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As China Growth Slows, U.S. Companies See Falling Profits

Beijing’s movers and shakers are meeting for the so-called “two sessions” this week, where they will discuss things like trade wars and economic development. The first order of business for the market: a new GDP target range that puts guidance as low as 6% to as high as 6.5%.

China is officially slowing. The 6% target is the lowest target set since the Great Recession of 2009. U.S. companies based there say they are expecting lower profits this year as a result of changing economic dynamics in the world’s No. 2 economy.

The high-end target of 6.5% GDP growth suggests Beijing has no plan for a 2009-style stimulus package , either. Investors have been daring China to increase stimulus, driving up mainland equity prices since the start of the year.

Premier Li Keqiang delivered his GDP target to the National Party Congress in Beijing on Tuesday.

More stimulus is coming, even if it is not the kind of bridges-to-nowhere and shadow banking stimulus that propped up Chinese markets for over a decade. Xi Jinping appears to have no appetite for increasing leverage.

“China is shifting focus…to improving growth,” says Meghan Shue, senior investment strategist for Wilmington Trust. “A de-emphasis on leverage concerns and an increased emphasis on tax cuts, for example, would be encouraging for emerging market equities over the next 9-12 months.”

Some of the newest fiscal stimulus measures include lower taxes and corporate pension payments getting cut by nearly 2 trillion yuan. The manufacturing sector will see their Value-Added Tax (VAT) rate go to 13% from 16%. And on the trade war front, there is a proposal that would give foreign entities the same rights as domestic entities when doing business in China. Chalk that up as a quiet win for the Americans in the ongoing trade spat between the two sides.

China’s economy has been showing signs of a slowdown for years. U.S. companies are no longer seeing the big profits from China compared with the rest of the world.

Worsening industry conditions and increased costs are also factors driving down profits. U.S. technology companies say their profitability is being hampered by competition from privately owned Chinese companies, according to a survey published this month by the American Chamber of Commerce of China.

Earnings before interest and taxes, or EBIT margins, are now lower in China than the rest of the world for more than a third of AmCham’s members. Thirty-six percent of them reported lower EBIT margins in China than globally in 2018, about the same proportion as in 2016.

China is still a top priority for American companies. But slower economic growth, uncertainty over the trade war, and modern China’s tighter regulatory and labor laws all have executives expecting lower returns this year. China is more expensive than it was 10 years ago. The added weight of Trump’s trade war is a new headwind.

Some 32% of respondents to the AmCham survey said they will invest less in China this year, compared to 26% who said so about 2018.

For the short-sellers out there, China’s economy is far from dead. Betting against Beijing has been a stellarly bad career move for an emerging market money manager.

The private Caixin China PMI Composite is over 50, hitting 50.7 in February. It was 50.9 in January. Anything over 50 is positive. Caixin’s Services PMI was 51.1 in February, down from 53.6 in January, which was the Lunar New Year month.

“China is pushing on the stimulus pedal,” says Brendan Ahern, CIO for KraneShares, a China ETF company based in New York. “Stimulus is beginning to trickle through the economy,” he says.

Chi Lo, a Hong Kong-based strategist for BNP Paribas Asset Management thinks Chinese GDP comes in closer to 6.2% this year.

“There’s upside risk to that number,” he says. “If you don’t get an extension of tariffs, then I think you can see 6.5% or more.”

The Deutsche X-Trackers China A-Shares (ASHR) exchange-traded fund is up over 30% year-to-date and on par to push last year’s bear market back into its cave. The Deutsche ETF, which tracks the China CSI-300, is beating the MSCI China and the MSCI Emerging Markets Index so far this year.

Following the latest leg of the China equity rally, valuations are now approaching their long-term averages. Investors may start to become more demanding on trade talks and first-quarter Chinese earnings, UBS strategists led by Jon Gordon wrote in a note to clients on Tuesday.

A 6% GDP in a $13.6 trillion economy is a hard number for global fund managers to ignore.

Last week, MSCI announced it was increasing its weighting of mainland China equities in its China A Inclusion and the MSCI Emerging Markets Index. China A-shares are now a fixture in any emerging markets portfolio.

Despite the lower target today, China is one of the three largest and fastest-growing economies in the world.

“China’s obsession with stability in every vector is a (economist Herman) ‘Minksyite’ nightmare,” warns Brian McCarthy, chief strategist for Macrolens, a China-focused macro investment research firm in Conn. “The best case for 2019 is that they can continue to dance ever closer to the edge of disaster,” he says.

For China, Li Keqiang thinks 6% is the lowest they can go to keep unemployment levels stable in an increasingly automated, high-skill economy. Some investors think China’s been growing sub-6% for years.

Investors have been busy betting on China stimulus in the form of more debt. That seems less likely. Now investors are betting on a peaceful resolution to the U.S.-China trade war. Trump and Xi are supposed to meet later this month at the Mar-a-Lago resort in Florida.

A North Korea-style outcome in Florida would heighten stock market volatility risk, with mainland Chinese equities likely to get beat up most. A slowing economy and a trade war without end is a massive buzzkill for China investors.
Source: Forbes

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