January is usually a month in which festive consumer activity ahead of Chinese New Year celebrations causes a surge in inflation. But this year consumer price rises, at just 2.5%, were no higher than December gains.
China equity market bears will see this as further evidence of economic slowdown.
BNP Paribas Investment Partners’ senior China strategist bemoans an “inherent domestic deflationary bias” that could hobble mainland growth prospects this year.
Chi Lo points to chart 2 above, which shows what Chinese producers get for their goods (the Producers Price index) and what other companies pay for these goods (the purchasing prices). Both measures fell steeply over the year to September 2012 and have continued to bump along in negative territory ever since.
Low prices slow growth by inflating real borrowing costs. While the nominal lending rate in China has been virtually unchanged over the past two years (since July it has been at 6%), when you factor in the falling prices at which companies sell their goods (see chart, left) real borrowing costs have spiked and remain up around 8%.
“Rising real rates and a margin squeeze for the manufacturing sector in China is effectively a tightening of macroeconomic conditions,” acknowledges Charlie Awdry, fund manager and China specialist at Henderson Global Investors.
China’s producers’ problems may be more complicated than a slump in global commodity prices, because at several times in the last 18 months – notably from February to ,September last year – China prices and global commodity prices, as measured by the CRB index, moved in opposite directions (see circled section on chart 2, above).
Exports provide little help, either. Those to the US are being penalised by the renminbi’s steady strengthening against the dollar – by more than 11% over the past three years. Those to emerging markets – against whose currencies the RMB has strengthened even more – (see table, right) – are also suffering, with Japanese exporters, supported an Abenomically depressed yen, now at a considerable advantage to many Chinese firms.
If they are underestimating inflation, Chinese equity investors may be in for a shock.
Growth companies’ earnings will disappoint, reversing recent gains in this sector. “Companies that can deliver earnings growth, such as Tencent, have generally done well, and in many cases their valuations have expanded (eg Tencent),” explains Awdry. These valuations will look less appealing if earnings targets prove excessive.
Investors should also shun value stocks, which some argue are cheap. This is a huge sector, says Awdry. “I would include all state-owned businesses that make up a large part of benchmarks like MSCI China and indices like the China Enterprise Index of H-shares listed in Hong Kong, which includes China Petroleum, China Construction Bank and China Mobile.”
The latest Chinese manufacturing data, meanwhile, shows little to counter fears of a slowdown. HSBC’s purchasing managers index (as of January 30) showed Chinese manufacturing in contraction in January, for the first time in six months. Hardly festive news for Chinese managers – or the shareholders of the companies who employ them.