Exposed in 2014: Measuring Exposure to China’s
Investment-Led Slowdown
By Ian Watt, Mike Liu and Adam Wolfe
Bottom line: China's investment-driven slowdown (RGE's most out-of-consensus view at present) remains underappreciated by markets. Our new Exposure to Chinese Investment Slowdown Indicator reveals countries’ overall exposure to shifts in Chinese and global demand for a number of key commodities, trends that will privilege consumption goods over metals. Combined with our Fed normalization indicator and market valuation, this metric reveals which EMs are vulnerable or resilient to these two key themes that will drive markets in 2014.
In EM equity, we see strong reasons to avoid South Africa next year because of its high valuation, significant exposure to the Chinese investment slowdown and weakening balance sheet (in terms of its reliance on external borrowing). Meanwhile, Russia’s growth stabilization, relative insulation from the Chinese investment slowdown and attractive valuation support our shift to a tactical long on
Russian equity, even though this asset class tends to be more correlated with global EM equity
(Figure 1).
For EM local currency sovereign debt, we see reason to be wary of Chile, not only for its direct trade exposure to China, but also for its indirect exposure via Chile’s trade partners. We also suggest avoiding South Africa as a result of its high exposure and overvaluation. By contrast, Brazil looks attractive, in part because it is approaching the end of its rate-hiking cycle.
Figure 1: Avoid South Africa, Favor Russia (equity valuation and combined Fed and China exposure indicators)
Valuation Score (relative, P/B over DM/EM Avg, vs. its
10y history)
3.5
Weak and Expensive South Africa
3.0
Philippines
2.5
Mexico
Malaysia
Thailand
2.0
Poland
Indonesia
1.5
Turkey
1.0
Chile
Brazil
0.5
Hungary
Peru
0.0
Singapore
-0.5
-1.0
India
Colombia
Argentina Egypt
Czech Republic
South Korea
Russia
Strong and Inexpensive
-1.5
2
3
4
5
6
7
8
Exposure to China Investment Slowdown & Fed Normalization Indicator
Two themes dominate the global macro outlook for 2014: The tapering of QE in the U.S.; and the rebalancing of Page | 2
1
Chinese growth. This paper focuses on the latter.
Our view on Chinese growth remains well below that of consensus: RGE’s baseline forecast for full-year 2014 is
7.0%, slipping to 6.5% by Q4 and below 6% in 2015; the Bloomberg consensus stands at 7.5% for 2014 and 7.2% for
2015. Bad debt accrued by local governments and the shadow banking system will require a partial bailout sometime around mid-2014, choking off investment and leaving the country without an immediate compensating source of growth. In addition to imposing a drag on Chinese output, the investment slowdown and rebalancing process will place disinflationary pressure on goods price increases and contribute to the end of the commodities super cycle. As a result, investment-based commodities, such as industrial metals, are likely to underperform consumption-oriented commodities, such as crude oil and agricultural products.
To measure the potential impact of the multi-year deleveraging process as the economy rebalances away from investment-led growth, we introduce the Exposure to Chinese Investment Slowdown Indicator. This
