Dire Straits

Over the past two decades, China’s economy has increased in value by a staggering six times!

Far beyond the most optimistic expectations, propelling it into second place behind the US in the world rankings, with a GDP of c. $19.4trillion. China has been a big winner of globalisation and grew its economy through the development and subsidization of low-cost manufacturing, backed by a highly supportive central government. Having exited it’s draconian zero tolerance Covid-19 policy, China’s economy, like those in the West, was expected to see a post-pandemic bounce. However, growth is now stuttering, the property bubble has spectacularly imploded and unemployment is rising.

What has gone wrong?

The global pandemic, war in Ukraine, a trade war with the US and concerns about supply chain security. This has seen more manufacturers pull production of components from China fearing further lockdowns, logistics disruption and trade embargoes, due to China’s stated ambition to re-take Taiwan. China is experiencing deflation as manufacturers struggle to shift inventory and there has been a loss of consumer confidence as Chinese manufacturers cut back on hours worked and wages. This has, in turn, hit the heavily indebted Chinese domestic property developers. China’s national debt, if off-balance sheet state municipal debt is included could be over 250% of GDP. China is the world’s biggest property market and its implosion has seen Evergrande become the world’s most indebted property firm resulting in it recently filing for bankruptcy protection. Country Garden, which was once China’s largest property developer by revenue, also faces a risk of default in the coming weeks. Indeed, firms covering 40% of Chinese home sales have defaulted.

No wonder the People’s Bank of China (PBoC) said ‘the economy faces new challenges.’  The PBoC has been trimming key lending rates, but there has not been another major stimulus package – so far.

Will China push the global economy off course?

Hopefully not. However, the IMF earlier this year forecast China will remain the top contributor to global growth over the next five years and is expected to represent over 20% of total world growth – double that of the US.  On the other hand, China’s deflation would actually be good news for the West’s fight against inflation.

China wants respect from the West and to sell its products into Western markets. The West wants the same, but needs to re-onshore manufacturing, to secure key raw materials. This may provide some leverage to and ensure China drops its ambition to invade Taiwan and expansion in the South China Seas. This is not going to be easy to resolve.

Let us hope that President Xi Jinping does not use Taiwan and military action, as a means of deflecting attention away from China’s economic woes. President Joe Biden, said he expects to meet Chinese leader Xi Jinping sometime later this year. However, last week the US, Japan and South Korea agreed a ‘new chapter’ of a close three-way security co-operation that has already upset Beijing. Nor will relations be helped by a report from the Observatory of Economic Complexity which believes it has uncovered China’s involvement in arming Russia with a range of military equipment.

 

What have we been watching?   

 

An important week with the gathering of the leading central bankers at the annual Jackson Hole conference in the US. Weak European and Asian business activity indicator readings suggesting a few countries are in contraction while the US is just about hanging onto growth. This news was the   countered by the US tech sector with a strong earnings report from AI chipmaker Nvidia which reported a 170% increase in quarterly sales revenue. Nvidia’s market value increased by 6% and it is now one of the ‘Trillion Dollar Club’ alongside Apple, Microsoft, Alphabet and Amazon.

Central bankers and the UK Chancellor will no doubt be sighing with relief. Wholesale gas prices in Europe have fallen after a planned strike at Australia’s largest LNG production plant looks to have been averted. Meanwhile, European gas storage capacity is currently almost at 92%. The UK energy price cap is set to drop by 7.2% starting on October 1st, going from £2,074 to £1,923. This reduction reflects the ongoing decrease in wholesale energy prices as the market stabilizes.

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In the UK, public sector borrowing came in at £4.3bn in July, lower than forecast helped by strong self-assessment tax receipts. While giving the Chancellor a bit of headroom, substantial drains on the public finances remain such as the government commitment to the pension triple lock. Government borrowing remains under greater scrutiny by credit rating agencies. The UK’s current debt-to-GDP is about 100% – far above the 45% median for ‘AA’ for countries that credit agency Fitch cited when it downgraded the US ‘AAA’ rating. Meanwhile, the August UK PMI manufacturing activity indicator remains in contraction with a reading of 42.5. This weak manufacturing data may counter the previous week’s strong wage growth when the Bank of England considers interest rates. Indeed, futures have edged slightly lower signalling peak UK interest rates of 5.75% with a small chance of going higher.

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Europe’s largest economy Germany is ‘still lacklustre and experiencing a period of weakness’ according to the Bundesbank. Germany remains a major trade partner with China which is creating an additional headwind to its manufacturing sector’s previous reliance on cheap Russian energy. This was reflected in the latest PMI manufacturing activity indicator reading of 39.1 -contraction. French manufacturing also remains in contraction with a reading of 46.4.

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US mortgage rates continue to rise with the average 30-year mortgage over 7.3% and not surprisingly mortgage applications are at their lowest level since 1995. The US August manufacturing PMI activity indicator remained in contraction at 47.0 although the composite, which covers the manufacturing and service sectors remained in expansion, just about, with a reading of 50.4.

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China’s domestic economic woes were further highlighted by reports that Chinese property developers need to liquidate $2trillion of property to pay down debt.

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Brent oil remained around $82 as China’s economy continued to overshadow the market.

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A proud India was quick to note that the country’s successful South Pole moon landing, which came after a Russian spacecraft on a similar mission had crashed, was far cheaper than making a Hollywood a sci-fi epic. The launch budget came in at $75 million, less than the cost to produce the 2013 Hollywood space thriller ‘Gravity,’ and significantly cheaper than the $165 million hit, ‘Interstellar’.

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Finally, July’s wet weather looks to have taken a toll of motorists. According to the AA, car breakdowns due to potholes soared by 20% in July. Common incidents included damage to shock absorbers and dented wheels. Not great for drivers, although garages will no doubt welcome the extra work. The Department of Transport is allocating over £5bn between 2020-2025 to resurface roads but say it is up to local authorities. Meanwhile, one recent estimate suggests it would cost £14bn to bring roads in England and Wales up to scratch.

 

Read Last Week’s Alpha Bites – Looking over the pond

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.