Below are a few observations on the current economic and investment climate in China.
Historically, investors have been rewarded by deploying capital in Chinese equities on the cusp of a transition from tight to loose monetary policy. We believe investors willing to withstand short-term risk will be rewarded. By any measure, public equity valuations appear cheap and have dropped substantially since their high in mid-2009 (Graph 1).
Liquidity remains tight, after more than 18 months of strict monetary policy and a clamp down on the domestic real estate markets. We believe a good measure of domestic liquidity is the valuation spread between the A-Share and H- Share Market. When liquidity is flush domestically, A-shares trade at a substantial premium. This spread narrows significantly when liquidity is tight. Currently, the A-Share/H-Share premium is at its lowest level in 5 years (Graph 2).
Policymakers remain firm on measures to control consumer price inflation, which has become a proxy metric for social unrest, and real estate prices. Premier Wen Jiabao reiterated this week that the government “won’t waver on real estate controls.” The government has also enforced this directive by utilizing more subtle methods. The municipal governments of Wuhu, Anhui Province and Foshun, Guangdong Province, presumably less keen to see a battered real estate market than the central government, proposed measures recently to ease property curbs. Both policies, however, were unexpectedly cancelled just a few days later. Although no official announcement came from the central government in relation to each case, it can be inferred that a higher power intervened. We believe that the real question is not whether the government will win the battle against real estate inflation – that contest looks to be already settled. We believe the bigger concern we have is whether there will be unintended consequences to these government initiatives. Judging from past records, the Chinese policy makers seem neither adept at tuning the real estate market nor the Chinese stock market.
However, two notable events suggest that the government is open to selective easing measures. Both were done in a targeted manner that is aligned with the policymakers’ aim of avoiding the reigniting of another speculative property bubble. First, the PBOC injected of 183 billion yuan (28.97b USD) into banks before the Lunar Chinese New Year. Second, Chinese banks have been ordered to roll over loans to provincial and municipal governments. Totaled at around 10.7t RMB (1.7t USD), these loans will be adjusted based on their utility and usefulness. We believe that highways loans might be extended, while “city squares” and other real estate loans might not.
Drawing conclusions in early 2012 will be difficult, as the Chinese New Year seasonality will always cause distortion. The close proximity between the Western and Chinese New Year holiday breaks will further exacerbate discrepancies this year. For example, January trade data was skewed severely, and suggests either an extremely sharp slowdown in Chinese exports or far more dramatic seasonality than would normally be expected. We believe that it was partly influenced by the developments in Europe, but mostly by seasonality effects.
On an aside, China appears to be addressing long-standing concerns about the quality of the economic data it reports. This week, Ma Jiantang, Commissioner of the National Bureau of Statistics, announced that China will begin using a unified system to collect industrial, retail sales and investment data to improve the accuracy of key economic indicators. The move was in response to long-standing concerns by the Bureau that interference and falsification of data collection at the local level was harming the credibility of the nation and its agencies. Increasing transparency is one of the long-term “tailwinds” that we have highlighted.