At the heart of China’s crisis is the determination of the new government to bring much more economic discipline to the system and to rebalance growth away from (wasteful) investment and into consumption. However, this is a very delicate task that the economy has few effective levers to deal with. If growth were to collapse too far as investment spending is restrained then consumer confidence would fall back, and consumer spending with it.
Consumers should be in good heart at present. Inflation is low – consumer price inflation is around 2% and producer prices are in deflation – while wage growth is running at 10%. The concern is that people could start losing their jobs. The HSBC index of industrial confidence has fallen below the critical 50 level (that separates expansion from contraction) and corporate profits are under pressure from high wage-growth and the appreciation of the yuan.
Bull vs. bear
The bulls in the market are hoping that all of the recent turmoil in the financial sector was to an extent planned. Their theory is that the authorities are seeking to squeeze credit growth out of the system.
The sceptics are concerned that the authorities are not in control and may be seeing consequences of their attempts to restrain lending growth that go far beyond what they had anticipated.
Earlier efforts to rein in lending to the real-estate sector have largely been ineffective. We believe the government is in part still paying for the trend of decentralisation witnessed under the previous regime. For example, attempts to rein in mortgage lending have generally not worked outside of Beijing. Central policies have not been implemented by regional governments; a reminder that a large part of regional government income comes from property development.
Valuations
Chinese equities continue to look cheap, but we would caution that cheap valuations have never provided a consistently good signal of outperformance or absolute gains from the market. The forward PE (price/forecast earnings) of the Chinese market for 2013 is currently 9.0, although seven out of 10 sectors have forward PEs above the average. The average multiple is dragged down by the financials sector, which trades on a 2013 PE of just 6.5.
The price-to-book ratio of financials remains above 1.1, although this may not be so cheap given the sector’s problems. Sectors that play to the more attractive long-term consumer theme are much more highly valued. For example, the consumer staples sector trades on a PE of 20.1, healthcare on 19.7, and consumer discretionary 12.5.
Like other major economies, China deployed enormous resources to fight off the impact of the global financial crisis. Like all countries, it is now coming to terms with the reality that even prior to 2007 economic growth was on the wane. The maturing of the economy means less employment growth, less productivity growth and fewer structural shifts that can boost GDP growth above a long-term sustainable rate of 6% to 7%.
