The narrative has changed from weak macro data post the May credit crunch to feeble company numbers – from capital goods to cosmetic sales – hence nothing to do with the trade dispute. With earnings finally being revised down, the discussion moves onto the shape of the cycle.
There are a number of differences to the policy response compared to the 2015 credit tightening. One outlier is that China might run both current account and fiscal deficits in 2019.
In our view, the authorities are getting closer to stabilizing monetary conditions. Although the trade negotiations are a “black swan” or “known unknowns”, the fact that the renminbi has fallen and the reserve requirement ratio (RRR) for the big banks has been cut to 14.5 percent under “normal circumstances” ought to have eased conditions.
The fact that the money supply and loan data is weak does not rule out the possibility of a “liquidity trap” – banks simply saving the cash without creating new loans. However, it should be borne in mind that: 1) Seasonally, it is a period of poor credit data. The banks create a significant proportion of new loans during first and second quarters. 2) Outside of the equity market and to some extent credit markets, asset prices such as housing have held up well. 3) The authorities have a lot more room to cut the RRR. A judgment call on a liquidity trap should wait until early next year.
Nevertheless, there are significant differences between the 2015-16 easing and the current credit crunch. First, the balance sheet of the People’s Bank of China has not expanded. In 2015-16, the PBoC lent to commercial banks, allowing them to underwrite bond issuance. Second, the authorities have not intervened directly in the stock market while stock suspensions are rare. Third, while fixed asset investment has picked up, a number of these projects had been simply canceled or restarted. Last, there are no signs of outright deflation; corporate pricing power remains firm.
Since there is a growing nominal interest rate differential between China and the United States, the PBoC can’t cut rates for fear of seeing foreign exchange reserves fall through capital flight. The government balance sheet, which had been pristine prior to 2015, is likely to widen. In this sense, the government will make transfer payments to the household sector to support consumer spending. Real incomes have been falling while increased housing unaffordability has undermined consumption.
We believe A shares are in the process of making a bottom. The yield curve has steepened, buybacks are growing and companies are delivering earnings disappointments well before the impact of the trade tariffs.
Once the Taiwan PMI troughs, this ought to be a confirming indicator that Chinese economic data ought to be past its worst if history is a clue. We continue to prefer CSI old-economy companies running high free cash flow and low gearing to the China developers whose cost of funding has risen substantially since May.
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