International Horizons – China in 2015
A slowing economy, falling inflation and concerns over policy maker’s ability to meet their growth target forced the Chinese central bank into action for the first time in 2 ½ years in November 2014.
The bank cut both the deposit rate and the lending rate by 25 bp and 40 bp respectively, delivering a boost to Chinese equity markets and commodity prices.
The central bank action of 2014 preceded January’s Q4 GDP figures, which indicated that the pace of the slowdown in China moderated during the fourth quarter, although policy makers missed their growth target of 7.5% as actual growth for the year is likely to have been closer to 7.4%.
Looking ahead, investors across the globe are wondering what the current year will bring for both the Chinese economy as well as for Chinese equity markets.
Below we explain why our outlook remains biased toward positive for equity markets, while our expectations for the economy continue to suggest softer growth during the year ahead.
The year ahead in China – 2015 Outlook
While rate cuts from the central bank may still have a moderate effect upon the pace of slowdown during Q1, consensus expectations suggest that the bank may be forced to act again in 2015 as the economy slows further during the year.
If this happens, the effect upon equity markets in China would most likely be positive as investors seek returns outside of the realm of fixed interest securities.
This could add further to the effects of moves taken by policy makers last year to begin liberalising access to Chinese shares. (See Shanghai – Hong Kong Stock Connect) .
The mutual access scheme, or Shanghai – Hong Kong stock connect, reignited local bids on Chinese A shares in H2 of 2014, before driving a greater influx of foreign capital toward the close of the year. As a result the Shanghai Composite Index has gained 65.49% during the last twelve months alone.
On balance we are sceptical of the chances for a repeat performance of 2014 success in 2015, although we do see stabilising economic data and steady bid from international investors, via Hong Kong, over the coming quarters as providing scope for the index to hold onto much of its recent gains throughout the year.
Looking ahead we see more flex in Chinese rates, which for a slowing economy, remain relatively high. While the economy will most likely slow further during 2015, this additional flex should enable the central bank to contain the worst of the fallout with further rate cuts and targeted stimulus.
For this reason we are less concerned over the Chinese economy today than we were six month ago. However, the financial system, as well as corporate & institutional balance sheets, remain opaque and this poses a risk to investors for two reasons.
First and foremost, as the economy slows further it is possible that loan delinquencies will increase in volume, which could prompt further defaults and insolvencies. While the Chinese government will likely resolve to intervene in order to shore up local confidence in the system under such a scenario, there could be some spillover here into international markets.
This would most likely be in the form of a market panic over the potential for a shock to global confidence, contagion of unstable conditions or some form of credit crunch, that could lead to fears of a Chinese financial crisis.
Secondly, further reductions to interest rates could lead to further adverse outcomes in the property market and among institutional balance sheets. While this would likely be a longer term factor, China has struggled to contain property price rises in many urban areas for a quite some time now.
The interest rate trajectory could give false hope to property investors and lead to overinvestment in an area where returns are likely to be low or negative for the foreseeable future. Not only is this an unproductive or wasteful practice for the economy, but it could also help to build further risk in the financial system over the medium term.
As a result, while risks have diminished marginally throughout recent weeks, potential for a hard landing in China still exists. For this reason, it is a 2015 risk that must also be acknowledged by investors.
SSE Composite Index 2014
SSE Composite Index / Weekly Intervals
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