China Riding the Global Economic Recovery

Wed, Oct 11, 2017 - 8:41am

The global economic recovery is strengthening and becoming more synchronized, according to updated projections for 2017 and 2018 by both the Organization for Economic Cooperation and Development (OECD) and the International Monetary Fund (IMF). China, the world’s second largest economy, is an important part of this improved outlook, and its equity markets have been outperforming.

Last year’s global growth was 3.1%. The OECD is forecasting a 3.5% advance this year and even stronger, 3.7% growth in 2018. China’s economic growth rate is projected at 6.8% this year, compared with 6.7% in 2016. The OECD anticipates moderate slowing to a 6.6% pace in 2018, in response to some easing of stimulus measures and efforts to stabilize the corporate debt and further balance the economy.

The IMF sees the present acceleration of the global economy as the broadest in the past 10 years. Their economists project a 3.6% advance this year, slightly faster than the OECD estimate, and 3.7% growth in 2018. China’s economy is projected to grow 6.8% this year, a 0.2 percentage point increase over the IMF’s April forecast. Similarly, their forecast for 2018 has been increased by 0.3 percentage points to 6.5%, based on the expectation that expansionary policies will be sufficient to maintain such an advance and external demand will remain strong.

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The latest economic data for China suggests some easing in growth momentum, but the picture is mixed. Export growth slowed in August, as did investment growth. In contrast, the official manufacturing PMI (Purchasing Managers Index) for September rose, as did the official non-manufacturing PMI. However, the Caixin PMIs for manufacturing and for general services, published by Markit, both declined. The main difference between the official and Caixin manufacturing PMIs is the broader coverage of the Caixin measure, which includes more small enterprises. That measure indicated that manufacturing continued to expand in September but at a slightly weaker rate. The Caixin general services PMI, however, slipped to its lowest level since December 2015.

Chinese equity markets drew back a bit in mid-September but then resumed their outperformance, which has been substantial year-to-date. The US exchanges currently offer 39 ETFs for Chinese equities. Excluding inverse and leveraged ETFs, there are 31. The majority of them have relatively limited assets under management (AUM) and thus limited liquidity, but nine have AUMs greater than $150 million, and four have AUMs in excess of $1 billion. Of these four, the strongest performer by far is the KraneShares CSI China Internet ETF, KWEB, with a total return year-to-date (as of October 9th) of 68.1%. That return is more than three times the 18.4% gain of the benchmark iShares MSCI All Country ETF, MSCI. For the other three largest ETFs, the year-to-date returns are iShares MSCI China, MCHI, 50.0%; SPDR S&P China, GXC, 47.5%; and iShares China Large Cap, FXI, 32.1%. Two other strong performers with a tilt towards technology are Guggenheim China Technology, CQQQ, 67.1%; and PowerShares Golden Dragon, PGJ, 56.7%. One attraction of PGJ is it contains only US exchange-listed companies that are headquartered or incorporated in the People’s Republic of China. These companies have had to meet US listing requirements.

Looking forward, the past volatility of Chinese equities should be kept in mind. It has been some time since a significant correction. While the moderation projected in China’s very strong economic growth is slight, China’s equity markets would be vulnerable to monetary policy tightening that was greater than expected, to adverse trade actions by the US, or to geopolitical developments that caused a widespread retreat from risk.

Sources: OECD Interim Economic Outlook, September 20, 2017; IMF World Economic Outlook, October 2017; Caixin: HIS Markit; Ned Davis Research; Goldman Sachs Research

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Chief Global Economist
bill [dot] witherell [at] cumber [dot] com ()