012

It appears the answer is yes.  After a few decades of the ‘financilization’ of all things in America – the past few years seems to have turned the tide (somewhat) away from a massive funnel of the best and brightest college grads deposited directly into the palms of Wall Street.  I’d note this specifically for Harvard B-school which is cited in the story below - that is the epicenter of future Goldman, Morgan Stanley, and JPMorgan-ites.  Anything that gets some of these brains into more of the ‘production’ (or even ‘service’) parts of the economy, rather than the ‘toll takers’ is a plus in my book.  It seems quite a sea change might be happening, as more want to be the next Steve Jobs, Bill Gates, or Mark Zuckerberg rather than the next person “doing God’s work”.

• Wall Street, once a magnet for America’s best and brightest, is facing a recruiting problem.  The industry’s loss of cachet, which started during the financial disaster, has been deepened by the lingering economic slowdown and a series of highly visible industry scandals that have drawn critical attention to the big banks.   The most recent public relations crisis came from the resignation letter this week in The New York Times op-ed section written by Greg Smith, a former Goldman Sachs executive director.
• Conventional wisdom holds — and Goldman’s public relations team surely fears — that the people paying closest attention to the controversies are skittish clients and down-in-the-mouth employees. But Goldman and other financial firms should also worry about scaring off are college and business school students, some of whom are looking askance at once-prestigious jobs in finance.
• College students who were once attracted to prestigious banks like moths to bonfires are increasingly turning to other industries in search of success. Insiders say that pained testimonials of industry life can scare off would-be financiers from even applying for jobs at the most selective firms.  “This is a significant problem for Goldman,” said Adam Zoia, the chief executive of the placement firm Glocap Search, whose clients include many aspiring big-bank employees and hedge fund workers. “Their perch of being the investment bank to go to is definitely at risk.”
• One former Goldman analyst recently decided to leave the firm after the rewards of a finance job no longer seemed to outweigh the costs. The former employee is now working at a small technology start-up for less money.  “Perhaps Smith is a catalyst,” said the employee, who spoke on the condition of anonymity because many of his friends still worked at the bank.  “There have always been unhappy people” in finance, he added, but “this is the year people are realizing things are structurally different.”
• The smaller paychecks are only making the decision easier for some students, who no longer view Wall Street as a fast-track to seven figure salaries. Last year, flagging profits at many Wall Street firms reduced some bankers’ compensation from stratospheric to merely generous. At Morgan Stanley, cash bonuses were capped at $125,000; some Goldman employees saw their annual cash payouts cut in half.
• Adding to the chorus of dissent, students now face criticism on their own campuses. Groups of protestors at Yale and Harvard stood outside bank recruiting sessions last fall, shouting slogans and holding signs with messages like “Take a chance, don’t go into finance.”
• “Everything from Occupy Wall Street to larger critical discourses of ‘fat cats,’ all of that has had some trickle-down effect” to young people, said Karen Ho, an associate professor of anthropology at the University of Minnesota who has studied the culture of Wall Street.
• The decline in the finance industry’s allure has been accelerated the explosion of the technology industry, which is making a play for some of the top-flight graduates who once walked nearly unquestioningly into Midtown Manhattan cubicles.
• A 2011 survey of 6,700 young professionals by the consulting firm Universum ranked Google, Apple and Facebook as the most-coveted workplaces; JPMorgan Chase, the highest-ranking bank on the survey, was ranked 41st.
• Chris Wiggins, an associate professor of applied math at Columbia University who sat on the panel, said he was seeing students shy away from Wall Street and veer toward industries where they could work and profit without bringing their morality under the microscope.  “The claim of investment banking that it serves a social purpose by ‘lubricating capitalism’ has eroded,” Mr. Wiggins said. “It’s simply very difficult for young people to believe that they’re serving any social purpose now.”
• Even at top colleges and business schools, which once saw Wall Street as hallowed ground, the focus is shifting. In 2008, the last recruiting year before the financial crisis, 28 percent of the employed seniors in Harvard’s graduating class went into finance. Last year, that number fell to 17 percent.
• Ben Pruden, a second-year student at the McCombs School of Business at the University of Texas at Austin, said on Wednesday that he planned to go into technology, not onto Wall Street, after receiving his business degree. He has a job lined up at salesforce.com after graduation, and said that although he knows people working in finance, including his sister, the once-irresistible allure of Wall Street held little sway with him.  “I have no interest in working at Goldman,” he said. “I want to build something. I don’t want to be working in an industry that effectively leeches off other industries.”

