Skip to main content

Expectations for China

I recently took a small position in the UltraShort FTSE/Xinhua China 25 ETF (FXP). This is the inverse fund corresponding to the FTSE/Xinhua China 25 ETF (FXI). After peaking in October, FXI has been moving down. It now appears to be forming a wedge-shaped chart pattern (see chart below). Price action on FXI has been narrowing as the ETF begins to get close to the point where the downtrend line meets the horizontal line. It has seemed like we are overdue to find out whether FXI was going break out to the bullish side or to the bearish side. On Thursday of this past week, it looked like the outcome had been resolved in favor of the bulls. Then on Friday, the ETF fell back inside the wedge. We remain waiting for the breakout.

Chart of FXI
Well, I'm no expert on China so I have been relying on the charts. What are others saying about the economic outlook in China?

According to academics from Wharton, China's economic situation is fairly positive though it is harder to predict the direction of stocks. Rather than focusing on the US impact on China, management professor Marshall W. Meyer feels that China's impact will be felt by the rest of the world.

He makes the point that China's huge demand for oil, metals and other commodities has pushed commodity prices up around the world. Now Chinese officials are taking significant steps to slow their economy to control inflation, Meyer says. That should stop the spike in commodity prices, but it also will likely cause a slowdown in growth worldwide in 2008. Referring to skyrocketing food prices, Meyer says that "the central government is adamant about restraining credit and, where they can, restraining prices, because the failure to do so creates social dynamite."

To stem inflation, Chinese officials have moved to tighten credit. Regional bank branches have been directed to assure that money is lent only to borrowers likely to pay it back. In addition, in a move meant to deflate the Chinese stock-market bubble, regulators have told Chinese mutual fund companies to stop buying Chinese stocks.

Meyer says that "the assumption has been that global growth will be driven by China and India." In addition, Meyer says he can't predict a recession in the U.S., "but I can see a slowdown in global growth because of the tightening in China."

Andy Xie, an independent economist and former managing director of Morgan Stanley's Asia/Pacific economics team, has a somewhat more positive outlook. He feels a US recession is a definite but in spite of that, the outlook for emerging markets remains robust.

Despite his positive outlook, Xie feels that China will see some challenges. Many analysts have discussed the vulnerability of China's export-led economy. "The Chinese are going to suffer," Xie predicts. "Whereas in the past, the U.S. used to absorb Chinese savings and products, it will now want to turn the tables and export to China. "It's going to be an enormous challenge for us. Next year is the first year of this new world."

What will save China, however, is increasing trade with other emerging markets. Xie notes that China's exports to the West are already winding down. He predicts a 10% to 15% growth rate in these exports over the next year compared to a growth rate of more than 20% in recent years. This trend is partly due to market saturation, he says, and partly due to the loss of some cost advantage to countries like Vietnam and Bangladesh.

Emerging market trade already accounts for half of China's trade growth, says Xie. These economies export precisely what China needs -- commodities such as oil, copper and iron ore. In return, they buy cheap Chinese-made consumer products and capital goods. "In the short term, this is going to be a huge cushion for China," says Xie. "Next year, exports will continue to grow."

Appreciation of the yuan has been much discussed in the financial press and has been something that has been encouraged by western governments. Scott Chu, Pioneer Funds' China representative, thinks it will have little impact on East-West trade. "When the yuan gradually appreciates, those low-margin, labor-intensive, heavily polluted and low-value-added industries will be forced out of China, and enterprises will start upgrading themselves into high-value-added businesses while also trying to improve their efficiency. That's why in recent months, you see that China's trade surplus number is actually going up instead of going down."

Chu also sees "real estate consumption... going up steadily. In short, China's consumption, exports and investments are all healthy, which suggests a 10% or above growth for 2008." Adds Xie: "My hunch is that next year is okay," but he cautions that it would be an altogether different story if the U.S. falls into a deep recession, with 2% or 3% negative growth for the year."

