Veteran Wall Street strategist Byron Wien is out with his latest monthly commentary.
He wrote it after taking a trip across Asia.
“I spent almost two weeks in Asia in June and in some ways it was an eye-opener,” he wrote. “In past years there was a sense of optimism everywhere you went. Now you get a feeling of uncertainty touched by apprehension.”
The major issue surrounds China, the world’s second largest economy.
Wien first discusses how the red hot economy has cooled off.
The critical problem in Asia is tied, not surprisingly, to China. While Chinese Real Gross Domestic Product (GDP) growth was reported at 7.7% in the first quarter, although some have suggested that the underlying rate was less than that. I have been watching electricity consumption carefully. While this is a volatile indicator, it is hovering in low single digits, suggesting that momentum in China is slower than many believe. Foreign direct investment was only up 1% in the first five months of 2013 compared to a year ago and it was down in 2012. Several years ago China’s major problem was believed to be overbuilding of apartments and offices. There were supposedly empty cities and a real estate collapse was widely predicted. It didn’t happen and today a survey of prices for residential real estate in 100 major cities shows a clear uptrend. The current major problem is non-performing loans at the country’s banks and so-called “shadow banks.” This weakness in the financial system has been with us for some time, but the People’s Bank of China has been willing to provide the liquidity necessary to keep the banks functioning, even though a significant proportion of loans in the system might be in default. Recently the banking authorities have decided to restrain what they believe to be irresponsible lending and this has raised further questions about whether the economy can grow at high single-digit-rates without easy credit.
When the Chinese interbank lending rate rose to 13% in June, investors feared that a period of tight credit might be starting. The prevailing view among knowledgeable observers in the region is that imposing some discipline on the banking system is the first step that China’s new leaders are taking to put the economy on a sounder longer-term footing. Other steps will include implementing serious measures to control corruption. Even the optimists, however, expect the changes to be slow in coming. There are other signs of weakness in the Chinese economy. The manufacturing purchasing managers’ index dropped to 48.3 in May from 49.2, indicating a further slowdown in industrial activity. The People’s Bank of China survey of financial institutions was also weaker and that is showing up in loan activity.
Indeed, China’s policymakers aren’t just trying to clean up the economy. They’re also trying to transform it into one that’s less reliant on exports.
The biggest challenge to China’s two new leaders is the rebalancing of the economy. In an effort to improve exports and build hard currency reserves, China made heavy investments in state-owned enterprises producing goods to be shipped abroad and also improved its infrastructure. In 1999 the consumer component was 46% of Chinese GDP. By 2010 it was down to 35% and investment spending was 45%. The five-year plan introduced in September 2010 set a goal of bringing the consumer back to 45% and reducing investment spending, but little progress has been made on that rebalancing goal. There are plenty of goods on the shelves of stores, but Chinese consumers seem reluctant to spend. Older people save for their retirement and healthcare expenses and younger families save for the education of their children and to buy a house or apartment. Incentives may have to be provided to stimulate consumption. If the economy is not rebalanced China will have to continue to rely on exports for growth. With Europe still in a recession, the U.S. growing at 2% and most of the developing world slowing, exports may continue to be disappointing. China’s new leaders have said they are focused on implementing reforms. Achieving a high level of growth is not their primary goal.
Those last two sentences are key to understanding what’s going on in China. They don’t want to risk blowing housing and credit bubbles. Perhaps it’s two late for that.
What they really want is sustainable growth.
However, this rebalancing act also puts the country at risk.
Overall I would say that Asian investors are somewhat more complacent than they should be given the clouded outlook for China. They don’t display the limitless optimism of previous years, but they believe they are in the right place at the right time. If there is an underlying fear it is that there could be some kind of crisis in China. It could be caused by a lack of jobs for younger people coming out of school. It could be caused by a partial meltdown of the banking system that could result from bad loans and not be containable by the People’s Bank of China. It could be caused by a political action. The fear is that the situation is tenuous, and that is in sharp contrast to the view that strong growth could continue indefinitely, the mood of past years.
Read the whole commentary at Blackstone.com.
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