Official numbers put China’s first quarter GDP growth at 6.7%–but it’s growth built on even more debt
Good news, right?
China’s GDP grew by 6.7% in the first quarter of 2016 from the first quarter of 2015. That hit the top of the government’s growth target of 6.5% to 7% for 2016. It also matched the median estimate from economists surveyed by Bloomberg.
Quite possibly not.
The growth hinged on another quarter’s worth of debt financing for an economy that’s already eyebrows deep in debt. Money supply climbed at a 13.4% rate in the quarter as the People’s Bank continued to pump cash into China’s economy. New loans by Chinese banks climbed to 1370 billion yuan in March. Aggregate growth in new financing was more than double the rate in the fourth quarter.
In other words debt keeps piling up.
You can see that reflected in the drivers for GDP growth in the first quarter. Home sales, a beneficiary of easy money, were up 71% in March 2016 from March 2015. Government spending grew by 20.1% in March, according to the Ministry of Finance, even though revenue grew by just 7.%. Fixed-asset investment jumped 10.7% year over year. About 30% of new non-financial credit went to local governments and their associated investment arms, in the first quarter. Local governments are the most indebted part of China’s financial structure.
China’s most recent five-year plan, released in December, stated the need for deleveraging China’s local government and corporate sectors. But there’s nothing in this quarter’s data that shows any deleveraging.
Official figures say that only 1.6% of loans from China’s commercial banks are non-performing. Nobody believes the official numbers, however. Private estimates say the bad debt percentage could be as high as 20%.
So the big question on today’s growth number (if you assume for the moment that it bears some connection to reality) is whether it is sustainable given the falling economic efficiency of piling new debt on top of old and without the tough-to-implement reforms that China’s economy needs.
Most technical indicators say we’re in a bear market. Whether you want to call it a rolling bear, or a consolidation, or pick nits since the Standard & Poor’s 500 as a whole hasn’t yet hit the down 20% territory now inhabited by many of former market leaders. (The February 12 issue of James Stack’s InvesTech Research newsletter does a superb job of summarizing the technical indicators pointing to a bear market. To check out Stack’s newsletter and/or subscribe go to investech.com)
But so far economic indicators aren’t pointing to a U.S. recession. Job growth and income growth are healthy. Although the Institute for Supply Management’s survey of purchasing managers in the manufacturing sector has fallen below the 50 mark that indicates contraction in the sector, the survey for the services sector hangs above that mark, despite recent weakness. In the housing sector the confidence survey for the National Association of Home Builders hasn’t shown the downturn that usually proceeds a recession.
This is a good moment to remember Nobel-prize-winning economist Paul Samuelson’s quip that “The stock market has forecast nine of the last five recessions.”
Why is this important?
Stocks can certainly experience a bear market without a recession so the fact that the economy may not enter a recession isn’t some kind of proof that stocks aren’t actually in a bear or headed for one. (The S&P 500 is hanging around a drop of 13% or so in a bad week–not bear market territory–but 60% of S&P member stocks are 20% or more off their highs.)
But the worst bear markets in terms of percentage drop and in terms of duration require a coincident recession. If the U.S. isn’t going to slide into recession, the bear that is breathing down our necks right now will probably resemble a deeper version of the 12.4% drop from the May 21 high of 2130.82 on the S&P 500 to the August 25 low at 1867.61.
By November 2 the S&P 500 had climbed back to 2109.79. Painful certainly but not terribly long-lasting.
To get a really, really painful and long-lasting bear you need to combine a drop in stock prices with a recession as we did in 2007, 2000, and 1980. The 2007 bear–and the Great Recession–took stock prices down 56.8% and lasted for 517 days, according to Yardeni Research. The 2000 bear resulted in a 49.1% drop and lasted for 929 days. The 1980 bear took stocks down 27.1% and lasted 622 days.
Now that’s pain–and the duration of that pain was enough to test–if not wash out–even the most steel-nerved of investors.
So the big question for 2016–after the horrendous start to the year–is will we get a U.S. recession in 2016?
I wish I could confidently scoff and say “No way,” but I can’t. I think a U.S. recession in 2016 is unlikely–but it certainly isn’t impossible.
The economy, I’m afraid could go either way–although I think the odds are in favor of “No recession.”
