China’s Great Expectations

Will slower growth from China be an obstacle for the bull? Source: Lintao Zhang/Getty Images.

Another month, another sign of a deepening economic slowdown for China—at least according to the most recent data. With April officially the latest lackluster month, China watchers fear the country may miss its economic growth target of 7.5-ish% for the first time in 15 years. Now, considering the target has long been the minimum acceptable growth rate, this probably sounds bad. Yet stocks don’t have much reason to fuss over whether one country—even as big as China—hits an arbitrary growth target. Moreover, markets have been well aware of China’s slowing growth for over three years. When something is widely discussed for so long, its ability to rattle a bull market is typically small.

If this is your first time digging into China’s slowdown, we can understand if you’re a bit perplexed: By most rational standards, China’s April data look just fine, if not pretty grand. Year-over-year, retail sales were up +11.9%, industrial production rose +8.7% and fixed asset investment gained +17.3%. These are eye-poppingly big numbers! Problem is, they’re all down from March’s data, which were widely (and rightly) regarded as a slowdown.

Then you add in some less lovely numbers, like the +0.9% and +0.8% y/y growth in exports and imports, respectively. While the trade data are a rebound from a rough March, and the exports are impressive when you consider last April’s numbers were inflated by all the shady players who filed false customs bills to bring money into the country illegally, it’s way down from even last year. And when you consider banks made new loans of about 775 billion yuan and “total social financing”—a broader measure of lending that includes bank loans, bonds and “shadow bank” lending—came in at 1.55 trillion yuan, compared to 1.05 trillion yuan and 2.09 trillion yuan in March, respectively. That compares with 793 billion yuan and 1.75 trillion yuan a year ago. China was already getting less growth out of new lending, and now lending is slowing down? We can see why folks would call that a red flag.

If you’re now mentally reciting the opening salvo to A Tale of Two Cities, we don’t blame you: As impressive as April’s numbers might sound in any other country, this is China—the land where double-digit growth has been a rite of passage in recent years. As a result, many fear China’s “hard landing” is finally here.

In our view, there just isn’t any reason to believe those hard-landing fears are any more valid than they were in 2011, 2012 or 2013. Yes, China slowed each of those years, with GDP growing 9.2% in 2011, 7.8% in 2012 and 7.7% in 2013. But it has been a gradual slowing, not a sudden drop to 3-4% (or worse). Based on what we’ve seen so far—and based on the continued, steady rise in China’s Leading Economic Index, the most likely outcome in 2014 is just a continuation of that gradually slowing trend. The same old thing headlines have hashed and rehashed for years now.

What matters more than China’s growth rate is the sheer amount, in dollars, it contributes to global demand. Even as China has slowed, its contributions have gone up since it has been growing off an increasingly larger base. Consider the following hypothetical using small numbers for simplicity: If a country with GDP of $100 grows 14% in one year, it contributes $14 to global GDP. But if an economy of $1000 grows at half that rate, at 7%, it contributes $70—five times more than the smaller country. And as the world’s second largest economy, even a “slower” growth rate means a huge contribution from China to global GDP. In 2012, China’s contributions to global GDP increased by roughly $327 billion and $340 billion in 2013—that’s a lot of fuel for overall global growth.^[i]

Why China is slowing is also important. It’s not because the country is losing steam or hitting the proverbial “middle income trap”—the driver behind most hard-landing fears. It’s because China’s Communist Party is making it slow. To keep the social harmony—and maintain their stranglehold on power—officials know the economy has to grow fast enough to create a certain amount of jobs and wealth. For years, this meant relying on an export- and investment-based economy to drive growth and capturing the low-hanging fruit of urbanization and industrialization. Now, with the workforce starting to shrink due to the one-child rule, labor costs are going up, so they need a new, more sustainable engine. So officials have started making incremental shifts to a more consumption- and service-based economy—those slumps in industrial output and fixed investment are deliberate.

But deliberate as the slowdown may be, it may make the masses antsy—a prospect the government wants to avoid. While frequently announcing they’re ok with slower economic growth in the name of longer-term progress, the government hasn’t completely removed its support. Officials have every incentive to ensure growth remains steady, and they’ve implemented various targeted stimulus measures. These include increasing spending on public projects like railways and low-income housing, reducing reserve requirements for rural banks—freeing up more capital for them to lend—and cutting taxes for small businesses. On the heels of April’s data, they eased mortgage requirements for first-time buyers and told banks to step on it. If slowdown signs persist, they’ll probably do whatever they think is necessary to keep growth from falling too far below the fuzzy target. Officials have said point blank they won’t resort to sweeping stimulus packages on par with 2008-2009, but there just isn’t any indication they’d need to.

Surprises move markets most. Considering China’s growth has been slowing for the past three years—accompanied by three years’ of (false) fears of a hard landing—the latest slowdown is the opposite of a surprise. Even if China ends the year slightly below its projected “around” 7.5% annual growth rate—far from certain one-third of the way through the year—markets have long since dealt with the implications of a slower-growing China. What matters more for global investors is that the Middle Kingdom remains a huge contributor to overall global growth. As this is highly unlikely to change over the next 12-18 months, China likely aids, not hinders, the global bull.