It’s been clear for a while now that China’s economy is slowing down quite sharply.
China’s manufacturing sector barely grew last month. The results from the latest manufacturing survey were also worse than analysts had expected.
The authorities are clearly getting worried. They have cut interest rates and are encouraging the banks to start lending more once again. So far, the only impact seems to be in the Chinese property market, which is the one area the government really doesn’t want to reflate.
But while the economic data is looking fragile, for the really grim news you have to look at Chinese companies.
The Outlook for Chinese Companies Isn’t Pretty
The giant state-owned enterprises have posted their worst figures since the grim days of 2008. First-half profits were down 11.6% on the year. The main casualties so far have been commodity-related companies. Chinese steelmakers have seen profits dive by 96% – it’s been described as a ‘disaster zone’ by the China Securities Journal.
But the big hope for China’s economy – its consumer sector – is also suffering. As the FT notes, everything from electronics retailers to airlines to sportswear companies are running into trouble.
There are two key issues, according to Société Générale economist Wei Yao. The first is that, because of China’s economic slowdown, inventories have been building up. That’s bad news for profits: it means companies have to cut prices to shift stock. It also makes life harder for product producers, because companies won’t order as much stock in future.
The second problem is tax. While profit growth has been slowing, tax bills are higher than they were in the first quarter. This squeeze on private companies is ‘pushing China into a state of profitless growth’, argues Yao.
The authorities are trying to turn things around. Indeed, many analysts are placing their bets on a second-half recovery. Ambrose Evans-Pritchard, writing in The Telegraph, suggests that China has plans to ‘ditch its reform strategy and prepare a vast stimulus package as the country’s soft landing turns uncomfortably hard’.
It’s certainly possible. We always say that politicians take the path of least resistance. And while the central government might be talking a big game, the regional governments are keen to boost their growth again.
But any big stimulus measures will just boost inflation and increase the bad debt load across the Chinese economy. That would set up China’s economy for an even harder landing in the future. And if there’s conflict between the central government and regional ones over this, I’m not convinced that a lending boost would have the same impact as it did in 2008.
We’ve been suggesting that you avoid industrial metals miners and ‘base’ commodities in general. The good times also seem to be ending for luxury goods companies. And we’re certainly not ready to buy Chinese equities yet.
And it’s why we’re staying bearish on China’s economy.
Contributing Editor, Money Morning
Publisher’s Note: This article originally appeared in MoneyWeek (UK)
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