Aurum Weekly Access - 3/30/12
China Conundrum
"It's one of the most important things at the end of the day, being able to say no to an investment.“ – Henry Kravis
In December, we published a note about our concerns regarding China’s economy and property markets. In January, we hosted a luncheon for our clients and contacts entitled, “China’s Economic Troubles and How It Will Affect Investors in 2012.” It seems the majority of investors shunned this advice, however, as flows came rushing into Chinese equities, pushing assets under management to a new record.
Source: Morgan Stanley Research Equity Flows Monitor, EPFR Global
This is despite the fact that China equities are up only marginally in the past few months, especially thanks to the downdraft in March. In contrast, U.S. indices are up 10% to 20% and hitting new recovery highs above 2011’s peak.
Source: StockCharts.com
The latest sell-off was attributable to a couple factors, including the HSBC Flash PMI (Purchasing Manufacturing Index), a survey of 400 small to medium sized companies. It showed contraction for the fifth straight month. The official PMI, which tends to cover larger companies, comes out on Sunday as investors will watch the release closely.
Source: Markit, HSBC
Also driving concern was BHP Billion, the world's largest miner, stating that China iron ore demand growth would soon fall to single digits. Since it has been a key beneficiary of China's property and fixed asset boom, investors took notice.
Even prior to this in early March, Premier Wen Jiabao confirmed our views about slower growth by unveiling a 7.5% target for GDP, lowered from the 8% bogey that stood for seven consecutive years. Official growth data typically outpaces the hurdle rate, but officials actually confirmed our reasons for distrusting the data. Per Bloomberg, "China's statistics bureau said local officials forced some hotels, coal miners, and aluminum makers to report false numbers, highlighting flawas in data tracking."i] We have been skeptical of the data, thus looking towards other sources that may diverge with the officially released version. Power production tends to be a truer data point to gauge growth and it indicates a lower trajectory than the past few years.
Source: CEIC
Thoughtful investors do not look for information that only endorses their current views. The question of “Why am I wrong?” should always be at the forefront. Bank of America economist Ting Lu believes the worst is over and China’s recent rough patch was due to weak external demand, the coldest winter in 27 years, political changeover causing distractions, and destocking by manufactures in the last quarter of 2011.[ii]
Credit Suisse also agrees that the concerns are excessive and the demise of fixed asset investment is exaggerated, as data from January and February showed improvement from 2011. It also sees housing data getting better and industrial production rebounding. In addition, the dramatic fall in consumer prices gives policy makers more flexibility to stimulate if required.[iii}
We remain uninspired about investing where infrastructure spending outpaces the income necessary to support projects and a credit boom slows quickly, as historically these scenarios do not end well. We recognize that authorities will enact stimulus to avoid an adverse economic downturn and the risks may be overstated. Nonetheless, our portfolios remain relatively neutral to exposure in China, with long positions from equity managers invested in quality companies in China offset by alternative strategies with short exposure to the region.
[iii] Deverell, Ric. “The Great China Debate.” Credit Suisse Research. 19 March 2012l
Important Disclosures
This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or warranty with respect to the accuracy or completeness of this material. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein.
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