Monday, 16 July 2018

A Chinese take-away

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  • Peters 475px June 2014

There is a lot of smoke and mirrors around China, but a shake-out might be healthy, says Anthony Peters.

I OPENED MY daily column on Wednesday last week with “It’s a tricky task trying to write about how much the Shanghai Composite has gone up or down in a day if one is typing away before the market has closed, for it can turn around any chosen number of percentage points either way in as many minutes”.

At that moment I was not aware that the Shanghai market, having been down at one point in the day by 5.5%, was being bought up by the People’s Bank of China – and that the intervention would lead the index to end the day about 1.4% to the good.

As recently as the end of the previous week, the Beijing authorities had declared that they had done their thing and that they were now going to stand back and let market forces take over. Three days later they were back in.

So they are now in control of the currency and in control of the stock market. Will somebody now please be kind enough to agree with me that they are also in control of the economic statistics and there too we only see what they want us to see?

It might not feel that way but in the past month Shanghai has traded in a much tighter range than the hype would suggest. The high and low for the month were made in just three trading days between July 24 and July 28 when it reached 4,184.45 at one end and 3,537.35 at the other. That represents a 15.5% swing but for all of the rest of the period, this past volatile week included, the index has traded within that range.

That’s all a lot of fun but at the end of the day Western market observers have to accept that whatever rules apply to our markets and to our investor behaviour have little to no validity in a Chinese context.

Whatever rules apply to our markets and to our investor behaviour have little to no validity in a Chinese context

MY GREAT FRIEND Alex “Moff” Moffatt of Joseph Palmer & Sons in Melbourne has done his own work on the subject and never ceases to remind people not to look for justification where there isn’t any.

We keep reading about how growth in China is slowing but as Moff keenly pointed out to me, nominal Chinese GDP in 2006 was US$2.3trn. By 2010 that figure had risen to US$5.1trn and it is forecast to reach US$10.4trn this year.

Thus, he quite sensibly argues (while launching a broadside at teenage scribblers with degrees in maths and three years experience in the research department) that nailing Chinese GDP growth in percentage points is meaningless when the basis has expanded by around 4.5 times in just nine years. Over the same period, the US economy has grown by about 26% in current dollars.

Whether the Chinese economy grows by 5% or 6% or 7% is not really all that relevant as long as it is still growing. The past year should have taught anybody with a triple-digit IQ that there is barely more of a correlation between China’s economic performance and the value of stocks in Shanghai than there is between its declared growth figures and the probability of 17 coming up twice in a row on a roulette table.

I repeat the advice given by Moff: forget the obsession with percentage growth for a moment and focus on the nominal value of Chinese year-on-year expansion.

Markets are getting themselves into a terrible stew as they now seem to be driven by a bunch of folks who don’t know what’s going on and therefore have reverted to trading on the basis of full speed ahead or full speed reverse. Now might be the time to switch off the Bloomberg and to do some fundamental thinking. Overall, the economies of the leading nations are not in such bad shape.

DON’T GET ME wrong. There is a lot about China and its growth that is trapped between the smoke and the mirrors. I was kindly made aware of a rather smart piece on the subject by fellow part-time IFR scribbler Elliot Wilson that appeared in the Spectator on August 15.

The country now suffers, as demonstrated in Elliot’s article, from overcapacity in all manner of areas, be that manufacturing or housing. There is surely an amount of overshoot and subsequently some right-sizing to be done. But to go from there to recession is a long way. A shake-out, a retracement, might in fact be overdue and entirely healthy. But is that a reason to get totally scared?

China is a pretty big place and as such has the propensity to make – and the ability to ride out – some pretty big mistakes. What is clear is that China is maturing and that the frontier spirit that always sees endless opportunity is no longer order of the day.

There are, however, still 1.3bn people who need to be fed, watered, housed and transported, and who still aspire to be better off than they already are. The IMF had US per capita GDP pegged at US$46,405 as per year-end 2014. For China, the same number was US$7,589 with a forecast for it to rise to US$11,449 by 2020. That forecast might be on the optimistic side but it still leaves a huge amount of room for China not to fall into the black hole of recession that so many fear.

Disappointment, as I like to repeat, is not an absolute value, but one that relates to expectations. Having those expectations set too high does not make them of themselves wrong. As Western investors, our problem is not only knowing what is the right level at which to set those expectations but also how to gauge them in light of Beijing’s ability and desire to intervene when least expected.

I don’t know the answer but what I do know is that applying our own, well practised economic measures and valuations to the Middle Kingdom will cause nothing but frustration and, as often as not, a loss. Now have a think about trying to apply our models to a casino like Chinese stock markets where the roulette wheel comes with a government sponsored double zero.

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