Fisher Investments on China's Tightening and the Long-Feared Hard Landing

2017 has had a lot going on, but until recently, one thing had been missing: China hard landing fears. They've taken center stage annually during this bull market, but all was quiet on the China front earlier this year as GDP growth beat expectations and capital markets didn't do anything wacky.

But now, this is changing. First, April economic data disappointed as credit tightened, sparking fears China can't have it both ways. Then the folks at MSCI, who are weighing whether to include mainland Chinese stocks in Emerging Markets benchmarks this year, gave the country's capital markets low marks.

Next, in late May, credit ratings firm Moody's downgraded Chinese debt for the first time since 1989. With that backdrop, color us unsurprised to find a June 13 survey of fund managers cited Chinese monetary policy as the biggest lurking risk to global stocks -- for the second straight month. But despite all this noise, in our view, there aren't new, material, negative fundamental changes in China -- the hard landing is unlikely as ever.

Those widely bemoaned April numbers did show decent growth, but industrial production (6.5% y/y), retail sales (10.7% y/y) and fixed investment (8.9% year-to-date compared with the same period in 2016) all slowed. The likely culprit: the government's efforts to curb junky debt, which include interest rate hikes, a crackdown on refinancing distressed debt and new curbs on opaque high-yielding debt investments. Meanwhile, the MSCI China A Index -- which tracks most mainland stocks -- slid 7.5% from early April to early May,[i] a mini-correction some interpret as an early sign the economy can't take the pressure.

Despite the slowdown, we don't think April's data should ring alarm bells. As Exhibits 1 - 3 show, industrial production, fixed investment and retail sales growth rates have zig-zagged lower for years. April's figures actually exceed most 2016-2017 figures. Monthly data volatility is normal.

Exhibit 1: April in Perspective - Retail Sales

 

Source: FactSet and National Bureau of Statistics of China, as of 6/13/2017. China Retail Sales, January 2011 - April 2017. January - February figures combined to remove Lunar New Year skew.

Exhibit 2: April in Perspective - Industrial Production

Source: FactSet and National Bureau of Statistics of China, as of 6/13/2017. China Industrial Production, January 2011 - April 2017. January - February figures combined to remove Lunar New Year skew.

Exhibit 3: April in Perspective - Fixed Asset Investment

Source: FactSet and National Bureau of Statistics of China, as of 6/13/2017. China Fixed Asset Investment, January 2011 - April 2017.

That said, there is some evidence the government's efforts to reduce financial sector risk are having an effect. Borrowing costs are up, debt issuance is down, and banks are issuing fewer wealth management products -- risky, high-yielding alternatives to traditional deposits. All are efforts to combat the issues Moody's highlighted last month -- overrated fears, in our view, though it is fair to say China's efforts to stoke growth in years past carried some side effects like supply gluts and a build-up of municipal debt.

These are manageable, however, and industrial production's lengthy slowdown is a testament to that. If the government's assault on easy credit is knocking output somewhat now, it wouldn't surprise. Sometimes, the impact is deliberate. This is the same government that blew up blast furnaces in 2014 to battle a steel supply glut, demonstrating its willingness to inflict collateral damage in the name of longer-term stability. Small pinches like this are normal for China and don't mean a hard landing is in store.

Even with the crackdown and slower growth, China is still, you know, growing, and officials have plenty of wiggle room to keep it that way. There are some signs they've already started loosening the spigots to ensure growth stays steady heading into the Communist Party's November leadership shuffle, including a big liquidity infusion in May. Vast foreign currency reserves -- which have increased sequentially the last four months straight -- provide further firepower. This might sound like kicking the can, but China has always had the ability to withstand some corporate and municipal defaults. It just hasn't wanted to. Should that change, markets might welcome a less interventionist approach as an important step in China's long-term evolution.

[i] Source: FactSet, as of 5/24/2017. MSCI China A Index (in yuan) with gross dividends, 4/11/2017 - 5/10/2017.

Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.

The content contained in this article represents only the opinions and viewpoints of Fisher Investments editorial staff. It should not be regarded as personalized financial advice and no assurances are made the firm will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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