Slowdown fears in the market have shifted to China. The past two days has seen the start of a shift in sentiment with China exposures viewed more as risk than as opportunity. There is clearly some slowing in China, and there should be, because the government has been trying to slow the economy to help contain inflation for the past year. China starting to slow is a positive because it helps inflation remain under control which is a key element towards China achieving its multi-year economic plans. Over the latter half of this week, the fear has shifted that the slowdown is no longer orderly and that it is accelerating towards a hard landing in China. If this were to be true, it would dramatically increase the chances of a global recession next year. I would go as far to say that a hard landing in China would make a global recession a sure thing in this environment. Fortunately, I believe the fears and reactions to China exposure in the market have been preposterous and have taken place on low volume days while investors are already anxious. I don’t expect the shelf-life of China hard landing fears to last too long.
It is nonsensical that China rapidly slows into a hard landing because China is one of the few countries tightening monetary policy. China is perhaps the best equipped country in the world to ease both monetary and fiscal policy. China has been raising interest rates steadily since the financial crisis from 5.3% to 6.56% today. China would have the ability to stimulate the economy rather quickly as they stop tightening interest rates. It would be reasonable to think that a hard landing could be avoided.
On the fiscal policy side, China has actually been rumored to purchase Italian sovereign debt – indicating that debt capacity is not an issue. China has sovereign debt to GDP ratios which are close to half those of the US and Europe. There is plenty of potential to incur debt if needed for fiscal stimulus to avoid a hard landing. Moreover, on the household side, there is much less leverage throughout the system. China consumption as a % of GDP is in the mid 30s and consumers have a very high savings rate. The housing market is much less leveraged than in the US. Property is either owned outright or with 50% down.
HSBC released their final estimate of the China PMI for the month of September at 49.9. For perspective, during the financial crisis this metric hit 38.8. China’s GDP growth was 8.7% during the year of the crisis. So a China PMI reading of about 50 is not in any way consistent with business falling off a cliff in China. Over the weekend, the official China PMI will be released. The official China PMI is expected to come in at 51.1 vs. last month which was 50.9.
Here are a number of charts so investors can assess whether there is real evidence of a hard landing or if the fears are overblown:
It is interesting that companies in Europe and the US which are exposed to China consumption have dropped 10% over the past two days. Generally the China exposure is between 10-20% of total sales. So the market effectively priced in over two days that between 50% and all of the sales in China evaporate. Some of the stocks that are “China growth geared” and trading based on these fears are as follows:
- Richemont (CFR VX)
- Swatch Group (UHR VX)
- PPR (PPR FP)
- LVMH (MC FP)
- Hermes (RMS FP)
- Nike (NKE)
- Coach (COH)
- Tiffany & Co (TIF)
- Ralph Lauren (RL)
- Yum! Brands (YUM)