China headed for soft landing in spite of global slowdown

With the latest inflation prints in China falling to 1.8 per cent in July, down from 3 per cent in May, and economic growth dropping below 8 per cent in the second quarter of 2012, it is clear that China is feeling the effects of a global slowdown.

It is therefore likely that we will see some further monetary easing from the People’s Bank of China (PBOC) and further volatility in equity markets. In the short term investors should be wary but towards the end of 2012 an improvement for markets is likely.

In early July we saw the PBOC move to cut its benchmark lending and deposit rates by another 0.25 percentage points. This provided some relief to markets, but the boost was only short-lived. It seems that now investors are becoming increasingly focused on what appears to be a worse-than-expected economic slowdown in China. Standing at 50.2, the July purchasing managers index (PMI) has not shown any improvement to its June value of 50.1. This data is in line with other indicators which show the Chinese economy slowing.

Many Chinese state owned companies and those in the private sector are finding it hard to deal with slowing exports and the government constraints on construction.

The central government reiterating its determination to maintain a firm grip on the real estate market is undermining sentiment.

However, lately we have seen continued new flows on various fiscal stimulus programs by local governments to bolster the economy including pro-growth projects in infrastructure and green energy production. It is important, however, to monitor closely the debt levels of local governments. Their revenues have been constrained by lower tax revenues and falling land values.

This means that equity markets could well remain volatile in the short term. We expect to see a series of profit warnings from Chinese companies, which would result in consensus earnings forecasts for 2012 being revised downwards across many industries.

As the downturn in corporate earnings may be worse than expected we could see share prices weaken, with analysts cutting their earnings forecasts more aggressively. In spite of this, in the medium term we believe that the earnings cycle is bottoming out.

Stability

As we approach the end of 2012 we will return to a relatively stable economic situation with growth stabilising. In spite of a global slowdown we feel that fundamentals in China remain relatively robust with consumers still willing to spend and the government able to provide further stimulus if required. Additionally, the moderation of the latest inflation data also provides more room for PBOC and the government to ease policy.

Over the short term China faces some headwinds, with a slowdown in infrastructure and construction as well as the eurozone debt crisis and concerns over a sustained US recovery weighting on sentiment. However, in the medium term we remain confident that this will improve towards the end of 2012 as Chinese central government continues to ease both its fiscal and monetary policy. The up-and-down cycle in firms earnings may soon be bottoming out, which along with improved fundamentals should underpin some improvement in second half of 2012. This should help to support a market recovery in the final quarter of 2012 for Chinese equities. Taking this into account we still believe the economy is headed for a soft landing and that economic growth should be higher than 8 per cent for 2012 overall.

Michael Konstantinov is an emerging market fund manager at Allianz Global Investors