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Major Transitions Are Taking Place in China

Last update on: Jul 19 2021

China deserves a lot of investors’ attention these days.

China would be important at any time because it’s the world’s second-largest economy. However, China’s recent weakness and unique problems make it an important subject.

Right now, there are major transitions taking place in China. It has too much debt, both public and private. The government is taking actions to reduce total debt and to limit new debt for anything that is considered an inefficient project.

There are a lot of inefficiencies in the economy. Some inefficiencies result from China’s communist heritage and long-term practice of sustaining businesses and government entities so that people would have jobs. Government policies also favored real estate investment using a lot of debt.

Other inefficiencies result from the massive stimulus package the country put in place at the depths of the global financial crisis in 2008. In another transition, the country is trying to shift from an export-led economy to a domestic, consumer-led economy. That requires changes in existing businesses and an increase in the middle class.

All of the above changes are significant and important transitions in the country’s economy. However, what seems more important now is the unresolved trade conflict with the United States. This trade clash is likely to lead to significant changes, though it isn’t clear what those will be.

The Trump administration is determined to reform the way China exports goods to the United States, perhaps limiting those exports. It also wants to change the way China and Chinese companies deal with U.S. corporations that want to invest in or sell in the country. There are allegations of Chinese entities spying, stealing intellectual property and pursuing other nefarious practices that the United States’ leaders wants curtailed, or preferably eliminated.

The main mechanisms to bring about this change so far are tariffs and other trade restrictions. The Trump administration’s actions have had immediate effects on China’s economy and markets.

China’s stock markets have suffered. Xtrackers Harvest CSI 300 China A-Shares (ASHR), a major exchange-traded fund (ETF) holding Chinese stocks, is down almost 25% for 2018. It also is down about 7.5% in October.

The yuan, China’s currency, also is taking a beating this year. Some analysts believe the country is deliberately allowing the currency to decline to offset the effects of U.S. tariffs. Other reports say the yuan is declining because of economic forces. The country is spending from its reserves to keep the yuan from falling even more than it has so far.

We’ve also seen economic growth in China slow. To be clear, the country isn’t in a recession or near a recession, but the red-hot growth rates of 10% and higher of only a few years ago now seem to be settling around 6-7%. Slower growth requires repricing of assets.

China’s stock indexes appear to be inexpensive, especially when compared to U.S. valuations. However, current valuation levels are around average for China — not cheap.

The trade conflicts undoubtedly will keep a lid on China’s growth and its equity prices. If there’s some kind of agreement between the two countries soon, that would likely cause a surge in Chinese equities. There was a brief rise in China’s equities last spring when it seemed the United States was de-escalating the conflict, but the rally was short-lived.

A continuation of the current conflict or an escalation (which looks like the most likely outcome) probably would cause China’s equities to decline further. Even if the trade conflicts are resolved or downgraded, China still has to deal with the other transitions it is undergoing.

The Data

New York-area manufacturers continue to be optimistic, according to the Empire State Manufacturing Survey. The index increased to 21.1 from 19.1. New orders and shipments increased, as did the prices of inputs.

Industrial Production increased 0.3% for the month, which is consistent with the previous two months. It increased 5.1% over 12 months. Business equipment increased a healthy 0.8% for the month.

Retail sales for the latest month were disappointing. September sales increased only 0.1%, following a 0.1% increase in August. Over 12 months, retail sales have increased 4.7%. Excluding motor vehicles and gasoline, sales were flat for the month and are up 5.0% over 12 months.

Consumer Sentiment, as measured by the University of Michigan, declined slightly to 99.0 from 100.1. The level still is very high. The average reading for 2018 is 98.5. Confidence in the government’s economic policies is the highest in 15 years, according to the survey.

The job market is robust, according to the JOLTS (Job Openings and Labor Turnover Survey) report. Job openings reached a record 7.1 million. For the fifth-consecutive month, job openings exceeded the number of those unemployed. New job openings also exceeded the number of new hires, which has been the case since January 2015. The rate at which workers quit their jobs remained at 2.4%. The layoff and discharge rate remained about the same at 1.2%.

The Housing Market Index from the National Association of Home Builders (NAHB) increased to 68 from 67. That’s consistent with where the index has been since June, but below the recent high of 74 reached in December 2017. Builders say demand is strong and lumber prices have declined for three months. The biggest obstacle, according to the home builders, is reduced affordability due to higher interest rates and rising costs.

Despite the optimism from builders, housing starts and permits came in below expectations. Starts were down 5.3% for the month and are up 3.7% over 12 months. Single-family home starts are up 4.8% over 12 months. Building permits were down 0.6% for the month and were at the lowest level since last November. They’re down 1.0% over 12 months.

The Markets

The S&P 500 gained 0.77% for the week ended with Wednesday’s close. The Dow Jones Industrial Average rose 0.36%. The Russell 2000 returned 0.89%. The All-Country World Index increased 0.69%. Emerging market equities rose 2.07%.

Long-term treasuries returned 0.45% for the week. Investment-grade bonds added 0.01%. Treasury Inflation-Protected Securities (TIPS) lost 0.16%. High-yield bonds rose 0.69%.

On the currency front, the dollar rose 0.08%.

Energy-based commodities declined 1.49% for the week. Broader-based commodities rose 0.87%. Gold returned 2.45%.

Bob’s News & Updates

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