Three observations from China’s economy important to Australian investors
There’s a lot going on to keep our attention this year. Our expectations remain that volatility has returned to more normal levels, after a long period of minimal volatility. And there are many triggers for volatility. However, investors should also be keeping an eye on China.
For investors in domestic equities, the variance of returns (the difference between returns) of different markets declines significantly when the US market falls. By that we mean to say that when the US market falls sharply, so does ours.
Investors should also be keeping an eye on China and recently management consultant McKinsey (no jokes about management consultants will be published in the blog comments!) produced an article sharing some of their insights from their work in China.
They noted four main observations, three of which are important for Australian investors.
- Growth is slowing — but China is still adding the equivalent of Australia every year
The first observation made is that 2018 economic activity weakened. To the extent that official Chinese GDP numbers can be trusted, official statistics placed real GDP growth at 6.6 per cent in 2018, the lowest rate since 1990.
No doubt aware of the limited truth in official Chinese data, McKinsey Global Institute publishes their own Economic Activity Index, tracking 57 different indicators ranging from retail and property sales to electricity consumption. Just remember garbage in, garbage out. This indicator also shows the Chinese economy is slowing. And the Index has been lower than GDP for the last four years.
Consensus forecasts expect Chinese GDP growth to fall to between 6.0 and 6.2 percent this year. Capital economics however believe growth will decline to circa 2 per cent within a decade and that China will not replace the US this century as a global growth powerhouse.
McKinsey note that even though China is slowing down, the absolute value of annual growth is equivalent to the entire Australian economy. In other words its adding an Australia-sized economy to its own annually.
- The consumer story is still strong, but changing
According to McKinsey: Negative sales stories from multinational companies in China such as Apple, as well as domestic companies including car dealers and cosmetic companies, have fed concerns about Chinese growth and are ignoring the long term story. “Chinese consumption is expected to grow by about $6 trillion from today through 2030.” This represents the “combined consumption growth expected in the US and Western Europe over the same period” and is double India and ASEAN economies combined.
China also added 13.6 million new urban jobs in 2018, exceeding the 11 million target.
There are however changes. Some consumers are trading down to cheaper products. Online sales grew in 2018 by 24 per cent and first-tier city consumption remains strong thanks to a “wealth buffer” from higher paying jobs and real estate prices.
- The credit crunch is real
According to McKinsey, following the GFC, eight years of government stimulus spawned shadow banking, informal lending and “a range of experiments in debt issuance.” Those eight years were then said to be followed by a couple years of conscious deleveraging and credit reduction.”
As we have noted in various Montgomery presentations, each stimulus by China has been less effective than the last and McKinsey also make this observation, stating; “recently the efficacy of government stimulus has been waning. Each renminbi of economic stimulus that the government pumped into the economy delivered less in actual GDP growth than in the past.”
McKinsey pointed out that since 2016, regulators have acknowledged these challenges and have emphasised deleveraging. Crack downs on shadow banking and Peer-to-Peer lending is having an additional dampening effect on the flow of credit, leading to a significant drop in credit availability. McKinsey point to the growth in outstanding credit falling from 13 per cent in 2017 to 7 per cent in 2018, below nominal GDP growth of 9.7 per cent.
When credit growth is lower than GDP growth that is the definition of deleveraging – something that we think may also happen in Australia.
But the data above doesn’t take into account China’s January stimulus efforts, which is itself a response to the prior slowing.
This has important implications for Australia in light of the China stimulatory actions since January this year.
- Acquisition opportunities are opening up for fast movers
The final point McKinsey make, which may be less relevant for Australian investors is that the government’s squeeze on credit has seen the number of bond defaults by private firms rise from 42 in 2017 to 147 in 2018. Once again, the data is probably the reason for China’s recent stimulatory action in January 2019.
McKinsey make the observation that “potentially increased openness to foreign direct investment across several sectors being discussed in broader trade-related negotiations, could create a window of opportunity for multinationals, with scale and significance in China, and the willingness to make bold moves, to acquire domestic competitors caught in the credit squeeze.”
We note the word “potentially” and also the not insignificant risk that after multinationals make their investment in China, the country could change its permissions at any time, confiscating the investment made.