China is facing into a period of painful economic adjustments

On February 8th, China will celebrate the Year of the Monkey. The monkey is famously a smart, naughty, wily and vigilant animal, and anybody trying to make money in the rest of 2016 will have to learn how to outsmart the animal.

A useful barometer of the Chinese economy is always to look on the streets and see what cars are clogging up the dual carriageways and main roads of the big cities like Beijing, Shanghai and Guangzhou.

By this measure, the world’s second largest economy is doing pretty well.

Sentiment is not good as far as monkeys go – it has remained below 90 since June 2014, far below the 100 breakeven level. According to the China Auto Purchase Sentiment Report, people are buying cars, but they are buying smaller, cheaper vehicles. Despite the fall in sentiment, this sees more Chinese households reporting that they currently own a vehicle.

The Car Purchase Indicator is a composite indicator designed to gauge future demand for cars and it fell 4.5 per cent to 83.2 in December from 87.1 in November, the lowest reading since April 2012.

But yet there is still obvious strength in the market. Despite a damaging emissions scandal, Volkswagen continues to lead the passenger car market in China, with deliveries of 2.63 million units from January to December. And while this is down 4.6 per cent, the fourth quarter of 2015 was a very successful one for the carmaker.

But then you look at the stock market.

With the nightmare of summer 2015 still fresh in the minds of badly burned retail investors, China’s stock market opened 2016 with a stark reminder that the fundamental situation in the markets remained deeply unstable.

China was forced to twice deploy its “circuit breaker” mechanism to halt trading as stock markets nose-dived by 10 per cent in the first week of the year.

After the second time, Beijing scrambled to abandon the mechanism, which the markets, especially overseas, had always considered a weak and useless measure. By abandoning the “circuit breaker”, the regulators appeared clueless on how to stabilise the market and the situation appeared to go back to square one.

Unlike many western economies, the stock market in China does not offer a bellwether of the overall health of the economy and even a massive slide on the stock market would be tolerable were the data coming out of the world’s second largest economy inspiring confidence on the future outlook.

New normal

However, these are the days of the “new normal” when the Chinese government is trying to sell the idea of slower, consumption and services-based growth and move away from the heady days of double-digit expansion which defined the economy for the past two decades.

Gross domestic product growth fell to a six-year low of 6.9 per cent in the July-September quarter and is forecast by the International Monetary Fund to decline further to 6.3 per cent in 2016. This level of growth is not enough to keep generating new jobs – there are more than 7.5 million graduates expected to enter the labour market later this year and robust growth is needed to keep the economy expanding at a rate that will maintain stability for the ruling Communist Party.

Cheng Shi from ICBC international research group expects growth to continue to slow in 2016.

“Firstly, the global economic recovery means weaker external factors for China’s economic growth. Secondly, for the last 30 years, China has accumulated massive capacity and the difficulty of keep on growing is increased and the growth rate declines naturally. Thirdly, it is affected by the ageing population and the labour cost has been growing for a long time. Fourth, the real estate market is going through an adjustment period,” said Cheng.

In the short term, the risks caused by structural economic adjustments will keep on showing and the pain is unavoidable, said Cheng.

“In the long run, the opportunities brought by deepening economic reform will gradually start to appear and the rise won’t stop,” he said.

"I think at the bottom of this is a fundamental story about a slowdown in China," Peter Oppenheimer, chief global equity strategist at Goldman Sachs told CNBC. "The focus at the moment is the ongoing weakness in the manufacturing sector but also the lack of evidence that traditional policy easing is really stabilising the economy."

He underlined concerns about further weakness in exchange rates, and the possibility for that to flow through the broader markets.

The collapse in growth shows that investors are reluctant to buy into the government vision of the “new normal”.

China’s stock market more than doubled between late 2014 and June, then dived by 30 per cent, an event that caused deep pain among retail investors.

"We expect growth momentum to slow in the first half of 2016, and for headline growth to fall to 6.4 per cent in the second quarter of 2016, before recovering in the second half of 2016 as more easing measures kick in," HSBC said in a research note.

“Policymakers need to strike a balance between financial and SOE reforms and the need to reflate the economy,” HSBC said.

To this heady brew, add in the slide in the Chinese yuan currency to a five-year low against the dollar, which has forced the government to spend tens of millions of dollars from its foreign currency stockpile to defend it, and you can see a perfect storm of negative factors clouding the outlook for the Monkey Year.

Overall it was the worst beginning to the year for the Chinese yuan since 1994, on growing concerns that the economy is weakening further.

The government last week guided the yuan 1.5 per cent lower to give a boost to the country’s export sector, which is bearing the brunt of China’s goods becoming expensive overseas compared to other Asian neighbours. The move to lower the yuan was not deftly done, and the resulting nervous reaction further weighed on share prices.

"Upbeat trade data could go some way to reassure global investors that China's economy is stabilising," said Tom Rafferty, lead China analyst at the Economist Intelligence Unit. "The data is in line with other indicators that suggest China's economy is stabilising on the back of sustained stimulus measures, some of which have been targeted at the external sector."

“There will be some qualms expressed about the reliability of the data, given the weaker performance in December of other major Asian exporters. However, China has consistently outperformed the region in what was a difficult year for global trade,” he said.

Then you have other anomalies.

During 2015, seven property developers reported annual sales of more than 100 billion yuan (€14 billion) as the property market continued to perform strongly, despite a slowdown, while a total of 104 developers reported annual sales of over 100 billion (€1.4 billion) in the same period.

The top three by sales were Vanke, with 261 billion yuan (€36.6 billion), Greenland with 230 billion (€32.3 billion) and Evergrande with 200 billion yuan (€28 billion). All involved will be hoping they can outsmart the monkey again in 2016.