This article is from MoneyWeek Asia, a FREE weekly email of investment ideas and news every Monday from MoneyWeek magazine, covering the world’s fastest-developing and most exciting region.
Sign up to MoneyWeek Asia here .
Visit the port of Hong Kong for the first time this summer, and you won’t know that anything is amiss. It’s a hive of activity, full of ships loading up on containers stuffed with Chinese goods for export around the world.
But a regular visitor might notice a difference. Nothing too dramatic – but compared to a year ago, there seem to be fewer ships and fewer containers. Those giant cranes are a bit less busy than before.
It’s not just Hong Kong. There’s a slowdown underway at most of China’s ports, which include six of the world’s ten busiest. Container volumes are still growing, but at around half the pace of last year. And the rate of growth is declining each month. It’s clear that demand for Chinese exports is taking a hit as the global economy slows.
This situation is likely to get worse, as we’ll see below. But despite what many are saying, this is not a crisis for China. An economic hard landing is not on the cards. Let’s see why …
The main reason for the export slowdown is, as you may have guessed, the impact of the credit crunch in the US. US consumers and businesses simply don’t want – or can’t afford – to buy as many Chinese goods as they have for the last few years.
You can see this in falling imports into US docks, such as Los Angeles, where volumes are off almost 14% year-on-year. You can see it in the narrowing US trade deficit. And you can see it in the results of China Shipping Container Lines (CSCL), the world’s sixth-largest container shipper, where revenue growth on trans-pacific routes has been weak compared to routes in the rest of the world.
It’s drawing more attention now, but this trend has in fact, been obvious since last year. Yet Chinese export growth has not collapsed, despite lower US demand. That’s because other markets such as Europe and oil-cash rich Russia and the Middle East have picked up the slack. This seeming indifference to America’s weakness has led many to conclude that “decoupling” – the idea that the rest of the world could fully shrug off a US slowdown – was a reality.
Sadly it’s not. All we’ve been seeing is a delay as the fallout from the US makes its way through the global economy. And now another one of China’s key export markets is undergoing a sharp slowdown.
The Eurozone will be the next market to falter
The latest GDP figures from the Eurozone confirm what should have been apparent all along – this slow-growing region with plenty of imbalances of its own is not much more resilient than the US. With GDP falling 0.2% in the second quarter and only sluggish growth ahead, there’s no way that China’s exports to Europe are going to stay as robust as they have for the past year.
Indeed, largely unnoticed by most commentators, there are already signs that European demand is fading. Container volumes on the Asia-Europe route are still up year-on-year, but the rate of growth is sliding fast. Shipping news service Lloyd’s List reports that some shippers have cut their charges in half to try to hold on to business as demand from exporters needing to get their goods to Europe falls.
As the eurozone goes into recession, this will only get worse. And currency effects aren’t going to help. As we mentioned last week, the renminbi’s three-year-long rise against the dollar has stalled, as Beijing tries to keep Chinese firms competitive in the slowing US market. But with the dollar now rebounding strongly against the euro, the renminbi is being dragged higher in its wake, as the chart below shows.
This will make Chinese goods more expensive for European buyers, just as recession-struck European consumers will be cutting back. China’s policy of hitching its currency to the dollar instead of a basket of currencies could come back to bite it here.
All this poses a very serious question. If two of China’s key markets are in slowdown and China is so export-dependent, how can China avoid its own slowdown?
Well, it’s simple – it can’t. The idea that China (and the rest of Asia) could totally decouple from the global economy was always a myth. But commentary on China tends to lurch from one extreme to another. Either it’s booming or it’s on the verge of collapse. The less newsworthy option – a moderate slowdown – is often ignored. Yet that’s by far the most likely outcome today.
Given how much we talk of China as export-driven, it may be hard to believe that exports have only accounted for around 15%-20% of China’s GDP growth in recent years. Yet it’s true: the bulk of growth comes from domestic demand – consumption and investment. Both of these should remain solid. There’s likely to be a fall in business investment, but government plans to invest several trillion in improving the nation’s infrastructure over the next few years should easily compensate for this.
But the economy and the stockmarket are not the same thing. So what might a slowdown – even a mild one – mean for investors accustomed to consistent double-digit growth in recent years?
Infrastructure stocks will be the safest shelter
Well, export-focused firms – many manufacturers, port operators and shipping firms for example – are going to be hit. Markets have recognised this and shares are already down sharply: for example, China Merchants Holdings, the largest listed port operator in China, has fallen more than 50% from its peak last year. Shipping firm CSCL, mentioned above, is down more than 80%.
As a long-term investor, I wouldn’t sell out of such stocks now. Ducking in and out of the market is a great way to increase your costs and reduce your returns. But equally, I won’t be adding to them yet, because they’ll probably be available cheaper at some point soon.
Instead, in the large-cap space the stocks that are likely to do best are those that will benefit from the infrastructure investment programme. That means companies such as China Railway Construction and China Railway Group which are expanding and improving the nation’s transport network. Other stocks that play domestic demand, operate in relatively stable industries and have good long-term growth stories are also likely to outperform. China Mobile, the biggest mobile carrier, is one obvious candidate.
