Profiting from China's Slowdown
The New Chinese Economy
The global economy is not looking as bad as many had feared. China’s Q2 GDP came in at an annualized rate of 7.5%, a tad slower than Q1’s annualized 7.7%.
There was a bit of nervousness leading up to the number, since China’s exports in June were 3.1% lower than in the previous year. Still, the 7.5% GDP was in-line with expectations and perfectly matched the Chinese government’s annual GDP target.
It seems the tremendous slide from double-digit annual GDP may have stopped losing ground. China is managing to avoid a hard landing after all, as it screams past Western economies that are barely able to sustain 2 to 3% growth.
Could this signal a bottoming of the slowing cycle? How is the global economy expected to change going forward? And who stand to benefit most?
World Slows China; China Slows World
It’s a bit of a vicious circle. As Western nations suffered under a pandemic of credit crises, the demand for Chinese goods slowed. This reduced Chinese exports, slowing GDP growth and putting pressure on Chinese jobs.
“The good news,” Ruchir Sharma, head of Emerging Markets and Global Macro at Morgan Stanley Investment Management, explains to Yahoo! Finance, “is that China doesn't need 7-8% growth anymore to generate full employment because the population is aging.”
The rapid growth in leaps and bounds the country enjoyed until recently was needed to fill the holes in its labour force and employ the nation. But now that China is a “matured economy”, as Sharma puts it, its focus is shifting toward keeping the jobs it has.
“They're less worried about growth in itself; they're much more worried about the severity of the job market,” Frederic Neumann, co-head of Asian economics research at HSBC, informed CNBC.
June PMI numbers out of China showed the manufacturing sector shed more jobs last month, with the sector cutting workers three months in a row.
Louis Kuijs, chief China economist at RBS, assesses China’s labour market as being under strain:
“In the first quarter, that data was still pretty good. There are signs that it's weakening now - both on the employment growth side, and on the wage growth side. They tell a picture that is consistent with some of the other labor market indicators and surveys that also point to a cooling down.”
But while the world slowed China, China is now slowing the world, as falling Chinese production reduces commodity consumption. Commodity-based economies that once thrived on deliveries to China – especially Australia, Russia, Canada, South Korea, Taiwan, Indonesia, and Malaysia – have thus been taking a hit on their export revenues.
A “Shifting World Order”
Sharma calls it a “shifting world order”, as “all these countries that benefited from China's investment boom, the commodities boom, get hurt,” Yahoo! Finance quotes.
To where is prosperity expected to shift? “The U.S. and other countries which import large amounts of commodities may in fact benefit from this development because lower commodity prices … may help the consumers in these countries,” Sharma expounds.
“I think we could see a shifting world order away from the commodity exporters which were the big stars of the last decade towards commodity importers which benefit from lower commodity prices,” the analyst predicts.
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The Cycle May Soon Turn
But there is a ray of hope for commodities and their producers. China will not simply stand by and let its economy deteriorate. Its citizens are growing more demanding, especially after enjoying such upward mobility these last two decades.
“I think that we're getting closer to a point where they are actually getting worried and will have to do something,” Neumann anticipates. “We're going to get more announcements [out of China] to help shore up the job market.” “If there are signs that the job market buckles, they will step on the gas and try to lift growth again, because that's obviously the number one risk in China.”
In its quest to keep its workers employed, China will increase production even if it has to throw money at it. “Beijing, in particular, still has big fiscal reserves,” Neumann pointed out. “It could roll out to spend on infrastructure for example to create jobs,” just as it did last September when it approved $150 billion in new infrastructure projects to keep workers employed.
As Chinese Premier Li Keqiang indicated this week, Beijing would not allow growth to fall below what the labour market requires. And as China opens its wallet, its foreign trade partners should soon start seeing a lift in exports of both commodities and higher-level manufactured goods.
Anticipating the New Investment Climate
What we may soon be seeing is a case of all the lights coming on at once, just as the global slow down saw all lights go off at once. Both the base materials and advanced manufacturing should benefit simultaneously.
Now that China’s slow-down has lowered commodity prices, manufacturers of advanced goods such as electronics, appliances, planes, trains, and automobiles should see increased profits from lower material costs. This has no doubt contributed to the stellar gains in U.S. manufacturing stocks at the expense of ailing commodity producers.
China’s June data showed that its industrial output has been increasing as well, rising 8.9% higher year-over-year, while retail sales rose 13.3% over the prior June. At this pace, the industrial demand for materials will inevitably lift commodities, perhaps as early as the second half of this year.
Thus, the shift to manufacturing has to at some point pull materials along with it. Now that metals and other natural resource producers have adjusted their operations to their commodities’ lower prices, these once hurting industries can finally return to profitability. Introduce just a little more demand for materials, and commodity producers will start generating some decent returns once again.
If China manages to stop its slowing growth and stabilize its GDP at its target 7.5% annual rate, while maintaining a steady level of employment by pumping money into its economy, the entire spectrum from base materials to advanced manufacturing should benefit together.
Where the last 5 years saw the U.S. central bank spend the nation out of recession, it looks like it’s China’s turn to open its treasury and spend its way out of a slow-down to the benefit of the rest of the globe. Especially when you consider the size of China’s wallet.
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