Although China’s real GDP growth is still strong at more than 7%, many have continued to predict a forceful response by the Chinese government to the “slowdown” in China’s economy. Beginning in Q2, policymakers have made some adjustments including: interest rate cuts, investment project acceleration and less hawkish property measures. There have been some recent signs that these measures are working: reported monetary data and investment statistics are stronger and selective basic material prices have rebounded modestly. While these are positives, major political changes and fundamental economic shifts pose considerable headwinds.
In terms of the major political changes expected, the Chinese Communist Party’s 18th Congress convenes in Beijing on November 8. Considered to be the most important political meeting in China in the past decade, the Party is expected to replace the current leadership in top positions with a new generation of leaders. Under new political leadership, the potential exists for more ambitious reforms on policy and economic structure. Many issues will be on the table, including environmental protection and further liberalization of the interest rate regime. These will all pose challenges for China to repeat its prior high growth levels.
In the medium term, global growth looks set to slow with the fiscal cliff worry in the U.S. and ongoing austerity in Europe. China’s export market share, after gaining for many years has hit a plateau and may be up for more serious competitive pressure after a 20%+ currency appreciation since 2005. This is troubling since manufacturing is still the biggest share (30%+ of GDP) and has been growing about 20%. Most forecasts of Chinese growth have this trend continuing for the next two years; however, these forecasts are relying on the historical GDP contribution from investments instead of forward-looking estimates. This means that if firms become less profitable and fixed manufacturing investments decrease, growth estimates will be further negatively impacted.
Taking into account all of these factors, the consensus forecasts for 8% growth in 2013 and 7.5% in 2014 seem too optimistic. Our global team has been correctly calling for a muddle through scenario in the developed economies for the past two years. Looking beyond Q4, we see China also embarking on a more moderate path, with successive slower GDP to come. This has implications for Asian bond and emerging market debt portfolios. Given this year’s tighter valuations, our investments in corporate credit will be focused on companies with sustainable business plans that utilize realistic macro growth assumptions. We expect sector allocations to be a large driver of relative returns as political, economic, and structural changes in China create divergent risks and opportunities.