In light of recent market volatility David Williamson, one of IEP Financial’s Directors, chats to Tom Becket of Psgima Investments about China and the potential drag to global growth.
DW: There’s been a lot of negative feeling towards China already in 2016. Would you say these feelings are validated? Has China suffered a slump in growth?
TB: Having spent some time last week speaking to contacts in Asia I can safely say that on the ground, things have not changed. Within China there are both areas of positivity and places where stress is evident. These respective dynamics have not changed over the last year; the old industrial part of the economy is performing poorly, while the services side is doing well. We have forecast 5% GDP growth from China this year, which is 0% growth in the old economy and 10% in services. There has been nothing that we have seen or heard to make us change our views. I was asked by one of our clients last week why I was so confident on China, when all others are so pessimistic. My retort would be that of course we are worried about China, but we just don’t envisage the outright collapse that most others are and believe that asset markets already reflect a miserable future environment ahead for China. If China does not collapse then there will be good returns to be made from assets linked to China. Our view is not that we are blindly optimistic on China, at a time when they are pursuing enormous structural economic rebalancing and having to deal with many issues, it is simply that we are not wedded to the consensus view that they will fail. There are major problems and there will undoubtedly be moments when we think we are wrong, but ultimately we still see China as an area of long term growth and opportunity. Frankly, it had better be, or equity markets are going to perform dreadfully in the years ahead, because there isn’t going to be much growth elsewhere.
DW: What would you pinpoint as these “many issues” China is currently facing?
TB: Our view is that this is less an economic issue than a policy and a communication issue. The words I would use to sum up China in the last few months are confusion and communication chaos. The policy flip-flopping by the Chinese authorities has been hitting their credibility. They have done a terrible job explaining the currency devaluation in August, the subsequent activity in the FX markets and more recently their actions in equity markets. One could make a case that they have lost control and certainly the various parts of the Chinese authorities are moving in different and contradictory ways. One hopes that they are learning their lessons.
DW: What do you predict will happen next?
TB: It is extremely difficult to say, but we need to focus on monetary policy, fiscal policy, the currency and their policy on the equity market. That’s all! We expect the Chinese to loosen policy further, continuing the action they started last year. We also expect further boosts to certain favoured projects from fiscal spending. With regards to the currency, the Chinese have stated repeatedly that they do not want or need a significantly weaker currency. In a statement last week, the Chinese pointed out that even with a strong currency, their share of global trade and exports grew last year. My view is that the Chinese need to be firmer in their statements and more convincing in their behaviour for the market to believe them. If they achieve this, then the deeply entrenched concern over China should ease. Finally, the Chinese need to let the equity market go; their activity is not helping and while we can admire their pursuit of free markets, they actually have to be seen to be believed. (Not that there are free markets anywhere anymore).
DW: Can you envisage a worst case scenario in regards to China?
TB: Certainly. There are definitely things that can make things worse from here. The worst case for the world and Asia, in particular, is that the Fed raises rates and there is no global growth. We might look back and have to say that the Fed has raised rates without the right environment. As you all know, we would have raised eighteen months ago, when the economy could easily have taken it. Given the dislocation in markets and the pervasive fear now, it could be argued that they have gone at the wrong time. Raising rates aggressively from here could be a disaster for Asia, unless the growth path stabilises. The other major factor concerns the Chinese currency and capital flight. In simple terms again, investors’ primary concern is that the Chinese have lost their marbles and lost control of the situation. They need to be clearer on their intentions with the Renminbi. The more they tinker without a clearly defined policy, the greater the capital flight from China. My contacts’ view was that capital flight is not necessarily a bad thing, as there was too much hot money in China, but certainly it needs to be less rapid than it has been in recent months. To conclude, a combination of rising US interest rates, poor communication over policy, a further major drop in the currency and excessive capital flight would make us very worried.
DW: What about those with shares in Asia or Emerging Market assets? Should they be selling and changing their neutral stances?
TB: If you are selling Asia and EM assets here it is because you think we are going in to a severe economic crisis. Market valuations on some assets in Hong Kong etc. are now at crisis levels. Valuations of Asia generally are at levels that are screaming “buying opportunity” unless one thinks that we are in Asian Financial Crisis or Global Financial Crisis territory. That is not our view. It is worth noting at the start of the year that credit markets in Asia have hardly moved. This is hopefully a positive sign. At some point this year, moving overweight EM assets for the first time since 2011 is a tantalising possibility.
DW: What would you say to reassure those worried about the current situation?
TB: We would always remind clients that we have been talking about China’s current situation now for three years. The Chinese are serious when they say that they want to rebalance their economy away from basic industry and towards consumption. This is a long term theme. Certainty they are tricky steps, but they are ones that China must take. The reforms they are pursuing today will lead to a better economic tomorrow. The process of reform brings a huge amount of uncertainty, but ultimately we don’t think the Chinese will lose control. Progress in the last one or two years has been ok, but investors want to see more commitment and better communication. On a short term economic prognosis, growth has slowed, but should start to improve in the months ahead and this could be a major factor around which global markets can stabilise. Notably, property sales and demand are going up; inventory in the housing market is clearing. Consumer spending is robust and retail sales are booming; this should continue. The Chinese administration’s throwback to Reaganomics and the pursuit of supply-side reforms should be noted and this boost could be a real driver for the economy and, in time, the equity market. Finally, the Chinese are targeting government spending on irrigation, water treatment, shanty town renovation and railroads as useful ways to spur the slowing economy. These factors should lead to better and more balanced growth ahead, which alongside communication is what the market wants. Let’s hope it comes soon.
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This article was originally published on Wednesday, January 13, 2016 – 14:04
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