China: risks and opportunities

This article is written by Ipek Ozkardeskaya, Senior Market Analyst at FCA regulated broker London Capital Group Holdings plc (LON:LCG).

Ipek Ozkardeskaya, LCG

Anyone who has taken a train from Beijing to Shanghai must have noticed the jungle of brand new, yet inhabited towers. They are famous in the region because they are mostly empty, left by themselves in no man’s land.

Ghost towers are somewhat a good caricature of China’s slowdown story. They symbolize heavily output driven growth, yet lacking demand from the end-users.

Growth revised down to 6.5%

China revised its official growth forecast to 6.5% for next year, much slower than the double-digit growth figures that had wet investors’ appetite a couple of years ago.

Shanghai’s stocks rise and fall

The Shanghai Stock Exchange began operating in December 1990, with the launch of the Shanghai Composite Index, the benchmark index of the Chinese stock market. Having access to the world’s biggest emerging market has been a benediction for investors. The rush has only been amplified by highly leveraged positions over the past couple of years. The index skyrocketed to 6124 in October 2007 from sub 2000 at the end of 2006, however the subprime crisis shred 65% off the index by the end of 2008.

After years of stagnation, the Shanghai’s Composite took off, starting from mid-2014. The index gained approximately 145% within a year.

When the Chinese slowdown story hit the global newswires approximately a year ago, it generated a wave of panic that caused a massive sell-off in Chinese stocks. Headwinds erased almost 50% off the Shanghai’s Composite. The index has recovered slightly more than 20% since then.

This year, Chinese stocks totally missed the global rally. The Shanghai Composite has been left behind as the Dow Jones and the S&P 500 stocks renewed all-time record highs through an almost two-month rally following Donald Trump’s victory as the 45th president of the United States.

How does the future look for China?

Although global investors have preferred to steer clear of Chinese stocks, the future may not be as smoggy as it seems. China remains a vast ocean of opportunities, yet to be sailed with good due diligence and extra care.

Despite a significant slowdown, China remains one of the world’s fastest developing emerging markets. It is home to 1.5 billion people and has an estimated worth of 10 trillion dollars.

As Ali Baba’s Jack Ma once stated, the domestic potential is so huge that his business has a long way to grow before hitting the barrier of the country’s overall expansion.

Unlike previous years, China is turning towards itself and seeking growth at the heart of its immense market. This is positive news given that the export driven growth scheme is severely compromised due to economic stagnation in Europe, South East Asia, Australia and other trading partners.

Chinese exports contracted by 5% on year to November

In addition, the growing Donald Trump threat to the US-China relations is another risk exposure to be reduced in exchange to high domestic potential. According to a recent Bloomberg research, a 45% increase in Chinese imports by the US could cause a 60% to 70% drop in China’s exports to the US.

What investors are looking for?

Fast spreading internet and the broad use of e-commerce combined with a 1.5 trillion consumer base could indeed be a gold mine for many businesses, without being subject to overall growth metrics before many years.

This immense domestic potential is exactly what some investors are looking to explore. Clearly, the country’s slowing economy should have reduced some of that potential and disappointed multinationals which have implemented their businesses with perhaps very high targets.

Overwhelming business targets have certainly played a role in investors’ disillusion in China.

Nowadays, businesses are scaling back their New Year forecasts to achievable, ‘down-to-earth’ levels. Hence, adjusted forecasts on a more realistic empirical database could be a better mirror to the reality and bring back the appetite in 2017.

Risks of a domestic overheating

Still, it may not be a good time to wear the rose-tinted glasses just quite yet.

Following the Trump win, the rapid depreciation in the Yuan has translated into higher costs for manufacturers and higher import prices for retailers.

So far, producer prices picked up 3.3% in November from 2.3% a month earlier, yet consumer price inflation remained under control at 2.3% year-on-year.

Chinese retailers have absorbed a good part of the shock. Nevertheless, the rising dollar will be reflected into higher consumer good prices sooner rather than later.

Depending on how much overheating this could cause, the People’ Bank of China could be pushed to take tightening measures and extra monetary precautions.

Chinese yields are rising significantly, as such biting into the country’s financial system.

Both inflation and growth figures will be closely monitored in 2017.

China has the potential to deal with bad loans

China’s bad loans remain a risk to the financial system, yet many analysts are convinced that China’s low level of external debt brings the problem down to an internal level. According to many, the country has enough resources to deal with the problem.

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