China’s leadership transition reveals steady growth likely to continue

But is Chinese growth data overstated?

An oft stated concern is that Chinese economic data is unreliable. During the strong years last decade China was frequently accused of understating growth. In recent times it has been claimed that it has overstated growth. As evidence for this many cite electricity production, which had been running well below the official growth rate. However, it’s worth noting that electricity production is traditionally more cyclical than GDP growth – reflecting its link to the energy intensive and volatile manufacturing sector. As a result electricity production slows more when growth slows. The next chart suggests this relationship is normal.

Source: Bloomberg, AMP Capital

While Chinese economic data is unlikely to be as precise as that seen in rich countries, the fact it shows both good and bad times, lines up with surveys conducted by foreign organisations (e.g. the HSBC/Markit PMI) and cross-checks against other countries’ export data suggests its roughly right.

What about the leadership transition?

Will it result in abrupt policy changes? The short answer is no. The new Chinese leadership, likely headed by Xi Jinping as president and Li Keqiang as premier, have been involved in policy setting for the last five years. They are unlikely to announce abrupt changes in policy from day one. Rather policy change will likely continue towards a greater reliance on market forces but is likely to remain gradual.

The outgoing president announced a target to double GDP by 2020, which implies annual GDP growth of 7% pa. While such a growth rate is well down on the 10.8% of the last decade, it is still very strong. China’s catch up potential remains immense. On a per capita basis, roads, railways, airports, phone lines, living space and cars are well below US and Australian levels. The next table highlights that it’s very hard to see any evidence that China has massively overinvested in infrastructure.

Huge catch up potential in China

Source: Bank Credit Analyst, AMP Capital

Consistent with this, the key drivers of China’s growth remain in place, via urbanisation (with the urbanisation rate being just over 50% there is still a long way to go) and strong productivity growth (on the back of high levels of investment).

What about Chinese shares?

Chinese shares have been in a bear market since August 2009 and have seen a fall of 41%. This has seen valuations become very cheap – with a price to historic earnings ratio of 11.2 times against a long-term average of 31, and a forward PE of just 9.6 times, suggesting a hard landing is factored in and pointing to the potential for attractive returns on a medium-term basis. This suggests Chinese shares are very attractive as a long-term investment destination.

Source: Thomson Reuters, AMP Capital

Concluding comments

Recent indicators suggest that Chinese economic growth is bottoming around 7.5%. While we don’t expect a strong rebound or radical changes following the leadership changeover, a hard landing is looking less and less likely. This should ultimately be positive for Chinese shares. A stabilisation in Chinese growth around 7.5% should also be positive for the Australian economy and resource stocks.

Key points

• After surprising on the downside into mid-year, recent Chinese economic indicators suggest growth is bottoming and is likely to come in around 7.5% this year.
• However, a sharp growth rebound is unlikely as policy has not been eased enough and export growth will be constrained by recession in Europe and slow growth in the US. Expect growth in 2013 to also be around 7.5%
• Radical changes in policy direction are unlikely under the new leadership. Change will likely remain gradual.
• Chinese shares are cheap and have probably bottomed.

Dr Shane Oliver is the head of investment strategy and chief economist at AMP Capital. Please note that this article is intended as general information and not as investment advice.