Investors already realise this, which means that in many cases, these stocks aren’t cheap. What’s more, being state-controlled they carry their own risks. They may be compelled to act in the national interest rather than shareholders’ interests. There is also the risk that their state-owned parent company may inject other assets into them at prices that don’t represent good value. This is a threat with all the large, state-controlled Chinese firms.
But they are easy ways to gain exposure to stable industries over the next few years, and as high-visibility stocks they should see plenty of investor interest. As a result, they’re likely to outperform the broader market.
But even so, one glance at the chart of the benchmark CSI 300 should convince you that there’s plenty of potential downside to come here. So even “outperforming” stocks could still leave you in the red near-term.
So if your portfolio does have significant exposure to China, and you’re concerned about this, you could consider hedging your exposure with a short exchange-traded fund (ETF) such as Ultrashort FTSE/Xinhua China 25 ProShares ETF.
This ETF inversely tracks an index of 25 large Chinese firms – in other words, it rises as Chinese stocks fall, and vice versa. Since it’s an Ultrashort ETF, it actually moves twice as far as the underlying index does. Because the underlying index only contains 25 stocks, it’s not a perfect proxy for the overall market, but it generally moves in line with it.
Surprising news from the rest of Asia
There’s a second questions we should ask: what does this slowdown mean for the rest of Asia? Weak demand in the US and Europe for Chinese goods could also mean weak demand for exports from other Asian countries, of course. But there’s also the tightly-interconnected Asian supply chain to consider. Many countries export goods to China for further manufacturing and assembly before they are exported on to their final destinations. So a fall in demand for Chinese exports is also likely to mean a sharp fall in China’s demand for these intermediate goods. In other words, we could expect trade within Asia to take a hit as well.
The surprising thing is that we’re not seeing this yet. Since the credit crunch began last year and US demand began to falter, export growth in the rest of Asia has actually risen, as the chart below from DBS shows.
On this chart the grey line shows the year-on-year growth in exports measured in US dollars, while the red line shows growth measured in a basket of major currencies (the dollar, euro and yen). “Asia 8” means the major Asian economies excluding China, India and Japan.
So why are exports still rising? Part of it is clearly down to the weak dollar. If you measure exports in dollars, then a fall in the value of the dollar against other currencies can make export growth look higher than it is in constant currency terms. But as the chart shows, that’s not the whole story. Export growth certainly rose more in dollar terms (the grey line), but it still rose when you adjust for this by looking at it in terms of the basket of currencies (the red line).
The fact is that Chinese demand for goods from the rest of Asia is rising even though US demand for Chinese goods is falling – the opposite of what we’d expect to see. That’s suggests that – so far – Chinese domestic demand is picking up the slack.
It’s possible that this is Olympic-related demand and that once the games are over, export growth will drop back sharply. But the other possibility is that Chinese domestic demand is already beginning to take over as a major player in Asian regional demand, as we expect it to do in the long run.
If that’s the case, then as long as Chinese growth remains solid, the rest of the region should suffer less from a US slowdown than it has in the past. It’s too early to know for sure, but we should find out in the next few months.
Turning to the markets…
Asian stocks slid further last week, led by a drop of 5.5% in Shanghai. Chinese investors appear to have finally abandoned the idea that the government will intervene to support the market and the market looks to be heading down further. In India, the Sensex was down 2.6% after five weeks of gains on the trot, while Indonesia fell 5%. Jakarta is now one of the worst performing markets over the last six months, as falling commodity prices and global demand raised fears of weaker export earnings. Crude palm oil – one of Indonesia’s key exports – closed at RM2,453/tonne on the Malaysian Derivatives Exchange, down 8% on the week and 35% since mid-May.
Vietnam was again one of the few exceptions, rising 10% on the week. Amid signs that the market is stabilising, the Vietnamese regulator announced that the maximum daily trading band for stocks will be increased to plus or minus 5% from plus or minus 3%. Trading bands were cut earlier this year in an effort to stop the index’s decline after the stock bubble burst last summer.
The earnings outlook clearly isn’t helping investor sentiment. The latest consensus forecast from the IBES database is for Asia ex Japan earnings to grow at 4.4% this year. That’s a sharp fall from 10% at the start of 2008, but even now analysts may still be too optimistic. The consensus for 2009 is for a rapid rebound to 16% growth in 2009, which looks unlikely given the headwinds the global economy will be facing well into 2009.
Times are especially tough for airlines and China Southern Airlines, Asia’s largest carrier by passenger numbers, was downbeat even when reporting a fivefold increase in first-half profits. The firm’s chairman expects ” a long period of hardship” after airlines were hit by higher fuel costs, slowing growth in passengers and tougher competition. The impressive-looking results were flattered by the rise in the renminbi against the dollar, reducing the value of its dollar-denominated debt and the firm didn’t say if it would have made a profit without those gains. China Southern, Air China and China Eastern Airlines, the country’s three largest carriers, are all down 60-80% in Hong Kong this year; the other two firms report earnings at the end of this month.