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Fog Over China

April 05, 2012 | Comments: 0 | Views: 127

When we came into this year, we expected the Chinese stock market to offer the next big opportunity for gains now that the U.S. market was rallying. We have been following China with that in mind. We even took the beating of the Chinese market last year as creating an opportunity this year.

The opportunity seemed clear enough. Last year China spent its time fighting inflation of one sort or other. The center of its concerns was the property market. China had applied a huge stimulus to its economy to combat the Great Recession and to maintain economic growth at the 8% target level. The stimulus worked and Chinese incomes grew.

What did the Chinese do with their growing incomes? The Chinese are savers for various reasons, not least of which is the lack of a safety net and government retirement support. At the same time, bank interest rates are low leaving enterprising savers to look for alternatives. One obvious alternative is the property market, hence the heating up of that market.

The property boom is a chief-but not the only- reason the Chinese authorities felt compelled to slow the economy. Whatever the reasons, the authorities succeeded in slowing the economy enough to the point where we are now seeing the signs of success.

This gets us back to expectations when the year began. The consensus about China was that we would see slowing and the relaxation of policy to allow the Chinese economy to resume a rapid growth path. As policy relaxed, the Chinese stock market would respond as before. The Chinese market was ripe for a recovery. (The MSCI China Index was down 18.2% last year.) A turn in policy should prove very rewarding was the market expectation.

We have seen some response by the authorities to the slowing. For example, there have been cuts in bank reserve requirements. They were raised throughout last year. There have also been some other marginal moves to ease monetary policy. The moves are all in the right direction, but taken together they do not add up to much.

As for the Chinese market, it has rallied along with the global markets. Matthews China is up 12% year-to-date. But the Chinese market is not the world leader, nor discounting any significant move by China to stimulate its economy.

The world is changing, and policy is changing along with it. All this was signaled earlier this month when China's premier Wen Jibao warned that growth will slow this year. As the Financial Times reported, Wen said, "the government seeks to overhaul the country's 'unbalanced, uncoordinated and unsustainable' development model." The new growth target is now set at 7.5%, about 0.5-1.0% below the old target.

The precise number itself is not so important. What is important is that growth has been dialed down. Some of the lowering of the growth target is simple acceptance of the fact that the old export model of growth has temporarily broken down. Europe is a prime market for Chinese exports, and a struggling Europe can no longer import as before. The U.S. too is not as flush as before. China recognizes this and its new trade growth target is for an increase of 10% as opposed to last year's increase of 22.5%. This can be shrugged off as a cyclical matter. Europe will recover and the U.S. will speed up.

Premier Wen is thinking beyond the business cycle. He is thinking about the fundamentals: Rely less on exports for growth, bolster private consumption and so forth. As he put it, "Expanding domestic demand, particularly consumer demand, which is essential to ensuring China's long-term, steady, and robust economic development, is the focus of our economic work this year."

Unfortunately, we have little notion of how China plans to achieve its goal and what the effect will be on parts of the economy. Uncertainty is going to hang over the Chinese stock market as its attempts to come to grips with the transition to a new government and a new economic model. But there is one important fact to hang our hats on, and that is the growth target of 7.5%. This is still rapid growth and larger than any other large economy will achieve this year.

Wall Street has by no means given up on the Chinese market. The fundamentals are attractive. As Frank Holmes, President of US Global Investors, wrote in a recent e-mail article, "the 12-month forward price-to earnings for the MSCI China Index is currently at 9.1 times." He notes that the 10-year average for the P/E ratio is 12.5 times. In other words, the China market is now cheap. Deutsche Bank strategists are looking for a P/E of 10.5 by the end of this year. We think their projection is low.

As this year has gone on, and we know more about the government's view of the future of the economy, our expectations for the Chinese market have been scaled down. The Chinese want growth but they are obviously wary of a boom. So far they have been slow to respond to the downshift in their economy. It does not look as if we will see a boom again in China's economy for some time. Still the market there is relatively cheap and the economy (and profits) are growing.

Not only were expectations high for China as the year began, they were also high for the emerging markets as a whole. As China redoes its economic model, it cannot help but affect its neighbors. It may well be that the expectations for the emerging markets will also have to be scaled back in light of developments in China. It may turn out that this is the year for plain home cooking.

Walter S. Frank has been the Chief Economist and Chief Investment Officer for Moneyletter for the past 25 years. He has had a long and distinguished career as an economist, financial advisor, and money manager. Mr. Frank is a regular contributor to Barron's and The Economist magazine.

For more information on the Moneyletter, visit our website

Source: EzineArticles
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