As I noted above job growth is very solid and income growth actually looks like it is starting to pick up. Low oil prices mean low gas prices mean more dollars in consumers’ wallets for spending on things other than fuel. The U.S. auto industry set a sales record in 2015 and doesn’t look poised to fall off a cliff in 2016. After it’s best year in a decade in 2015, the U.S. housing industry is forecast to see 1% to 3% sales growth in 2016. That’s not a house on fire but growth isn’t recession. U.S. interest rates are low–and I think it’s likely that the Federal Reserve will pause its rate increases until it sees signs that U.S. growth is a solid 2% or so. Right now forecasts call for earnings growth to resume in the second half of 2016 as year-to-year comparisons with the slow growth of the second half of 2015 make beating estimates easier. That would have a big positive effect on CEO confidence levels. That’s important because worried CEOs fire people and don’t invest in their businesses. A modest increase in oil prices to, say $45 a barrel, would take pressure off some oil companies and reduce worry over banks’ exposure to bad loans in the energy sector.
That’s not a forecast for rip-snorting economy in the second half of 2016–but it is a picture of an economy that isn’t in recession.
Unfortunately, none of those positive trends or news items is a lock. China’s economy, despite the current round of stimulus, is likely to continue to slow. The U.S. economy doesn’t look like it will get any help from Japan and a EuroZone growth recovery is possible but questionable and won’t produce big numbers in any case. Developing economies and commodity-oriented economies such as Australia and Canada are likely to struggle. There is the possibility of a beggar-thy-neighbor round of currency devaluations that would further hurt U.S. exports. We’ve got weak governments coping with big problems in the EuroZone, the Middle East, Russia, and Japan. And I certainly would never rule out that U.S. politicians might be something stupid in an election year that might hurt U.S. growth. Nor can I absolutely rule out the possibility that the Fed got it wrong when it decided to raise interest rates in December.
It’s going to be hard to tell what the economic trend line is over the next few months because beginning in March we’re likely to see splashy moves from the central banks of the EuroZone, Japan, and China. I think all three of these central banks are signaling that they will move strongly in the early spring to stimulate their own economies. The likelihood is that will rally stock markets for a while but then leave markets open to a return to the crisis of confidence that I see in the financial markets right now. To my eyes a big part of the current slide in global stocks markets is due to investors and traders losing confidence in the ability of central banks to produce growth in their economies or to prop up the prices of financial assets for very long. That could see us return to the current malaise after the failure of a promising rally in the spring. That kind of volatility will make it very hard to find a longer-term trend worth hanging onto.
I guess you could color me “hopeful” that the U.S. will avoid a recession–which would help investors avoid the worst kind of bear market–but worried that a recession is possible and that financial markets having lost faith in central bank policies will wander lower.
As China’s leaders began the country’s annual Central Economic Work Conference today, December 18, a private survey modeled on the U.S. Federal Reserve’s regional Beige Book survey of economic activity showed that China’s economy continues to weaken.
The annual economic conference will set a goal for economic growth that will be announced at the spring meeting of China’s congress and determines policy steps to achieve that goal. China President Xi Jinping has said that China must grow GDP by an average of at least 6.5% a year over the next five years.
The Chinese Beige Book, published by CBB International, New York, reports data showing that reaching that goal is going to be very, very tough. In contrast to recent official Chinese government data indicating that the Chinese economy showed signs of stabilizing in November, the private Beige Book reports that national sales revenue, output, prices, hiring, borrowing and expenditure were all weaker in the third quarter than in the second quarter. Government data on industrial production, retail sales and fixed-asset investment all exceeded forecasts for November.
Maybe it’s just a difference in reporting period—third quarter ending in September vs. November–but reading the Beige Book it’s hard to imagine a big turnaround happening so quickly in such big chunks of such a huge economy. For example, the Beige Book showed that corporate profits continued in slide in the third quarter. The percentage of companies reporting profit increases slipped to the lowest level recorded. In the manufacturing and services sectors revenue, employment and profits all fell. (Retail and real estate held up reasonably well, CBB concluded.)
