OpinionJul 31 2014

‘Consciously uncoupling’ now an economics term

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In one of the strangest pieces of PR this year, Gwyneth Paltrow and Chris Martin announced the end of their marriage as a decision to “conscious uncouple”.

As odd as this phrase seems when applied to the institution of marriage, perhaps it could find a home in the world of economics instead.

Market commentators often point to the de-coupling and re-coupling of emerging and developed markets as reasons for concern or relief.

The prevalent view at present seems to be that emerging economies are set to benefit from the gradual economic improvement taking place in the developed world. As a result, it seems the highly intertwined nature of the global economy makes this ‘unconscious re-coupling’ all but a given.

China remains an excellent example of an emerging market that should benefit from improved growth in developed markets.

China is the world’s biggest trader and exhibits the big cyclical fluctuations typical of an emerging economy. It is not a utopia of economic growth by any stretch, and recent trade data has been slightly disappointing, but the outlook for Chinese exports is more constructive and the new exports component of the purchasing manufacturers’ index rose solidly in June.

That said, China is likely to have a tough time hitting the official 2014 growth target of 7.5 per cent by trade alone and the economy still faces two sizable risks — credit and housing — on its way to reengineering the economy.

The 7.7 per cent annualised growth rate achieved in the second quarter confirmed that the Chinese economy looks to have bottomed and managed to avoid the feared ‘hard landing’. However, the uptick in growth reflects the mini-stimulus measures implemented earlier this year and credit growth in June expanded rather than contracted — as had been expected.

Policymakers have so far managed to refrain from indulging in a repeat of the mass stimulus measures undertaken in 2008. Instead, they have persisted with temperate pro-growth policies and targeted support for infrastructure investments. But against the backdrop of moderate global growth, officials have not yet been able to go cold turkey on investment.

Furthermore, the government faces a tough job weaning the country off credit. Credit grew by nearly 17 per cent in June compared to a year ago, as measured by total social financing, in an economy which expanded by 9.5 per cent in nominal terms.

Because credit growth continues to outpace economic growth, Chinese officials will want to avoid pushing credit growth too high and are likely to do more than tinkering to keep the economy on track.

The second point which gives investors goosebumps is the Chinese property market. Many years of easy credit has led to an excess supply of housing, but the market is showing the early signs of a turn, as over-supply is being met with tighter monetary policy.

While TSF growth is still high it has slowed, particularly within shadow banking, which was associated with more speculative activity. As a result, developers have faced higher funding costs and a restriction in the availability of credit. Simultaneously, mortgage costs have kept rising, all of which is weighing heavily on housing demand.

All of this appears to spell trouble, but an outright property market collapse seems unlikely as the fundamentals for demand remain. The ratio of urban dwellers to the total population rose from 36 per cent in 2000 to 54 per cent in 2013 and the pace remains stable with approximately 20m people moving to the cities each year.

Meanwhile, there has been selective easing of property restrictions by some local governments and the People’s Bank of China recently asked that the largest banks increase efforts to ensure first time home buyers were getting the required support.

Growth looks to have stabilised in China but whether this is a good sign or not depends on how you view the world. In the near term, it would appear that the economy is still being supported by credit, as Chinese officials find that redistributing the economic pie is more difficult than first thought. The worries about how much economic growth is being propped up by the country’s overreliance on credit will therefore persist.

These worries about how this will add to the country’s reliance on credit will remain. For investors this debt overhang and property market should be monitored, and explains some of the reasons why Chinese valuations are among the lowest of many emerging economies — only Russia is currently cheaper.

However, there are early signs of trade rebalancing and a modest transition to a more consumer-led economy. Just like Gwyneth and Chris, we may see China start to benefit from a re-coupling with the developed world.

Kerry Craig is global market strategist of JP Morgan Asset Management