China’s imports badly missed expectations Tuesday, rising just 11.8% y/y versus expectations of 18.0% y/y. Yet Chinese equities rallied.
Why the dichotomy? The answer may be in two parts. First, the reality may not be as bad as the headline number indicated. After all, commodity imports rose substantially by volume. Copper volumes led the way, rising to a new all-time record on the back of a whopping 48% y/y gain. Most analysts estimated the miss on import numbers was due to the faster-than-expected commodity price declines. It takes time for spot prices to filter through contracts, and it appears analysts underestimated the speed with which it occurred.
Still, both exports and import growth rates continued to decelerate, which brings us to the second—and more important—reason Chinese equities may have rallied. It’s likely inherently forward-looking equities care more about the outlook than the recent past. And China can’t afford a recession. With its authoritarian government structure, a recession breeds social instability and revolt. With no ability to vote, protests are the only way for the people to express their displeasure.
Therefore, the more its economy slows, the more stimulus China likely needs to add to maintain economic growth. This is primarily done by expanding loan growth, which is closely controlled with loan quotas. Much-higher-than-expected December loan growth and the first acceleration in loan growth rates since November 2010 seemingly further illustrate this. Additionally, since September China has cut income taxes and oil production taxes, raised power prices while limiting coal prices (incentivizing energy production), cut banks’ reserve requirements, delayed the implementation of Basel’s stricter bank regulations and approved local governments to extend the maturity of bad debt. Not bad for a few months’ work.
Importantly, China’s equity markets historically tend to track these domestic loan growth cycles, outperforming Emerging Markets when loan growth accelerates and underperforming when it decelerates. Therefore, with money supply growth rates appearing near a cyclical trough and most signs pointing towards a reacceleration, the outlook for Chinese equities appears bright.
Exhibit 1: China Money Supply Near Cyclical Low
Source: Thomson Reuters.
Exhibit 2: China Loan Growth Vs. Relative Performance
Source: Thomson Reuters.
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