Santa Barbara, CA – (StockNewsDesk) – 09/24/2014 — Many had hoped the Chinese economy was re-accelerating, finally turning a headwind for the global economy into a powerful tailwind, more than five years after a worldwide rally in asset prices. Instead, the trend of slowing growth continues unabated.
Goldman Sachs joined other Wall Street banks, such as Bank of America Merrill Lynch and Royal Bank of Scotland, in downgrading China’s growth outlook for the third and fourth quarter. Both quarters’ estimates were reduced to 7.1 percent, from 7.2 and 7.3 percent, respectively. Overall, 2014 growths were estimated to come in at 7.3 percent, a slowdown from the previous year’s 7.7 percent. 2015’s annual growth rate was also downgraded, in expectations that the central government will continue to prioritize financial stability over growth.
The main driving force for the downgrade was manufacturing data, which reversed the slight uptick in previous months, suggesting the improvement was transitory. Furthermore, the credit conditions continue to tighten in the country, increasing risk in future months and years. Goldman Sachs believes that property prices and inflationary pressures will continue to hamper the Chinese economy years into the future, with growth falling to 6.7 percent in 2016 and 2017, the lowest rate in decades.
Commodities – A Canary in the Coal Mine
One early hint to the weak manufacturing data was the freefall in commodity prices such as copper, oil, and other industrial metals. This weakness was a sign that Chinese factory production was slowing. China remains the largest consumer of commodities and has the biggest impact on marginal demand.
Another contributing reason is the strong dollar, which pushes down commodity prices but also tightens credit conditions, especially in emerging markets. This is another drag on demand for Chinese goods. Commodity price action will be an important real time indicator of the Chinese economy, making it a good counter to the lagging economic figures.
Shanghai Stock Exchange Rallies on Stimulus Hopes
Interestingly, the Chinese stock market rallied on the downgrades and weak economic numbers. In fact, while many global stock indices have been weak, the Shanghai Stock Exchange has defied this trend. This is one sign that market participants have already discounted this bad news. One sign of a strong trend is that it can rally on negative news.
Furthermore, the relative strength is impressive, given that China’s stock market remains at 2009 lows, while global stock indices are 100-250% above these levels. One possible reason for the strength is that it increases the chances that policymakers will shift their focus from financial stability concerns to stimulating the economy.
In this scenario, it makes sense that the slowing manufacturing data, retail sales, investment, and deflating property market would fuel increases in stock prices. Most likely, policymakers would stimulate by cutting interest rate and reserve requirements. The expectation is that 7% is the unofficial line in the sand, although the official target remains 7.5%. Unless drastic action is taken, this target seems unattainable this year.
Policymakers are in a precarious battle between draining some of the excesses in the market while still hitting growth targets. In recent years, because of mounting inflation and a booming property market, the focus has been on financial stability. Now, with growth slipping below target and pressures, easing of the market’s anticipation of monetary intervention seems rational.