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Thursday, January 19, 2012

International Thursday #3 : China's Growth Story Strictly Fiction ?

That may be too severe a judgment. Still, before you buy the GDP stats recently released by the Chinese, read the fine print, urges Patrick Chovanec in SEEKING ALPHA:

Today, China’s National Bureau of Statistics (NBS) released the end-of-the-year GDP figures of 2011. According to official tallies, China’s GDP grew 8.9% in the 4th Quarter, a steady but modest decline compared to 9.7% in Q1, 9.5% in Q2, and 9.1% in Q3. GDP growth for the full year was 9.2%.
There are two pieces of data I saw today, easily lost in the fine print, that I found particularly revealing. First, the NBS disclosed that real estate investment accounted for 13% of China’s GDP in 2011 (compared to Stephen Roach’s estimate of 10%), and grew at a rate of 27.9%. However, I noticed something that I admit I missed before, in my earlier calculations — that this is a nominal rate (not adjusted for inflation) whereas the GDP growth rate figures are real (they take inflation into account). The real (and therefore comparable) rate of expansion for real estate investment in 2011 was 20.0%. 
So I went back and re-ran the numbers, using these more accurate figures. Given GDP growth of 9.2% (a higher starting point than I used in my initial calculations), a real growth rate of 20.0% for real estate implies a real growth rate of 7.6% for the rest of the economy. If, in 2012, real estate construction were merely to level off at zero growth, and the rest of the economy was unaffected, that would bring overall GDP down from 9.2% to 6.6%. That’s higher than the number I initially came up with, but still well into “hard landing” territory. The fall-off of 2.6% is also closer to the 3.0% drop I initially calculated than the 1% decline predicted by Stephen Roach. I errored in my back-of-the-envelope exercise, but my point remains a valid one. Keep in mind, these calculations assume no impact on dependent industries like steel and cement, no impact on the financial system, and no correlation to related risks in the Chinese economy — the latter two of which I will expand upon in my next post of the series.
Keep in mind, these calculations assume no impact on dependent industries like steel and cement, no impact on the financial system, and no correlation to related risks in the Chinese economy. 
How realistic is a leveling-off of real estate investment? This is where the second piece of data I noticed fits in. The NBS — somewhat curiously– did not publish December figures for property and other fixed asset investment. However, the Financial Times did interview Wei Yao, an economist at Société Générale, who made some of his own calculations. According to him, the growth rate for real estate investment saw a rapid deceleration from 20.1% in November to 12.3% in December (it’s clear from looking at the original source data that these are nominal rates; the real rates to plug into the GDP equation would be substantially lower). 
The FT article also notes a nearly 25% decline in new housing starts in December and a 26% year-on-year rise in unsold property. And it’s not merely real estate investment that’s decelerating. Nominal growth in fixed asset investment as a whole — hitherto the main driver of growth in the Chinese economy — dropped from 25% y-on-y in October to 21.2% in November and 18.5% in December. That’s precisely the kind of broader deceleration I’m going to be focusing on the next installment of my analysis.

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Paul Santos, also in SEEKING ALPHA, sees a Chinese downturn already occurring. Beyond the drop in the Baltic Dry Index, Santos points to "a serious slowdown in demand, and that, too, is already registering on public statistics, pertaining to cement consumption, automobile production or pig iron ", whose broader implications are as follows :
First, it's perhaps not a coincidence that commodities have shown to be on a downtrend for months now. But given that the real time impact that still seems to be happening now, one would expect such a downtrend to continue. Crude has managed to avoid most of the brunt of this downtrend, but taking into account the magnitude of China's importance, one would expect that Crude, too, will be hit.
This trend will obviously not only hit commodities, it will also hit commodity producers hard, both countries and companies, with a special emphasis on iron producers like VALE, BHP Billiton BHP and Cliffs Natural Resources CLF, given China's position as the world's largest producer of steel by far, as well as steel's importance to the Chinese investment boom. It is no coincidence that these companies are trading at such low multiples, this is what happens in these kinds of cyclical industries when they are about to face a negative cycle.
Beyond iron and other commodities, one would expect coal to also be hit hard. Not only will it be facing a huge slowdown on the steel industry, but it also faces incredibly low natural gas prices as well, which will pressure coal prices on electricity generation. Here, too, the shares have already taken a huge impact, yet if this slowdown continues one would expect that impact to extend further and for prices and estimates to plunge a lot more. Some names that might be hit further include Peabody Energy Corporation BTU, CONSOL Energy CNX, Alpha Natural Resources ANR, Arch Coal ACI, Patriot Coal Corporation PCX and others. This trend was actually in the news on Friday, with Patriot Coal speaking of lower exports for coal used in steel making.
The Chinese economy slowdown is no longer some speculative story. It's real and already showing in the economic statistics. This slowdown can have broad market impact, and will hit some sectors particularly hard. While I highlighted commodities in general, and iron plus coal in particular, the impact will certainly be much broader.