China May Have Saved Itself, But What About The Rest Of Us?

There was more incrementally good news out of China on Saturday.

Industrial firms’ profits jumped 13.9% in March (YoY), a sharp snapback from the 14% decline witnessed in January-February (the Jan-Feb data is lumped to together to account for the Lunar New Year).

This is just the latest sign that the world’s second-largest economy is stabilizing following a disconcerting swoon the effects of which were felt across the globe.

Markets have digested a string of upbeat data out of China since the end of March. Between PMIs, exports, credit growth, retail sales, IP and a Q1 GDP print which showed that contrary to expectations, the Chinese economy did not decelerate further during the first quarter of the new year, the page has turned (shrill cat calls about “fake data” notwithstanding).

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The problem: good data equals less stimulus.

The last two weeks have been defined by jitters about what the improving outlook for the Chinese economy means for Beijing’s propensity to pull the various monetary and fiscal levers at their disposal. Officials clearly feel like they can afford to be patient on further RRR cuts and this week’s targeted MLF looks like proof that a piecemeal approach is likely going forward. That might sound prudent to you, but it’s something of a let down for those hoping to see a “kitchen sink” stimulus push designed not only to bolster domestic activity, but to prolong the global cycle as well.

Chinese equities suffered through their worst stretch since October this week, falling more than 5%. The Shanghai Composite’s underperformance versus the S&P was the widest since early 2016.

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Make no mistake, this tension between better data and fading stimulus hopes is a big deal.

Nobody wants to see China’s economy decelerate anew, but on the other hand, market participants are perhaps even more nervous about a scenario where decent data leads to complacency from Beijing. Have a look at this chart:

(SocGen)

That illustrates how critical China’s credit impulse really is and it speaks to the notion that the main reason why the US was insulated in 2018 was Trump’s stimulus. Here’s SocGen with a reasonably upbeat take:

Going forward, we should see US earnings growth bottom out, as we think it is too early for an earnings recession cycle. A lot of bad news is already reflected in expectations, while China’s ongoing monetary and fiscal support and central banks’ “Great Retreat” should put a floor under risky assets for now. As the Chinese economy surprised to the upside with the latest 1Q19 GDP print (6.4%, versus consensus of 6.3%), the green shoots of recovery in China’s credit impulse (change in new credit issued as a percentage of GDP) should allow global PMI figures to find a bottom, especially in the US.

A nice thought, but there are a couple of problems. First, it’s not clear that credit supply in China is the problem. We’ve been over this a dozen times if we’ve been over it once. Too much leverage and a still tenuous outlook for the economy are likely constraining credit demand, which means Beijing is, arguably, pushing on string.

Further, Barclays argues that the character of China’s recent stimulus push may limit positive spillovers. “China has shown some signs of turnaround in March data, but the traditional positive spill-over effect into the rest of the world, especially in bellwether countries like Korea and Taiwan, appears rather muted”, the bank writes, in a note dated Friday.

You might recall that South Korea contracted in Q1 by the most in a decade, underscoring the notion that the global economy is far from out of the woods. Exports are set to decline for a fifth straight month in South Korea, an ominous sign for global trade.

For Barclays, the lack of spillover from China’s stimulus is due to Beijing’s domestic bias.

“Investment has picked up in real estate and infrastructure, but weakened in manufacturing [and] China’s imports from the rest of the world stayed soft in March”, the bank goes on to write, adding that “with Korea and Taiwan heavily involved in China’s electronic/machinery intermediate goods supply chain, they may not be direct beneficiaries of such policies.”

(Barclays)

Between questions about diminishing returns on credit supply (i.e., the “pushing on a string” dynamic mentioned above), the inwardly-focused nature of fiscal stimulus and the possibility that, paradoxically, an improvement in the data could be “bad” news if it leads to less stimulus on both the fiscal and monetary fronts, you’re left to question both the will and the ability of Beijing to prolong the global cycle.

We’ll leave you with one last passage from SocGen:

…given China’s increasing importance to global growth since its entrance into the WTO at end-2000, we attempt to understand the impact of China’s credit impulse on equity markets’ forward earnings. Taking the previous two episodes of Chinese government stimulus, in 2012 and 2015, we calculate the change in US and World ex-US 12m forward EPS, several months before and after the U-turn in China’s credit impulse indicator. The results are striking — global earnings expectations tend to rebound after China stimulates its economy.