China's rebound to linger

Analyst says it is time to turn cautiously bullish on China.

DBS Group Research noted:

The successfulness of resisting the temptation of over-loosening credit alongside the absence of gigantic fiscal stimuli to fuel growth has created very favorable conditions for staging at least a mild technical rebound that may last 2-3 quarters.

Geographically, China is a huge country. 19 provinces out of 27 have reported GDP growth in 3Q12 in excess of 10%. Some provinces such as Tinjian, Chongqing and Guizhou even registered GDP growth of almost 14% YoY in 3Q. What dragged down the overall level of GDP growth predominantly comes from export-oriented provinces such as Guangdong and Zhejiang. Provinces in the middle and western part of China are relatively unscratched by trade demises. It is domestic demand that uplifts their GDP numbers.

The rebound is supported probably by “re-stocking”. The end of a “de-stocking” cycle is naturally followed by the need for stock replenishment. The recent surge of copper imports in China partially reflects such emerging trend. It also mirrors the inter-temporal increase in infrastructure spending as a result of China’s highly directive fiscal spending.

That partially explains better reading of October’s PMI at 50.2. The initial stage of the rebound is likely to be mild as more justifications are required to firm up market confidence. That said, valuations of Chinese stocks are trading at historically low. And the probability of introducing new reform policy initiatives is high after leadership transition is completed.

Inflation is not a prevalent threat now as CPI has consistently advancing at a rate of only 2% in recent months. The risk of asset inflation, however, remains well alive. The good thing is that the Chinese government knows this well. Should China lift up the administrative restraints on property market, the impact could be explosive given the strength of pent-up demand accumulated over almost 24 months.

Yet, 19 provinces are able to grow more than 10% without the “property fever”. That explains why the market shall unlikely see more reserve requirement ratio and interest rate cuts. Interest rate outlook is thus at best neutral without any upward/downward bias at this juncture.

It looks like the forthcoming rebound will come geographically from the middle/western part of China as the export-oriented provinces will continue to suffer from the volatility of external trade. It is unclear whether the collective strength of the inner provinces can drive growth in a sustainably manner. The answer is probably not. But it definitely buys the new leadership some time to come up with concrete reform initiatives that must be executable in practice.

In short, it is time to turn cautiously bullish on China. Smart money will likely keep pouring into HK/China. Both HKD and CNY will continue to be well buttressed by hot capital inflow in the near term. Should economic fundamentals in 4Q12 and thereafter subsequently confirm the earlier bets by such smart money, monetary authorities in HK/China will have a hard time dealing with inflow.