Market Analysis

Reading Chinese Tea Leaves

Bifurcated sentiment about China’s economic present and future speaks largely to overall sentiment in 2011—but how to read the tea leaves when truly assessing China?

  • Many recognize China’s been a contributor to global economic growth over the past few years—and 2011 thus far.
  • But sentiment surrounding where China goes from here is bifurcated, much like overall economic sentiment.
  • Both the bullish and bearish camps find news stories to support their views.
  • At the end of the day, though, the truth likely lies somewhere in the middle.

Many realize China’s economic growth has been a contributor to demand (and therefore global economic growth) over the past few years. And to date, 2011 has been no exception. But the significant contribution their fast growth has provided globally has also given rise to bifurcated sentiment exemplifying our view of market sentiment more generally in 2011. Some are bullish on Chinese growth (rightly, in our view) and extrapolate that to extreme bullishness on Chinese equities (wrongly, in our view). Others fear overheating, bad lending and the downstream global effects of a potential slowdown in the Middle Kingdom.

Recent news has fit in nicely with the seemingly schizophrenic reaction typical when discussing China. For example, the bearish China camp cites headlines like bad Chinese regional government debt hitting banks . Earlier this week, China Merchant Bank became the most recent (and largest this year) to announce a recapitalization, indicating Tuesday it would issue rights to raise up to 35 billion yuan (~$5.4 billion). Several other smaller recapitalizations have also been announced this year. But as we’ve said, Chinese recapitalizations are hardly new. Nor need they roil markets excessively.

Folks have also been concerned China would batten down the hatches excessively in an attempt to rein in inflation. And Thursday, the HSBC/Markit China Manufacturing PMI dipped below 50 points (contractionary). Some immediately grabbed onto this as a negative macroeconomic sign of the future. While it’s true a contractionary PMI figure isn’t good, it’s also only for one month and one segment of China’s economy—and a very similar contractionary PMI figure occurred in July last year. (Reacceleration followed.)

The bullish China camp cites broader economic data—like the fact China’s taken numerous steps to counter inflation and yet its growth rate remains robust. IMF estimates indicate it’s likely to remain so moving forward, and we agree. But some stretch this point to be mega-bullish about Chinese stocks in the here and now—which we think is overstating the case. While China’s economy seems poised to continue as a global economic tailwind, it’s not a straight line from GDP to stock returns (as we illustrate here)—a reason to be carefully selective if you choose to invest in Chinese equities. Some even reference valuations as cheap—but fail to note heightened IPO activity and slowing loan growth (two primary drivers of China’s equity market).

Within both camps are grains of truth. China’s growth will require greater financial liberalization—a potential problem for the still-communist country—though they’ve begun to take small steps in that direction. Ultimately, this fast-growing country with GDP per capita that ranks #126 globally has a long way to go to reach developed world status—both in wealth and financial reforms. But it seems to us the rapid road higher China’s economy has taken is likely to continue through 2011 and possibly beyond. And we think there are worthwhile opportunities to be found in China—as in most EMs—but our optimism on Chinese stocks is more guarded and selective.

If you would like to contact the editors responsible for this article, please click here.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.