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2012: The Year Ahead– Investors in China pin hopes on slowing inflation and rate cuts

2012: The Year Ahead– Investors in China pin hopes on slowing inflation and rate cuts Ian Fraser

China faces some severe challenges in 2012. They include wage inflation which is undermining its economic model, the delicate task of popping a property price bubble without bringing down the whole economy, inadequate macro-prudential oversight, and a growing suspicion about widespread corporate fraud and weak governance.

There is also the delicate matter of the country’s massive bad-debt overhang. While the monetary easing that is widely anticipated this year should provide some relief, analysts at Societe Generale believe that Beijing has basically lost control of the country's financial system thanks to the topsy-like growth of shadow banking in the Middle Kingdom.

These sorts of issues are music to the ears of the Sino-bears, who include hedge fund players such as Kynikos Associates’ Jim Chanos and Ecletica’s Hugh Hendry. Chanos and Hendry are so confident that China’s great experiment with 21st century capitalism will end in tears (as many do should GDP growth fall below 6% p.a.) that they have found astute ways of shorting the Chinese market, including buying the CDS of companies that are major exporters to mainland China.

One of the main negatives for China, as highlighted in QFINANCE's recent emerging markets 2012 blog is the absence of full decoupling.

Basically China’s economy remains highly dependent on the export of cheaply produced manufactured goods to the developed world. However, with developed markets still in detox, learning to live with a zombiefied banking sector and with massive deleveraging underway, demand in these territories is likely to be muted (which is of course bad news for Chinese exporters). It's as if the China express has coupled itself to a powerful brake-wagon. Andrew Gillan, manager of the Edinburgh Dragon Trust, puts it like this:

"It has become clear that almost nowhere is immune from the debt problems in Europe and the US. Until real progress is made by politicians in the West, Asian markets including China could will remain weak …. Battered export markets make China’s slowdown worse. While Beijing has room to stimulate if need be, the climate for earnings has worsened and mainland valuations are not compelling.”

Writing on the FT’s Beyond Brics, Credit Suisse’s chief regional economist Dong Tao said:

“I do not expect a hard landing in China. Despite a slowdown in exports and weaker fixed asset investment, private consumption is holding up too well … But I do believe that China is going to grow more slowly than before – and for a longer period than was previously expected.”

Tao has cut his forecast for Chinese GDP growth to 8% for 2012, down from an actual 9% in 2011, and said that growth in exports will slow to 6.9% in 2012, a significant slowdown on the rip-roaring 17% export growth of the previous year.

However despite all the above, and despite dire equity market performance in 2011 (China's Shanghai Composite index fell by 22% in the year to December 31), most long-only investors are upbeat about prospects for the world’s biggest economy. So are they delusional, or is just because they have units to sell?

The commonly held view among long-only investorS is that, as and when inflation falls and the central bank eases interest rates, Chinese growth will pick up again and the country will avoid a hard landing. Zhang Han, a strategist at Guotai Junan Securities, predicts that the Shanghai Composite Index (SHCOMP) will gain 36% in 2012 as a result of slowing inflation which will permit policymakers to cut interest rates and bank reserves.

Fidelity president of investment Anthony Bolton, who launched the group's China special situations fund in April 2010 predicts a major rebound in Chinese equities:

“What I see is very attractive valuations today in China against history. It will become apparent in the next 12 months that the house of cards view of China that some international investors have is going to be wrong. That will lead to quite a reassessment of the international views on China.”

Mark Mobius chairman of Templeton Emerging Markets, is so confident of a rebound that he has increased the weighting of Chinese equities in his flagship emerging markets fund by five percentage point to 27%. He believes the emergence of the renminbi as a reserve currency alongside the dollar and the yen will boost China’s fortunes. Mobius said:

“In January 2011, China started allowing its domestic companies to use the renminbi for overseas investments. That was regarded as the next step in a series of measures that China has put in place to internationalise the renminbi. It’s very possible that the renminbi could become a global reserve currency by 2020.”

Andy Beal, manager of the Henderson TR Pacific Investment Trust, also believes talk of Sino-Armageddon is wide of the mark.

“There are undoubtedly some significant structural issues facing the economy [but] we expect steady progress to address these and believe the government retains significant fiscal and monetary fire power to move aggressively to protect the economy from the impact of the eurozone crisis or a weaker US economy.”

In a recent blog post Tony Levene of Mindful Money highlighted the longer-term factors that should underpin Chinese growth. He quoted Schroders fund manager King Fuei Lee as saying:

“while fears of a cyclical slowdown in China may put many investors off the region, the reality is that the bigger picture trend of stronger economic growth driven by urbanisation, industrialisation and positive demographics will continue to unfold across Asia over the next two decades.”

King Fuei Lee urges investors to put aside short-term obsession with share price gains and focus instead on the fact that almost two-thirds of long-term equity returns in Asia comes from dividends.

The Sino bears, including Pedro de Noronha, managing partner at London-based hedge fund firm Noster Capital, certainly make a very credible case for imminent economic collapse in China. When you weigh up the ursines case versus that of the bovines, it  makes you wonder if it is the latter who are clutching at straws.

Further reading on the outlook for China and the outlook for the Chinese economy:

Tags: Andy Beal , Anthony Bolton , Beyond Brics , China , china future , China housing bubble , china property bubble , China Real Estate Bubble , Dong Tao , Eclectica , Fidelity , Fidelity China Special Situations , Guotai Junan Securities , hedge funds , Henderson , Hugh Hendry , Jim Chanos , King Fuei Lee , Mark Mobius , Noster Capital , Pedro de Noronha , SHCOMP , Sociéte Générale , Tony Levene , Zhang Han
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