China’s third quarter growth rate has fallen to 6%, says Beijing. No it hasn’t. It’s more like 3%, says Morningstar’s China economics team led by Preston Caldwell in a report dated October 29.
While Donald Trump and his economic advisor Larry Kudlow try to convince Wall Street today that trade talks are going well and the two sides will still ink their so-called Phase 1 mini-deal this year, investors are noticing something awry in China. Companies are sourcing product elsewhere in modest, yet increasing numbers. China’s usual high fixed asset investment numbers are falling. Economic policy makers could be afraid of debt burdens and don’t want to overstimulate the economy. Growth is slowing. Industrial production is contracting.
To make matters worse, the full brunt of tariffs hasn’t quite been felt fully by China. The average incremental tariff rate increased to about 12% in the third quarter from about 9% in the second quarter. If Phase 1 talks result in no signed agreement anytime soon, Morningstar predicts it would send the average U.S. tariff rate on Chinese imports to over 20% by the first quarter of 2020.
The dollar/yuan exchange rate has helped offset some of the tariff costs. The yuan has weakened by about 5% since the end of the first quarter. For exporters, China is still cheap.
The bulk of the third quarter decline was due to the consumer durables index component of the Morningstar proxy for measuring GDP. It contracted 4.1% from 3.8% growth in the second quarter. Morningstar analysts believe there is a chance that the locals may be temporarily pulling back on spending in anticipation for new government subsidies. Still, slowing durables consumption matches the trend in place since early 2017. And stimulus has been trickling in since.
Two of the other Morningstar proxy components that brought them to the 3% figure also saw a marked decline in the third quarter. Their power proxy index is now in line with the other index components after being a positive growth outlier for about two years.
But it appears the real drag that brought Morningstar’s number down to 3% is industrial production. Industrial profits are down 5.3% year over year versus August’s contraction of 2%.
“Neither a surprise nor a market mover,” says Brendan Ahern, CIO of KraneShares in New York. “U.S. tariffs are still exacting their toll on export-focused manufacturers.”
The industrial sector slowdown might also be understated, especially if China is over-estimating inflation, Morningstar report authors warned.
Meanwhile, China’s dependence on credit to sustain economic growth has so far thwarted Xi Jinping’s attempts to convince the provincial governments to deleverage. Debt growth remains above nominal GDP growth rates.
“We’re not surprised that China’s economy has failed to recover, given that credit growth stalled after a slight rebound in the first quarter,” Morningstar analysts wrote.
China-bound investors will be watching for solid Singles Day sales on November 11. If they disappoint, emerging market funds who are mostly overweight China could finally start shifting positions.
China’s A-shares have been outperforming the MSCI Emerging Markets Index all year. Only Russia, as measured by the VanEck Russia (RSX) exchange traded fund, is beating the CSI-300, an index tracking mainland China equities listed on Shanghai and Shenzhen exchanges.
Official consumer spending showed a mixed picture in the third quarter. Nominal retail sales grew 7.8% year over year in September versus a high of 9.8% growth back in June. Real retail sales fell only 30 basis points from August.
China’s National Bureau of Statistics’ household survey data suggests that most of the spending went towards education, entertainment, and “miscellaneous services.”
Morningstar said that their own sampling of alternative consumer sales data such as box office revenue, telecom revenue, and air passenger volume suggests tepid consumer services growth. China’s number crunchers are more upbeat on that and Morningstar’s team is not, which brings their forecast so much lower than official figures.
E-commerce giant Alibaba – the company behind Singles Day – announced this week that Taylor Swift will be performing at the Mercedes Benz Arena in Shanghai where the shopping spree will have their telethon-like tally of sales. If Swift can hype Singles Day shoppers to spend, the China consumer bull narrative will remain in tact. If she fails, and Singles Day ends up being mediocre, all bets are on for more stimulus in the months ahead out of Beijing.