China’s construction decline
The below graph reflects the recent decline in construction in China, as well as the boom and bust cycles in China’s past. While construction growth rates remained strong from 2000 to 2007, and had rebounded post-2008 crisis, construction growth rates have once again bottomed out at a 0% growth rate over the prior year. This article considers the trends in construction growth within the context of overall investment in China’s economy, and considers the implications for China’s equity markets.
A slowdown in investment
As we noted in the first part of this series, China has seen investment as a percentage of its economy continue to rise dramatically post-2000. Over the past year, overall investment as a percentage of China’s total economy has finally showed some signs of slowing down, as investment has fallen from 47% of the economy to 46% of the economy since 2009. While the slowdown in investment is encouraging, you could argue that investment levels are still far in excess of what the Chinese and global economies can support under current economic growth conditions. As China’s consumption rates as a percentage of the total economy have been declining for many years, it’s especially possible that these trends in strong investment and weak consumption could reverse.
As the above graph suggests, the more dramatic decline in construction over the past year in China is a contributing factor in China’s overall declining rate of investment. This economic data reflects much economic data seen across the globe: economic conditions softened post-2008 crisis—though they improved from 2009 until 2012, as large government stimulus spending compensated for a decline in private sector consumption and investment. However, over the past year, the government stimulus is beginning to wear off, and the private sector has yet to pick up the slack in the overall economy.
Emerging markets ripple effect
While the decline in construction in China might be encouraging in terms of managing oversupply in soft global economic conditions, raw materials exporters, such as Brazil, will likely be affected by China’s slowing imports of construction materials, such as iron ore. Iron ore and minerals producer Companhia Vale Rio Doce (VALE) has seen its stock price fall from $35 per share to closer to $15 per share since January 2009. With slowing demand in the United States and European Union, China will therefore be importing fewer raw materials from other emerging market countries, and purchasing manufacturing indices in emerging markets, such as Brazil, have moved from expansionary to contractionary levels since the beginning of 2012.
Going forward, investors will need to be mindful of declining investment, including construction-related investment, on China’s overall economic growth rates. Plus, should China’s slowing growth rates post-2008 continue, other emerging market economies and equity markets will also experience additional pressures.
For investors who think China can orchestrate a smooth deceleration in economic growth without significant disruptions to the banking system and also contain inflation, enhance productivity, manage investment growth, and grow domestic consumption, perhaps the weakness in Chinese equity prices over the past two or three years would present a more attractive price. China’s iShares FTSE China 25 Index Fund (FXI) is down roughly 15% from its November 2011 post-2008 highs. For China skeptics seeking to embrace the more recent economic trends seen in Japan and the United States, as reflected in Japan’s Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan (EWJ), as well as the USA S&P 500 via the State Street Global Advisors S&P 500 SPDR (SPY) and Blackrock’s S&P 500 Index (IVV), the US and Japan markets may appear more attractive than China’s iShares FTSE China 25 Index Fund (FXI) and South Korea’s iShares MSCI South Korea Capped Index Fund (EWY). For further analysis as to why Chinese equities could continue to underperform Japanese equities, see Why Japanese ETFs outperform Chinese and Korean ETFs on “Abenomics.”
For related analysis, please see the following series.