The Week In Hindsight, 14 March 2014

Heavy downgrades to Chinese growth expectations overnight on Thursday helped drive European markets lower at the open on Friday, along with some concerning statements made by the nation’s Premier Li Keqiang.

JP Morgan and Bank of America Merryl Lynch both announced lower forecasts for Chinese 2014 GDP, each revising estimates from 7.5% down to 7.2%. This was while the more bullish UBS reduced expectations for GDP of 7.8% down to 7.5%. In addition to this, the Chinese Premier also roused concern among investors by saying that further defaults of bond issuers over 2014 were inevitable.

This sour sentiment was later echoed by Nomura’s head of rates trading who stated, in interview, that default risk was highest among corporate businesses and local government issuers. The cost of Credit Default Swaps (Insurance) on Chinese central government bonds has also risen this year to 99 basis points, up from 63 basis points in January and representing an increase of 52%. Despite this, many analysts continue to hold a bullish outlook for Chinese equities.

Given that concerns over financial stability are likely to remain a focal issue, both in and away from China; the outlook for over leveraged companies who require new credit in order to remain afloat is not favourable. This is as the pace of credit creation is likely to slow at a faster rate than the current slowdown in the economy, adding weight to various forecasts that defaults will increase over the year. The direct implications of this to other firms is difficult to predict individually however, they are clearly not positive for the commercial environment as a whole, in the near term at least.

For these reasons, our overall outlook for China, once again, continues to remain in place and unchanged. Although it is likely that some CNY equities will perform well over 2014, for us, the risks continue to outweigh the potential gains and for this reason we believe price action is best observed from a safe distance.

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