This is despite the central government's efforts to cool investment in real estate. Property prices will only fall when the U.S. dollar strengthens and liquidity starts to flow out of China, according to Xie.

What about Chinese stocks?

Touching on expectations for Chinese equities, Xie is upbeat. Following the subprime crisis, money that would have flowed to the U.S. will instead come to China, he predicts. "Wall Street financiers, ... are arming themselves with funds and taking aim at China... So the asset bubble you are seeing here is probably going to become bigger" next year.

Meanwhile, Chu, when asked whether the P/E ratio is too high for China's listed companies, notes that "in certain periods of emerging markets, concurring currency appreciation and excessive liquidity, it's common to see a high P/E ratio. You can't simply compare China to Japan, the U.S. or Hong Kong, since the capital flow in those mature markets is free and is looking for the lowest P/E ratios with the highest profit growth companies. But in China, it's a different story because the country has relatively tight regulation on foreign exchanges and there are limited choices for investment."

In general, he concludes, China's stock market is more expensive than those in the U.S. and Europe. But there is logic behind it. "First, it's an indicator of high growth... Some companies in China are in a monopoly position and therefore it's understandable to see high P/E ratios.

"From the perspective of demand," he continues, "you can see that with an inflation rate of 6% to 7%, the ordinary Chinese people are moving their bank deposits to the assets market. As long as the actual interest rate is negative and the yuan keeps appreciating, the money from both home and abroad to buy these assets will keep on growing, and growing fast."

Chu suggests taking a cautiously optimistic approach to China's A share market in 2008. "It will be very good if you have a return of between 10% and 30% next year. My view is that after the first quarter of 2008, the market will have a deep correction."

Meanwhile, in early December, China's government announced a "tougher" economic policy for 2008, which is a rare and significant change in its official stance. Chu says that the biggest risk for China now is inflation. "The actual inflation rate is far exceeding the official number of 6.7%. If inflation expands to a certain point, it will be a disaster for the whole economy and the stock market as well."

Zhou Qiren, an economics professor at Peking University, noted in a speech in Beijing in early December that the main challenge China's economy faces comes from its currency. "Excessive liquidity is reshaping the price level and pushing up all the [basic] costs." Adds Zhou: "It's unprecedented in the history of [mankind] that labor, information, technology and capital can be flowing freely and be re-organized around the globe. This forms the basis for a big transformation. China has experienced tremendous growth in the past three decades. But I see 2008 as a major turning point for its economy."

Conclusion

It seems that the experts see continued strong growth in China. "Decoupling" is more real than many of the US pessimists think. Trade with other emerging markets will support economic growth in China. A strengthening yuan could actually benefit China.

On the downside, inflation is becoming a serious issue among the populace. Food prices are soaring. Petroleum prices are rising and are being held in check by government decree. Prime Minister Wen Jiabao announced that China would freeze energy prices in the near term. Banks are seeing limits put on lending. The government is raising interest rates.

What does this all mean for Chinese stocks? It is difficult to say. Chinese stocks are clearly showing a rich valuation but, as described above, there are valid reasons for that. Others are saying that we are witnessing a bubble and that eventually the stocks will come back to earth. The experts are expecting a moderation in growth from a previously torrid rate but are wary of risks from domestic inflation and a potential severe recession in the US.

Will all this be sufficient to cause a breakdown in the FTSE/Xinhua China 25 ETF? I'm back to watching the charts.

Sources: What's Ahead for the Global Economy in 2008? Reports from the Knowledge@Wharton Network

Disclosure: author owns shares of FXP

Comments

Anonymous said…
I always like to think from the logical term instead of only from the experts point of view.

I learned that 10% of the rural maids that came to Shanghai to work has turned into stock traders.

This is a serious matter. What do maids know about investing and trading?

