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Aidan Yao on China: 2017 Q4 outlook

Aidan Yao on China: 2017 Q4 outlook

Market commentary
15 November 2017

Key points:

  • Economic momentum dissipates further heading into the fourth quarter…
  • …reflecting short-term pains of reform policies
  • Divergence between “New” and “Old” China grows ever more apparent…
  • …which requires more careful examination of data granularity
  • With weakness anticipated, economy is on track to deliver 6.8% growth this year
  • Continued reforms will lead to slower but more balanced growth in 2018

The Chinese economy lost a little more steam heading into the final quarter of the year. While seasonality had an impact (with a longer holiday this October compared to 2016), government policies were the key driver of growth deceleration, in our view. In particular, the campaign to clean up the environment has curbed production in heavy-polluting industries, resulting in a 1.3% drop in mining output. More strict enforcement on environmental standards also weighed on fixed asset investment (FAI) in mining, cement and non-ferrous metals. With the winter season anti-pollution campaign in full swing, weakness in these sectors will persist for the coming months.

Elsewhere, policy tightening in the housing market has continued to gain traction. Weakness in nation-wide house sales deepened in October, falling 6% yoy in volumes and 1.7% in values. Given the fading impact from the housing subsidy scheme, which has supported the destocking process this year, we think the market correction will continue well into 2018. Even though hard-landing in the property market is unlikely given the more balanced supply and demand dynamics, lower residential investment and housing-related activities (real-estate services, retail sales of furniture and appliances, etc.) will affect growth and China’s demand for commodities. The housing market slowdown lies at the heart of our lower growth forecast (6.5%) for 2018.

Another policy operation, which has been a surprise for the market this year, is financial deleveraging. Tightened macro-prudential regulation has significantly affected banks’ off-balance-sheet activities, forcing them to withdraw liquidity from the shadow banking system. Reduced “financial churning” was reflected in the persistent decline in M2 growth, which fell to a record low of 8.8% in October. Slower credit growth, combined with funding restrictions on local government funding vehicles, has also pressured fixed asset investment growth to its lowest since early 2000s.

The above suggests that China’s economic rebalancing – away from investment – has made progress. Luckily, this rebalancing is not all negative for short-term growth. The official crackdown on “Old China” have diverted resources to many “New China” industries, leading to a divergence in many macro data. Take industrial production as an example, mining output declined by 1.3% last month, while production in electronic equipment/computers/IT products rose by 12.8%. In FAI, investment declined by 2.2% in heavy polluting industries, but grew by 16.8% in high-tech sectors. In retail sales, the 6% growth in offline sales paled in comparison to the 34%yoy growth in online sales. Alibaba, China’s largest e-commerce operator, saw this year’s Single’s Day sales jumped by almost 40% last week. The bottom line is that, with the economy rebalancing rapidly, many aggregate data is becoming increasingly misrepresentative of the macro reality. Delving deeper into data will be important for selectivity in investment in this polarizing economic environment.

Overall, today’s data confirms our forecast of further growth deceleration in Q4, leaving annual growth at 6.8%. For 2018, we think the balance of China’s reform and rebalancing policies will have a net negative impact on growth speed, but positive for growth quality, in line with the desired mix conveyed by President Xi at the Party Congress. We are now looking for 6.5% growth in 2018, with a further improvement in the economic structure. The latter, engineered by official policies, will be the dominant drivers of financial markets. Stay tuned for more details in our 2018 outlook.

Notes to Editors

Source: All data from AXA IM as of 14 November, 2017.

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