The stimulus fades and trade growth slows: A problem for future growth expectations?
The below graph reflects an apparent decline in the rate at which Chinese exports and imports have been growing. The red line reflects the rate at which exports exceed imports (trade surplus). Though growth rates in trade declined in the wake of the year 2000 Dot Com bubble and the 9/11 incident, subsequent stimulative measures on behalf of the Bush Administration (the Bush Tax Cuts) reinvigorated the U.S. economy, to include the U.S. consumer. Chinese trade activity subsequently remained brisk until the 2008 crisis arrived. Since 2008, Chinese trade data may have entered a new, slower growth phase. This article takes a look at the recent slow-down in China’s trade data and considers the implications for Apple’s sales outlook in China.
Stimulus measures fading in China: Will the recovery be self-sustaining?
In November 2008, the Chinese government announced a $586 billion stimulus package to maintain economic growth targets of over 7% per annum. Plus, local governments spent at least another $500 billion or more to support their regional economies in China. As in the USA, under the $700 billion Troubled Asset Relief Program (or TARP), these measures staved off a crisis and led to a strong bounce in economic activity. However, as a few years have passed, these stimulative measures have begun to wear off, and growth rates have returned to lower-than-normal levels. Capacity utilization in steel and cement is in the 70%-to-75% range—well below the 82% target. As the above graph reflects, China’s total exports may be topping out, as growth in exports and imports is pretty close to zero.
When exports are 27% of gross domestic profit and exports flatline, it becomes harder for China to hit an overall GDP growth target of 7.5%. When investment levels are running at record high levels of over 47% of GDP due in part to stimulus-related spending of around 5% of GDP per year since 2008, it becomes harder for China to hit an overall growth target of 7.5%. Consumption has bounced a few percent from 31% to around 34% of GDP per year since 2012, though not enough to offset the flatlining export growth data. So, if China wants to maintain 7.5% growth, it may have to run more government deficits (the government has low debt levels, so this isn’t a problem yet, as long as Chinese banks aren’t failing). Or, China can keep on building factories and push capacity utilization levels even lower, which will likely make Chinese banks trade even further below book value.
Lastly, China can and consume and build 1 billion iPhones at $200 every year to prop up the economy. That’s roughly what it would take to offset the 2.5% drag on GDP growth that could be generated by flat export growth. That would be a lot of iPhones—about $200 billion worth. Apple’s China revenues are already just over 10% of that number. Perhaps domestic consumption, at half U.S. and Japan levels as a percentage of GDP, will add another 2.5% of GDP growth to compensate for the lack of export growth. This consumption growth rate versus export growth rate will be key in determining China’s overall growth rate and, to some degree, Apple’s China-based sales.
Sustainable growth, or moonshot growth?
As reflected above, China’s trade activity grew dramatically from 1999 through 2007—averaging nearly 20% per annum growth rates. It’s important to note that China’s GDP in 1999 was a mere $1 trillion U.S. dollars then, though it reached nearly $3.5 trillion by the end of 2008—more than tripling in size over these nine years of strong growth. China’s GDP was approximately $5 trillion in 2010, though it now stands at $8.2 trillion for the 2013 calendar year. China’s GDP growth rate averaged 9.2% from 1989 until 2013, reaching as high as 14.20% in December 1992, though falling as low as 3.90% as of December 1990 while China was in its earlier phase of expansion. China’s GDP hit a more recent high of 11.9% in the second quarter of 2010, in the wake of the massive government stimulus package, as we mentioned above. However, China’s GDP growth rate has been steadily decelerating, and it stood at 7.4% as of the end of the second quarter in 2014.
Trade is strong, while trade growth is slow
The above graph of trade activity reflects the associated decline in China’s GDP growth rates. Though absolute levels of GDP and production are impressive, the astronomical historical rates of growth in both the trade and domestic sectors of the Chinese economy show signs of slowing. As we noted in the prior series on wage inflation in China, China has enjoyed exporting into strong economies in the USA and European Union (EU) prior to 2008. Post-2008, both the USA and EU have relied upon government spending to fill the consumption gap created by consumers, which lost an average of 40% of net worth in the USA from 2007 to 2010 as housing and equity markets declined globally.
Global economies are picking up, and this should eventually support the soft PPI and capacity utilization data, as we noted earlier. The days of 10% to 20% growth in trade are probably over, though with a gross domestic product of over $8 trillion, even a 5% growth per year in trade, with trade at around 30% of GDP, means $120 billion per year in new trade-related economic activity. Apple’s China sales, in total, are just over $20 billion per year. A hypothetical slowing of trade growth to 5% per year would equate to about an incremental growth of $72 billion per year of electronics-related trade. At $600 each, 5% ongoing electronics-related trade growth for China could come to about 120 million iPhone 5s. Apple sold 34 million iPhones in 2013, though most were, older, cheaper models. These figures are merely intended to provide some insight into the size of Apple’s China-related business in proportion to China’s overall trade economy size and growth rates. Apple is definitely a big part of China’s trade with the world, though $20 billion in China-related sales versus China’s$2.4 trillion trade economy is just under 1.0% of the total trade economy of China.
The USA and EU: Growth is improving
There’s been some recovery in global economies in the USA, EU, and China as a result of governmental fiscal stimulus, though the levels of national debt have grown dramatically as a result. The U.S. has managed to move real GDP growth rates from -2% to over 2.0% since the 2008 crisis. The IMF notes an anticipated growth rate in the USA of 2.8% for 2014 versus 1.9% for 2013. After six quarters of contraction, Euro area GDP finally turned positive (0.3%) in the second quarter of 2013. The IMF projects Euro area GDP growth to strengthen to 1.0% in 2014 and 1.4% in 2015. Like the USA, weak population and productivity growth, combined with low levels of new investment, have meant historically weak growth data.
Asian equity outlook
The weakening yen and relatively flat wage growth in Japan have supported Japanese markets, as reflected in the Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan (EWJ) ETFs. Aggressive monetary policy in the USA has supported the S&P 500, as reflected in the State Street Global Advisors S&P 500 SDPR (SPY), State Street Global Advisors Dow Jones SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV), which have been up nearly 18% over the past year.
However, tapering is now in play, and higher rates in the five-year Treasury could cool U.S. valuations going forward. Given China’s current financial challenges in the banking system, both the U.S. equity markets and the Abenomics-driven Japanese equity markets may continue to outpace China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). However, if U.S. valuations continue to increase over the year, China’s valuations should eventually become increasingly compelling. With FXI’s key holding, the banking flagship Bank of China, trading at 0.84 price-to-book ratio and a 4.95 price-to-earnings ratio, you have to wonder how much lower Chinese banks and financials could go.
To see why Japan’s ETFs DXJ and EWJ have been outperforming China’s FXI and Korea’s EWY, please see The Bank of Japan Tankan supports a 2014 Japanese equity rally.