By Paul Rogers
Pessimists on China do not lack for evidence: In September, a private survey of manufacturing activity, the Caixin China PMI fell to 47.3—its lowest reading in six-and-a-half years. Official PMI rose slightly to 49.8, up from August’s three-year low of 49.7; however, it remains below 50, a level that indicates manufacturing expansion. Factory production in August grew 6.1% year over year (YoY), which was weaker than expected. Fixed asset investment increased at a 10.9% pace YoY for the period January–August, also shy of forecasts.
Importantly, however, China’s consumer sector is growing, which is easily overlooked when viewing economic progress through the traditional lens of manufacturing activity and is not yet captured in many of the traditional measurements of Chinese economic activity.
Chinese retail sales have exceeded expectations, increasing 10.8% in August from a year before. Certain monthly consumer metrics also paint a more positive picture of the economy, with movie box office sales, airline passenger counts, and 4G mobile subscriptions all showing YoY growth. According to some analysts Chinese consumption data may also be understated due to quirks in calculation methodology. Official retail sales data do not include the sale of services, except those rendered to the government and investment services. It also excludes sales from e-commerce companies, which despite their small size have attracted a large portion of sales away from their brick-and-mortar competitors. In addition, our analysts have observed that property markets in Tier 1 and Tier 2 cities (ranked by population size) are now stable or rising, following a period of slumping sales. We find this quite encouraging as property has a more direct impact on wealth and consumption than industrial activity does.
We believe that authorities will focus on stabilising the Chinese economy and financial markets before pressing for deeper reform. China’s recently announced reform of its state-owned enterprises (SOEs) is disappointing. While its proposal to blend in private capital should expose SOEs to market forces and help alleviate capital misallocation, consolidation among SOEs may reduce competition.
It is critical for investors to keep in mind that the highly publicised Chinese stock turmoil relates to the mainland-traded A-share market, a separate and distinct pool of stocks from the H-share market. H-shares are Chinese domiciled companies (commonly thought of as “blue chip”) that are listed on the Hong Kong Stock Exchange. These often represent different companies than are listed on the mainland and only H-share listed stocks are constituents of MSCI’s indices. Meanwhile, A-shares, or China’s onshore market, are not represented in MSCI’s indices and only have about 2% foreign investor participation.
Recently, attempts at partial market liberalisation were made with the launch of the Hong Kong–Shanghai Stock Connect programme which resulted in extreme volatility in the A-share market this year. While government intervention to stabilise stock prices can be seen as antithetical to a free-market framework and has temporarily prevented the market from discovering its equilibrium level, we believe that at this point in China’s evolution, financial market stability outweighs free-market ideals. Some estimates, only about 7% to 10% of the Chinese population has any exposure to the A-share equity market, however, the negative impact on investor sentiment has been significant.
We remain cautiously optimistic that China will meet its 2015 growth target of 7% but are not fixated on that number. We continue to expect growth to decelerate to more sustainable levels over the coming years, probably in the 4-5% range and for that growth composition to evolve as China continues to shift from a fixed asset investment economy to an economy based more substantially on consumption. We remain overweight China relative to the MSCI EM index and have a portfolio of holdings across a wide swath of sectors for a broad, balanced, and diversified exposure.
Paul Rogers is manager of the Lazard Emerging Markets Core Strategy
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