Keeping an Eye on China
- China is the world’s second largest economy after they had their own industrial revolution.
- The economy is run by the government through their “5-Year Plans.”
- Chinese stocks may be signaling a slowdown in the economy, which could put the global economy in trouble.
- The Renminbi is weakening, which is likely a trade war tactic by the Chinese government.
An Introduction to the Chinese Economy
China is unique compared to the rest of the world’s top economies. It boasts the highest population, the second largest economy, and it is a command economy. Their economy is run by the government, and they have been in charge since 1949.
A command economy needs to be planned by the government. In a capitalist economy, market forces determine what products and ideas fail, and which succeed. In China, the direction of the economy is determined by the heads of the communist party, and they build what is called the 5-Year Plan.
How China Became a Giant
Around 1980, Chinese manufacturing began to take off. They had a modern day industrial revolution which made China the manufacturing powerhouse it is today.
There are many possible reasons why China has become the economic force it is today, so fast. Cheap labor, the rise of efficient shipping, and favorable trade deals have all attributed to the Chinese economic gorwth. Today, China’s is the worlds largest manufacturer, and exporter.
Though the economy relies heavily on manufacturing, that is not the only place where growth is taking place. During this economic boom, China has slowly shifted from a poor rural population into an urban population.
Through the years, China has accumulated lots of debt to build the infrastructure necessary for a modern economy. With manufacturing bringing people out of poverty, and the government spending on infrastructure, Chinese GDP grew at 10% a year for 3 decades.
However, debt created growth is not sustainable, and China has directives in their latest 5-Year Plan to deleverage, and strengthen the economy for the future.
Today, China is in their 13th 5-Year Plan (2016-2020). “This 80-chapter, more than 60,000-character document seeks to address China’s ‘unbalanced, uncoordinated, and unsustainable growth’ and create a ‘moderately prosperous society in all respects’ through innovative, coordinated, green, open, and inclusive growth.” (Source)
The communist party is committed to adjusting the economy to be sustainable and efficient. The first thing they are addressing is over-leveraging, and shadow banking. This is likely to hurt over the short-term, but in the long-run, it should help grow a stronger, more efficient economy.
China’s Stock Market
There are two stock markets in China, The Shanghai Stock Exchange, and the Shenzhen Stock Exchange.
The troubles in Chinese stocks began in August of 2015. The prior year, stocks grew almost 180%. After such a quick rise, the index inevitably lost 50%. In 2016, the Shanghai index tried to make a recovery, and it rose about 37% over two years. The Shenzhen Index remained relatively flat.
Now, the two indices have broken to bearish levels, and their is likely to be future stock weakness. This could be a signal of a weakening economy.
Already, Chinese indicators are starting to show some sluggish growth, and some economists are predicting GDP growth under 6.5%. A slowdown in China could hurt the global economy.
The Trade War
A slowdown in the Chinese economy could be coming at a bad time, considering the trade war with the U.S. As the world’s largest exporter, China relies heavily on exports to the U.S. A trade war with the U.S. is going to hurt their top industry in their top market.
However, they are setting up their markets to help ease the pain of tariffs. Most notably, they are letting their currency plunge.
A weak currency relative to the U.S. Dollar, or any currency, makes domestic goods more competitive. Also, businesses that export to China, lose revenue. This is because they sell the goods in the weak currency and exchange the revenue back to the strong currency.
All things being equal, companies either lose revenue because they have to keep prices the same, so they get less when they exchange the revenue, or they lose revenue because they raise prices to maintain their margins, but end up selling less because of supply and demand.
This gives them a negotiation tool, and a trade war tool. If Trump and China decide to continue the trade war, they can continue to let their currency depreciate.
This makes them more competitive domestically, and it will likely hurt U.S. exporters. Otherwise, they can use the depreciation as part of a negotiation, where they can prop up the currency in exchange for less tariffs.
What U.S. Investors Should Watch
China is a global powerhouse, and without their strength during the Financial Crisis, the world economy could still be in shambles. Now that China is focusing on sustainable, long-term growth, their economy is likely to slowdown, and it could mean trouble for the global economy. Industrial commodities such as concrete, steel, and copper, could take a hit if China demands less.
Investors also need to watch their emerging markets holdings. China makes up about 30% of the MSCI Emerging Markets Index. As we have seen in the charts above, Chinese stocks are struggling this year, and they are a drag on emerging market holdings. If Chinese stocks keep falling, we may see emerging market funds struggle too.
Lastly, the most important thing to watch could be the trade war. China is a big market to U.S. companies, and the depreciating Renminbi, tariffs, and weakening economy can all play big roles in large cap stock balance sheets.
We should expect a slowdown, or at least weakness, in the Chinese economy. Their current 5-Year Plan is trying to clean up the economy as it deleverages debt, and focuses on sustainability and economic inclusion. Chinese stocks may be showing similar sentiment.
A trade war could exasperate the slowdown, but they are not going down without a fight. This could be seen by the lack of intervention in their currency. A weak currency will hurt U.S. exporters to China, and this can be used as a negotiation tool.
However, a slowdown in China, is not likely to be contained. It could spread to other economies, and ultimately, it could cause a global slow-down. U.S. investors need to pay attention to China and the trade war to fully understand the risks for companies that rely on Chinese consumers for growth.
Read the blog with charts here: www.brtechnicals.com/analyzing-the-chinese-financial-markets/