Tags: B School, Bill Gates, Bonfires, Business School Students, College Grads, Conventional Wisdom, Critical Attention, D Note, Economic Slowdown, Ed Section, Finance College, Financial Disaster, Goldman Sachs, Greg Smith, Morgan Stanley, New York Times Op Ed, Resignation Letter, Sea Change, Steve Jobs, Toll Takers
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On China and the End of the Commodity Super-Cycle

Wednesday, March 7th, 2012

China had a massive surge in its demand for commodities over the past decade, fueled by its housing boom and infrastructure investment boom. From 2000 to 2010, China’s imports (in value terms) of iron ore surged by 42.5 times, thermal coal 248 times and copper 16.2 times. During the same period, its production (in quantity terms) for aluminum jumped by 441.8%, cement 219.5% and steel 396.0%. It is the biggest consumer in virtually all commodity categories in the world. In Credit Suisse’s view, China was the key factor behind the global commodity supercycle. After a period of economic slowdown, all eyes are on China, hoping that the middle kingdom can return to its might in commodity demand. CS cuts through all the cyclical factors and asks whether China’s mighty demand for commodities will return in the medium term – their answer is ‘No’. As the economy shifts its growth engines away from infrastructure, construction and exports toward consumption, especially service consumption, the propensity of demand for commodities is bound to decline. Getting a massage simply does not use as much steel as building an airport.

Credit Suisse: Can China’s mighty demand for commodities return?

In this note, we ask whether China’s mighty demand for commodities will return in the medium term. We think the answer is “NO.”

• The golden age of infrastructure investment is behind us now.
• The golden age of the housing boom is behind us now.
• The golden age of exports is behind us now.
• The golden age of policy stimulus is behind us now.

but…

• One more leg of urbanization is expected.
• Further acceleration in policy housing is likely.

still…

• Trend growth in the next decade is projected at 7% to 8% versus 10.7% in the past decade.
• Growth engines will likely shift from exports and infrastructure to consumption.

which means…

• It should take less commodity consumption for each unit of GDP.

1) The golden age of infrastructure investment is behind us now.

After ten years of very aggressive build up of infrastructure, the penetration of highways, railways, airports and power stations has surged. Infrastructure investment is down by 25% in the 12th five-year plan from the 11th five-year plan, after adjusting for inflation. The actual moderation could be much bigger, in view of the very aggressive infrastructure investment by the local governments as part of the fiscal stimulus in 2009.

2) The golden age of the housing boom is behind us

Home ownership in China has reached 67% in the urban sector, above the world average now, and would be much higher if the rural area were included. Housing prices are getting out of reach for those who rely on a regular salary. An average person in China needs to spend ten years of salary to pay for an average apartment, versus the world’s average of about six years. The affordability ratio for local salary earners in most tier 2 and tier 3 cities is not much better.

3) The golden age of exports is behind us

Cyclically, exports seem to be on a rebound, but structurally, China’s competitiveness has been weakened because of surging salaries among the migrant workers and continued appreciation of the RMB. It may take ten years before the legend of the “world’s factory” disappears, but the best times are certainly behind us.

4) The golden age of policy stimulus is behind us

Beijing may launch some minor fiscal subsidies for consumption and reshuffle the tax code. Restrictions on bank lending has eased a little too. But there is no way that the government will launch another massive stimulus similar to what it did in 2009. The consensus among the decision makers is that the package of stimulus in 2009 did more harm than good to the long-term sustainability of growth.

What is not over and what may accelerate in the next few years?

1) Urbanization has another leg to go.

The industrialization model in China is changing. Over the past two decades, industrialization and modernization has been done through funneling rural labor to the coastal areas and export industries. In the next two decades, we believe industrialization and modernization will take place locally, at the village level. That would create new needs for commodities.

2) Policy housing construction will likely accelerate.

The central government realizes that high housing prices have become a source of social instability, so it is committed to provide subsidized housing to its citizens, with a target of building 36 million units during the 12th five-year plan (2011-2015). Progress was disappointing last year, as local governments have neither the money nor the incentive to deliver. We think policy housing construction is likely to accelerate over the next two years, though it is not clear who will pay the bill at this moment.

The big picture is that China’s trend growth is expected to slowdown to 7% to 8% over the coming decade, from 10.7% recorded in the previous decade. As the economy shifts its growth engines away from infrastructure, construction and exports toward consumption, especially service consumption, the propensity of demand for commodities is bound to decline. Getting a massage simply does not use as much steel as building an airport. In 2011, it took 71 million tones of steel for one percentage point of GDP growth – that is unheard of in the world’s modern history. We project that the ratio should moderate to 30-40 million tones for every percentage point of GDP growth by 2020. There will be cyclical ups and downs, which may affect China’s demand for commodities and commodity prices, but we think China’s supercycle for commodities is behind us.