There are always leaks from this annual economic meeting and it will be interesting to hear what China’s policy makers are advocating to end the slowdown in economic growth. After all policy makers haven’t done nothing to fix the problem; it’s just that what they’ve done—such as six interest rate cuts since 2014—hasn’t worked. Particularly worrying is evidence in the Beige Book numbers that show evidence that deflation is taking hold in China’s economy—in spite of the interest rate cuts. Deflation hurts corporate profits since even companies that are selling more wind up selling at lower prices. And central banks intensely fear deflation since monetary tools have a tough time reversing embedded deflationary expectations. Just ask the Bank of Japan.
Those interest rate cuts haven’t succeeded in getting more companies to borrow in order to expand production or to buy more efficient machinery either. The percentage of companies borrowing fell to a record low in the third quarter.
The CBB Beige Book is based on surveys of more than 2,100 companies across China and interviews with bankers, managers, and company executives.
Inflation in China at the consumer level rose in October at just a 1.3% rate year over year. That, the National Bureau of Statistics said on Monday, was the lowest rate since May and well below the 1.6% rate in September. Economists had expected an increase of 1.5
A truckload of implications (or at least five) follows from this number.
First, combined with the disappointing showing on exports and imports in data released over the weekend, it reinforces forecasts of slow growth in the global economy. The fear of slow global growth has led to another day of declines in emerging markets. The iShares MSCI Emerging Markets Index ETF (EEM) was down another 0.38% on Monday.
Second, with inflation in China so low, the People’s Bank of China is relatively free to cut interest rates, reduce bank reserve requirements, and otherwise stimulate growth in the Chinese economy. I think the Chinese markets will start to anticipate some or all of those measures in fairly short order. (Think possible short-term rally.)
Third, with low or no inflation in the global economy, there isn’t anything that I can see that stands in the way of a stronger U.S. dollar. (The U.S. dollar, in fact, hit a six-month high against the euro on November 9).
Fourth, with a stronger dollar and lower global growth expect weaker commodity prices. Oil was up slightly today as of 3 p.m. in New York time after days of decline but copper was down 0.47%.
Fifth, a stronger dollar means more cash flowing into dollar assets, which is likely to damp increases in U.S. interest rates when/if the Federal Reserve moves. The yield on the 10-year U.S. Treasury held steady on Monday at 2.31%.
Update October 27, 2015. Despite China’s economy showing signs of slowing, revenue growth at Alibaba (BABA) blew through estimates for the second quarter of the company’s fiscal year. Wall Street analysts were looking for revenue to grow by 27% and instead Alibaba recorded 32% revenue growth.
Gross merchandise volume—the value of goods sold on all of the company’s platforms–rose by 28% year over year. Remember how some U.S. Internet companies have had trouble with the transition from a PC-centric Internet to one dominated by mobile platforms? No signs of that at Alibaba. Mobile platforms accounted for 62% of gross merchandise volume. Mobile revenue grew by 183% year over year. Annual active buyers increased by 386 million, a gain of 26% year over year.
Revenue in China grew so strongly that international sales as a percentage of revenue actually fell from 9% of total revenue to 8% in the quarter. Alibaba’s co-founder Jack Ma has said he wants to see international markets account for 50% of sales.
Newer businesses almost grew fast enough to make an impression on the top line. Cloud computing revenue, for example, was up 128%, but that still amounted to revenue of just $102 million off a very small base.
Yesterday when I recommended buying Alibaba’s ADRs at the end of the New York trading day, I said pay just enough attention to fundamentals to see that they aren’t going to stand in the way of the Alibaba momentum story. Fundamentals did much better than that today and that should leave momentum to run until at least the $95 level that the ADRs hit in June. After that it’s an issue of timing—do the ADRs hit $95 before or after the big Lunar New Year’s holiday, which could supply another momentum boost. (Lunar New Year falls on February 8 in 2016, the Year of the Monkey. People born in the Year of the Monkey are witty and intelligent with a magnetic personality.) I’d hold on for $95 or until the Lunar New Year, depending on Alibaba’s momentum after the big Single’s Day shopping holiday and the Western-style December shopping festivities.
The ADRs finished the day up 4.1% at $79.48 after trading as high as $82.79. That still leaves good overhead room to my $95 checkpoint. I’d watch momentum more than price (and certainly more than valuation) at this point.