China & Global Economy – a closer look.

In my previous (July) newsletter I referred to the possibility of the next few months could have increased volatility as a result of concern about the US interest rate increases – that may or may not have occurred in September and the slowing of China’s economic growth.

The reality is that from late August and through September the US investment markets reacted to both statistics from China and the decision NOT to increase interest rates in the US. The October wobbles arrived early and in many respects reflected an overdue market correction after such a long stretch of calm and stability since the last correction in November 2014.

The Australian investment markets (as measured by the ASX200) have been in a decline since May mostly due to the falling resource stocks and the major banks dropping from their overvalued positions. Typically investment funds that clients are in, such as Investors Mutual and Perpetual Industrial, would have been largely unaffected by this, as they shuffled their investments elsewhere some time ago.

The decline in resource investment was anticipated to eventually occur over a 2-3 year period, starting around 2015. Instead it in fact occurred suddenly over only 6 months. The slowdown in China being the key cause for iron ore prices falling dramatically in the past 6 – 9 months.

So what about China, is it all doom and gloom ?

The real GDP of China has been a major issue in the past few years often suspected of being overstated. The preferred measure for tracking the economy has been rail freight movements, electricity production and lending for developments.

These figures are reported regularly on monthly or quarterly basis and are easily tracked as part of the industrial productions process. Without doubt the GDP based on these measures is sliding down as major infrastructure developments taper off following a heady 2 decades.

What is less easily reported is the service economy’s contribution to the GDP since many statistics are only available on annual or half yearly compilation of data.  The size of the service sector has now nudged the industrial sector into 2nd place, although due to the frequency of the data this is less well known. E-commerce, entertainment, health services are all growing within China at double digit rates and creating GDP components that are less obvious than past industrial production figures.

Nicholas Lardy the senior fellow of the Peterson Institute of Economics is of the view that too much is overlooked in the services sector of China and its contribution to the GDP, given that is now is the largest contributor to the economy and also has some major sectors growing at double digit rates. The doom and gloom pervading the press and the news items at this time conveniently overlook half the economy and seem to be wishing for a doomsday scenario to play out. It makes for better headlines.

The reality is more mundane.

The Shanghai share market has had a major correction, even a crash that only affects about 8% of the population. It has now dropped back to a level that it was 12 months ago.
Poor regulation of the market there has caused this problem and will need to be rectified as part of the Chinese regulatory reform process.

The industrial production component of the economy is slipping in both absolute terms as a percentage of GDP and also relative to the (more difficult to measure) services sector of the economy.

The newspapers and the media like a headline. The worse the better.
Talking about a global market correction of 10-15%  isn’t a Headline.

BUT …

  • The Tapering of the China growth figures will not bring the global economy to a standstill. And the China figures while officially overstated probably are not as bad as some media outlets like to run in the story-line.  Additionally, the IMF headed by Christine Lagarde has come out and more or less stated the same as above.
  • The US recovery is still chugging along, slow and steady like the proverbial turtle. Reinforcing my previous estimation of a dribble up / trickle up ongoing recovery. Typically there are 9 – 10 key areas that economist look at -  and the US generally is ticking the boxes in 7 of 10 cases most months that data comes in.
    So everything is normal.
  •  The recently released detailed statics that the US Federal reserve uses for their analysis also shows some interesting hidden gems. The average profits of the major companies appear to be falling. But once you strip out the oil companies’ well publicised falling profits the remainder of the field are doing OK and actually edging their profits up, either as increased sales or falling costs as fuel costs fall.

The reporting season that is almost upon us during October should reveal this data in more detail.