CBA: Don't get too excited about the strong start to 2017 for China's industrial sectors

Photo: Greg/ AFP/ Getty Images.

After a prolonged, Lunar New Year break, China finally released its latest report card on industrial output, fixed asset investment and retail sales for the first two months of the year on Tuesday.

Aside from a noticeable deceleration in retail sales, something that appears to have been driven by temporary factors associated with the expiry of a discounted sales tax rate on small vehicle sales at the end of last year, the data was, on balance, strong.

Fixed asset investment (FAI) in urban areas expanded 8.9% year-on-year in the first two months of the year, well above forecasts of 8.3%. Industrial output grew by 6.3% over the same period, topping the 6.2% level expected and an acceleration on the 6.0% pace reported in December.

Coupled with continued strong readings for manufacturing and non-manufacturing PMI reports earlier in the year, it only helped to solidify the belief that Chinese commodity demand, hence prices, will remain elevated in the year ahead, consolidating on the substantial gains recorded across most bulk and base metals a year earlier.

And, as a linchpin for much of Chinese construction activity, that understandably extends to the outlook for Chinese steel demand for many investors and analysts.

A 5.8% year-on-year lift in crude steel output in the first two months months of the year — the fastest growth since December 2013 — only helped to bolster that confidence.

While yesterday’s data was a strong outcome, not everyone is convinced that what happened in 2016 will be replicated this year.

That list includes Vivek Dhar, the Commonwealth Bank’s mining and energy commodities analyst, who cast caution on strong start to the year for China’s industrial and construction sectors.

“While the bullish sentiment from today’s data combines well with stronger activity from China’s manufacturing sector, we remain reluctant to upgrade China’s steel consumption,” he wrote following the release of the data.

“The policy reversal last year that led to credit expansion and greater support for China’s commodity intensive sectors saw China’s apparent steel consumption increase only around 2% in 2016. We expect a result only slightly higher this year as policymakers are keen not to recreate the same demand conditions that saw overcapacity in China’s industrial sectors flourish.”

On the outlook for demand, Dhar says that while infrastructure investment will continue to be a supportive factor in 2017, he’s not expecting property construction to be as influential as was the case last year.

Source: CBA

“Property sales and real estate investment grew sharply in the last two months, tantalising the market with hope that property construction could lift again,” he says.

However, in his opinion, that will not be replicated later in the year.

“Concerns over a housing bubble and financial risks have already led to restrictions on home purchases and lending. We expect these restrictions will weigh on property sales and real estate investment in 2017.”

Offsetting that slowdown, a view that is bolstered by a recent sharp deceleration in house price growth across the country, Dhar thinks that the government will continue to roll out infrastructure investment ahead of elections later in the year to show they can achieve stable economic growth.

“We continue to believe that China will look to infrastructure investment in 2017 to drive growth as China’s top leaders prepare for elections in November.”

While Dhar suggests the demand picture will be mixed, he believes that commodity prices are likely to be driven more by supply factors, rather than demand, this year, seemingly a continuation of the pattern in 2016 when government policy to reduce overcapacity and supply disruptions both within China and abroad saw prices for coking coal, iron ore, thermal coal and steel, among others, soar.

However, he cautions this equation could change if “Chinese commodity consumption lifts sharply”.

An undoubted risk given the speed policymakers managed to turn around demand when the economy weakened noticeably at the start of 2016.

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