What China’s wild markets are really saying about its economy
It’s fair to say the markets in China have been a bit erratic lately. In the past week, Chinese equities recorded the biggest one-day loss in five years, before rebounding by 3% the next day; the yuan dropped against the dollar by the most ever over a two-day period; and bond prices tumbled after the government said traders could no longer use some risky bonds as collateral. People began to panic a little.
The headlines grew so frenzied that a New York colleague asked me, half seriously, “Is China imploding?”
From the vantage point of Beijing, a collapse looks far off. The construction sites in all directions are proceeding apace. Congestion and car honking are as prevalent and annoying as ever. And the hazy air signals that factories are still pumping out stuff.
What’s going on in the Chinese economy is that people are getting acquainted to a new story—actually, a “new normal,” as the government frames it. The 25-person Politburo said last week that “new normal” is a focus on quality economic development while incorporating previously outlined reforms, which include lessening state-planning and liberalizing interest rates and the currency.
In the past year, China’s old model of building infrastructure and churning out commodities has slowed way down—industrial output growth hit a six-year low in September. That means old-style GDP growth has fallen while quality growth of the new-normal variety is slow to arrive. Markets are thrashing around in part because traders are trying to guess at which point the government steps in to save GDP growth from falling too low. What recently sent Chinese stocks jumping by 25% in just three-week span—three weeks—was the first interest rate cut in two years. It seemed to provide evidence that China’s government will keep the economy buzzing around its stated goal of 7.5% growth this year.
So what’s really going on in China? Three indicators help explain what’s going on in the world’s No. 2 economy (or No. 1, if you follow one Nobel Laureate’s thinking) and give ammunition to those on both sides of the argument of whether China’s economy is headed for trouble or a continued rise.
The Manufacturing PMI (purchasing managers’ index) gives an indication of whether China’s manufacturing industry is expanding or contracting. Just a few months ago, back in the summer, China’s PMI’s had hit a two-year high and was expected to keep booming on the momentum of a stronger U.S. The good ride ended in November, when the HSBC China PMI hit a six-month low of 50. Anything above 50 reads as expansion, anything below contraction. Export growth to significant markets was way down, reflecting the worldwide growth pinch. The momentum that China’s factories had built up over the past half year, after the index started the year below the key threshold of 50, looks gone.
2. A Lower 2015 GDP Growth Target
We’re back to that phrase again: new normal. It’s meant to emphasize the slower-growth, reform-led economy China plans to run over the next decade. The phrase has recently appeared in the state-run People’s Daily and the Politburo’s statements. President Xi Jinping himself used it at last month’s APEC meeting to suggest that slower, more sustainable GDP growth was agreeable.
The most important test of the government’s new attitude will be whether it reduces its target for 2015 GDP growth to 7% from 7.5% this year. Almost all analysts now agree it will do so. The reduced target for next year would signal that China’s government believes the economy is mature enough to provide jobs for the country of 1.4 billion people while growing at the slowest rate in two and half decades.
The government is debating whether or not to make the cut at a conference in Beijing ending today. (State-run CCTV has provided 7 reasons to follow the Economic Work Conference. Unless the target figure is leaked in the state media, it won’t be announced till the spring.)
The silver lining of China’s recent slower growth—this year most analysts expect GDP growth to come in below the target of 7.5%—has been that more of the growth is coming from services instead of heavy industry. The share of what China calls “tertiary” industries has passed the share of “secondary” industries (including mining, manufacturing, production, and construction) for five consecutive quarters. In the third quarter, tertiary represented 46.7% of GDP.
When Premier Li Keqiang said last year that China’s GDP growth must achieve its goal of adding 10 million jobs a year, tertiary industries were no doubt on his mind. Because the service industry requires more labor, the continuing shift away from heavy industry is benefiting China’s economy quarter by quarter. China recently said it reached its goal of 10 million jobs in September, or three months early.
3. Rising Stock Prices
The stock market isn’t always a good place to go looking for insights into the bigger economic picture—the way U.S. stocks keep hitting record highs amid tepid economic data is one cautionary tale—but stocks as an investment class have at least some relationship to their home market. What China’s stock market seems to be saying is that the economy will be just fine.
After stocks fell 5.4% on Tuesday on news that a Chinese regulator was banning investors from using some low-quality bonds as collateral to buy stocks, the Shanghai index rebounded the next day and was steady today. Earlier this week I wrote about an analyst who believed China was just in the early stages of a bull market. That call got an endorsement today from Templeton’s Mark Mobius, the godfather of emerging markets who’s been investing there for 40 years. Mobius told Bloomberg he’s buying more Chinese stocks amid what he envisions as a long-term bull market. The Shanghai index remains 50% off its peak level in 2007.
China’s stock markets have been volatile, in part because so many small investors are using leverage to amplify their bets, but investors are endorsing the view that China won’t suffer terribly amid future slower growth.