I am no economist, and certainly no expert on China, but the recent sprinkle of better than expected manufacturing data has caused many market participants to summarily dismiss the dreaded hard landing scenario for the planet’s second largest economy. Since China’s new leadership completed their months long transition in March, the message has been fairly clear, they are willing to sacrifice short term growth to “allow economic adjustment”. In fact the leaders are inheriting an economy that has been growing at its slowest pace in 2 decades, with Q2 marking the longest sub 8% GDP streak during that time period.
Many would argue that the massive underperformance ytd by the Shanghai Composite (down 6.25%) adequately reflects China’s strains on growth, while sporting some of the most attractive equity valuations the world over (Shanghai trades at about 11x earnings vs the SPX and the EuroStoxx 50 at almost 16x). Earlier this year it was very much in fashion by macro traders to be short emerging markets (including China) and long SPX, this trade has since come unwound a bit, which could be one reason why the SPX has floundered over the last month, and the Shanghai is up in that same time period.
The one year chart of the Shanghai Composite (below) reflects the fairly strenuous debate taking place over the future growth in the country, earlier in the year, the index crashed almost 25% from the highs in February, to the lows in June, and has now seemed to find some sort of equilibrium, albeit at a fairly crucial technical spot as it tries to get unchanged on the year.
A few weeks ago I made a defined risk play that Chinese equities would in fact re-test the early summer lows with defined risk, but carefully made the argument (here) that on a longer term basis that China was probably not a great press on the short side. While the new leadership is willing to allow adjustments to the economy, and take out some fairly dramatic overcapacity, I highly doubt they are willing to sit by and watch and economic implosion that could lead to social unrest. Once we get a resolution to the situation in Syria, the Fed’s decision on QE, and the impending budget skirmish in Congress, I suspect global growth, or the lack there of will once again be the main litmus test for future gains in global equities and will likely be the source for pick up in second half earnings growth that so much of the year to date rally in the U.S. has been looking forward too.