A Bull In A China Shop by Shane Obata and Triggers

China’s stock market is on fire…

…But its economy is cooling off.

Can the divergence last? And what’s next for China?

Stay tuned to find out…

Money flows

Corruption

According to the Financial Times, “Mr. Xi (China’s President) has launched the most aggressive anti-corruption drive ever seen in Communist China” in order to strength the public’s perception of the Communist party’s legitimacy.

“Lavish banquets have stopped” and “gift-giving is less generous.”

The war on graft may be one of the reasons the growth of China’s luxury market was negative in 2014:

Bull In A China Shop

Although some areas were strong, men’s wear and watches were particularly weak.

Furthermore, the gambling industry has suffered…

Gambling revenues

Total gaming revenues in Macau are now contracting – year over year:

Bull In A China Shop

Likewise, VIP revenues are also suffering.

China’s housing market is also under pressure…

Housing market

Chinese home prices have been cooling off since early-mid 2014:

Bull In A China Shop

Still, they increased over 100% from 1999 to Q2 2014.

Despite the concerns mentioned above, China’s stock market continues to rally…

Top performing stock markets in 2014

As reported by CNBC, “the two Chinese benchmarks, the Shanghai Composite and the China Securities Index 300, came 2nd and 3rd in the list of best performing stock markets in 2014.”:

A Bull In A China Shop: Lots Of Great Charts

The Shanghai Composite finished last year +52.84%; it continues to rally in 2015.

But what’s driving it???

A-shares accounts, margin debt

The drastic increase in the number of new A-shares accounts – which began in early 2014 – suggests that retail investors are piling into the market:

Bull In A China Shop

What’s more concerning is that they’re taking on a lot of debt in the process.

Could China’s market continue to rally from here? Surely.

Nevertheless, there are reasons to be cautious – one of which is its decelerating economy…

Slowing growth

Economic output

On the surface, it seems as though everything’s alright in China.

GDP growth came in at 7.3% in Q4 of 2014:

Bull In A China Shop

It’s been in a downtrend since 2010; however, it’s actually quite good – relatively speaking.

Then again, GDP doesn’t tell the whole story…

Real activity

China’s “real activity indicators” suggest more weakness than its economic growth does.

Cement production growth was negative and steel and electricity production growth were marginally positive on Jan 20, 2015:

Bull In A China Shop

Moreover, each of these indicators has been in decline since mid-late 2013.

Falling commodity prices also suggest that China’s slowing down…

Commodities

China is the world’s biggest consumer of coal, iron ore, and copper. It follows that falling metal prices may be indicative of weaker demand from China:

Metal Prices

The same can be said for falling coal prices.

China’s growing debt load is also concerning…

Debt

China’s outstanding credit to GDP is at 200.11%:

Outstanding credit

What’s more is that non performing loans have been rising since late 2011-early 2012.

How has China accumulated so much debt in such a short time? Overinvestment

Investment

China’s gross fixed capital formation grew from less than $1 trillion in 2005 to more than $4 trillion in 2013:

Capital formation

In addition, China’s gross fixed capital formation as a % of GDP is > 45%.

To put this in perspective, India’s is < 30%, Japan’s is < 25%, and both the US and EU’s are < 20%.

That said, China is trying to move away from its dependence on investment…

Going forward

FX reserves

“China’s foreign (exchange) reserves are falling, even though its trade surplus is (at) a record high.” – Jamie McGeever:

Forex reserves

Why are they falling? Presumably because China is trying to reduce its reliance on the USD.

And then there’s consumption…

Consumption

“There is still huge room for Chinese consumption to grow rapidly. Its private consumption represents only 36% of its GDP, compared with the world’s average of 60%.” – Li-Gang Liu:

Final Consumption

It’s likely that China will focus more on growing from within in the future.

What are the key points to remember???

That’s all folks!

Anti-corruption policies and a softening housing market are pushing money into China’s stock market.

Meanwhile, its economy is losing momentum.

This discrepancy might last for some time but there are multiple risks to consider.

If China wants to strengthen its economy then it needs to shift its emphasis from investment to consumption.

–          $hane Obata