Tags: Acceleration, Commodities, Commodity Categories, Commodity Consumption, Credit Suisse, Demand Cs, Economic Slowdown, Global Commodity, Growth Engines, Infrastructure Construction, Infrastructure Investment, Investment Boom, Iron Ore, Massive Surge, Medium Term, Propensity, Stimulus, Supercycle, Thermal Coal, urbanization
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The Economy and Bond Market Cheat Sheet (October 31, 2011)

Monday, October 31st, 2011

The Economy and Bond Market Cheat Sheet (October 31, 2011)

Treasury yields were higher this week as European leaders reached an agreement in principle to recapitalize the region’s banks, address the Greek debt situation and expand the European Financial Stability Facility. This agreement largely removed the threat of another full-blown financial crisis and money shifted back toward riskier assets.

Another piece of good news that supported riskier assets this week was the release of third quarter GDP data. GDP rose 2.5 percent in the third quarter, matching expectations but also quieting some critics expecting the U.S. to fall back into a recession.

Strengths

• The resolution of the immediate crisis in Europe was the most significant positive event this week.
• GDP rose 2.5 percent in the third quarter as consumer spending rose 2.4 percent.
• September durable goods orders, excluding the volatile transportation sector, rose 1.7 percent. This is the largest rise six months.

Weaknesses

• Consumer confidence fell to the lowest level since March 2009, which was the bottom of the global financial crisis. Concerns surrounding jobs and real incomes drove the survey down.
• Global news flow continues to point toward an economic slowdown as U.K. factory orders fell to the lowest level this year, the Bank of Canada sharply reduced its fourth quarter GDP forecast and expectations are for growth to slow below four percent in Brazil next year.
• Inflation risks remain as the Reserve Bank of India raised interest rates by 25 basis points due to stubbornly high inflation.

Opportunities

• With the European news behind us for the time being, investors will refocus on economic data such as next week’s ISM manufacturing report, the Federal Reserve Open Market Committee (FOMC) meeting and October unemployment data.

Threats

• While the current European plan to deal with the crisis is a positive step forward, many details still need to be worked out. Moreover, the plan does not deal with potential problems in other European countries such as Portugal, Spain and Italy.

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The Economy and Bond Market Cheat Sheet (October 24, 2011)

Saturday, October 22nd, 2011

California Union Iron Works Turbine Machine Shop, c. 1918

The Economy and Bond Market Cheat Sheet (October 24, 2011)

Treasury yields were flat to down this week. It was a choppy week, up one day and down the next, and even though economic news flow and earnings data were supportive of continued economic growth, lingering concerns surrounding a possible Greek default and government policy actions to deal with that were likely responsible for the positive bias in fixed income.

One encouraging bit of information came from the Philadelphia Federal Reserve’s manufacturing data, which showed new orders bouncing back strongly and hitting the highest level since April. The recent economic data has not matched the gloom on the economy and so far third quarter earnings announcements have not indicated a significant economic slowdown. At this time it appears concerns of a “double dip” are overblown and the economy may even positively surprise.

Strengths

• Industrial production rose 0.2 percent in September, matching estimates.
• The Conference Board’s index of leading economic indicators (LEI) rose 0.2 percent in September and is up 5.9 percent on a year-over-year basis.
• Housing starts jumped a surprising 15 percent in September, with the greatest demand seen in multi-family housing.

Weaknesses

• China’s GDP grew 9.1 percent in the third quarter. While 9.1 percent is very strong in absolute terms, it was below the 9.3 percent expected and the slowest growth in more than two years.
• Consumer prices in the U.K. hit 5.2 percent in September, which is a three year high. Commodity prices have receded in recent months and expectations are for lower inflation so this data point is somewhat troubling.
• Mortgage applications hit a 15-year low even as mortgage rates have hovered around 4 percent in recent weeks.

Opportunities

• With the economy weak and concerns brewing about an additional financial crisis, the Fed will remain accommodative for some time and bonds appear well supported in the current environment.
• Globally, central banks have become attuned to the risks of a global slowdown and will likely act to bolster economic growth.

Threats

• All eyes will be on the European Summit this weekend. A positive outcome could be a threat to the treasury market which has benefitted from a “flight to quality.”
• The treat of another global financial crisis cannot be ruled out.

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