Our economy in Malaysia had the same problem prior to the financial crisis in 1997. Our taxi drives were busy discussing about stock market back then!
Anamika said…
Market is all set to touch old highs. So, get invested in stocks you like and enjoy profits. Keep watch on BSEIndia website for updates in stock market and to get Free Share Trading Tips
Anonymous said…
shareinfoline.com is the leader in giving share tips for Indian Stock market. Let the Market go up or down, With our tips, you will always be in profit. With the team of our chartist giving excellent share market tips, we are always able to provide 80% success ratio. There results can be found in our website shareinfoline in Past Performance Page. The Past Performance is free to view and the share tips over there would help you to become our member and get our shares & stocks tips.

We also provide commodity tips and our results are comparatively far better than other players in this field. commodities trading have become quiet common and has got a good volumer.

Visit shareinfoline.com for more details
Priya said…
Stock market is a volatile market. Where people invest with the intention of making money but many traders and investors end up as a looser. Must be wondering what makes one trader a winner in the stock market and another one as a looser in the market.

In Indian stock market many people have many doubts but they don’t want to clear them by consulting professionals nor they want to raise there questions where other traders and investors can help them out. But now many portals are coming up with QNA sections where investors and traders can exchange there views about stock and stock market. Indeed it’s a great help for everyone who are related to stock market.
Priya said…
Stock market is a volatile market. Where people invest with the intention of making money but many traders and investors end up as a looser. Must be wondering what makes one trader a winner in the stock market and another one as a looser in the market.

In Indian stock market many people have many doubts but they don’t want to clear them by consulting professionals nor they want to raise there questions where other traders and investors can help them out. But now many portals are coming up with QNA sections where investors and traders can exchange there views about stock and stock market. Indeed it’s a great help for everyone who are related to stock market.

Stock Market Trading Tips

Popular posts from this blog

Brazil - in a bubble or on a roll?

A couple of years ago, no one recognized the real estate bubble even though it was under everyone's nose. Now, analysts and bloggers are seeing bubbles everywhere they look. One of them, they say is in Brazil whose Bovespa stock market index has doubled in the last 12 months. Does the bubble accusation hold water? I don't think so and here are 7 reasons why Brazil is by no means a bubble economy: Exports have held up over the past year thanks to demand from China for Brazil's soya exports and iron ore. This was helped by the the Brazilian government's drive to improve trade links with Asia and Africa. Export diversification, spurred by a more active trade policy and increased focus on "south-south" trade under current president Lula, helped mitigate the decline in demand from OECD (Organization for Economic Co-operation and Development) countries A "sensible" economic framework has been in place since the 1990's. This has included inflation

Thursday Bounce: Trend Busters, Swing Signals and Trend Leaders for July 9, 2009

This is a quick post to announce that we have published Thursday's Trend Leaders, Swing Signals and Trend Busters at Alert HQ . All are based on daily data. Today we have the following: 72 Swing Signals -- A couple of days ago we had 35 signals, today we have twice as many. Happily, we now have 65 BUY signals, a mere 4 SELL Signals plus 3 Strong BUYs. Whoo-hoo! 56 Trend Leaders , all in strong up-trends according to Aroon, MACD and DMI. There are 18 new stocks that made today's list and 60 that fell off Tuesday's list. 48 Trend Busters of which 5 are BUY signals and 43 are SELL signals The view from Alert HQ -- Talk about mixed signals. If you look at our Swing Signals list you would think the market was in the middle of a big bounce. BUY signals are swamping the SELL signals and we even have a few Strong BUYs. Yes, there's a good sprinkling of tech stocks and tech ETFs but the distribution is pretty broad-based with a good number of different sectors represented, eve

Trade Radar gets another update

Some of our data sources changed again and it impacted our ability to load fundamental/financial data. In response, we are rolling out a new version of the software: 7.1.24 The data sourcing issues are fixed and some dead links in the Chart menu were removed. So whether you are a registered user or someone engaged in the free trial, head over to our update page and download the latest version. The update page is here:   https://tradingstockalerts.com/software/downloadpatch Contact us if you have questions or identify any new issues.