The markets saw a jump in volatility last week, and while stocks in US and Europe ended the week with gains, Chinese stocks ended lower. The Shanghai Composite fell 7.9% for the week. Macquarie Equities Research (MER) released a research report this morning, excerpts are found below…
 
Global markets under extreme volatility: Last week, A-shares slumped 15% in the first two trading days, breaking below the 3,000 level, possibly due to the miss of a reserve requirement ratio (RRR) cut over the previous weekend. Triggered by the concerns on China, global markets also suffered panic sell-offs. On Tuesday evening, the PBoC was forced to make a double cut (Interest rate and RRR) to calm the market. A-shares recovered a bit after that, closing the week down 8%. H-shares fell for the third straight week by 4%, while northbound buying under the Stock Connect saw the largest weekly inflow since the program’s inception last Nov. Global markets calmed down later as well, after the U.S. 2Q GDP was revised to 3.7% on Thursday.
 
Expect better headline growth in Aug due to low base: This round of global sell-off was partly triggered by China hard landing fears, which are overdone, in MER’s view. Within the next two weeks, China will release Aug macro data, which could help alleviate the current growth and deflation fears. In short, headline industrial production growth in Aug could rebound mainly due to a low comparison base, while CPI inflation could rise to the highest level seen in the past 12 months. Meanwhile, MER sees policy makers are serious about the 7% growth target for this year and thereby policy easing has been ramped up. As such, MER expects a U-shaped path from 2Q15 to 4Q15 (GDP: 7.0%, 6.8% and 7.2% in yoy terms).
 
Rebalancing underway quietly: If one chooses to focus only on the upstream industrial sectors in China such as energy and mining, one might conclude that China’s economy is in deep trouble. However, if one looks at the whole industrial landscape, one might have a more sanguine view from better performances in those downstream industrial sectors. The picture would be more comprehensive if one were to look at consumption. Despite all the hard landing fears, Chinese consumers drive more, as gasoline consumption grew 13% yoy in 1H15. They travel more, as Ctrip, China’s largest online travel agency, saw revenue up 46% yoy in 1H15. They also enjoy more leisure time, as movie cash box increased by 48% yoy in 1H15. Overall, MER sees China is still in a rebalancing process, which could be quite painful sometimes. But it doesn’t look like a collapse underway.
 
Latest update on local government debt: Over the weekend, the National People’s Congress disclosed the latest numbers for local government debt. As of end-2014, total local government debt was RMB24tn, up from RMB18tn as of mid-2013. With the central government debt added, China’s total government debt to GDP ratio was 58% as of end-2014, up from 52% in 2010. Also last week, the Ministry of Finance announced that the quota for local government debt swaps will be raised to RMB3.2tn this year, up from RMB2.0tn. It will lead to higher local government bond issuance later this year, giving more ammunition to local governments for infrastructure investment.
 
RMB to remain stable in the near term: Now it should be clear to Beijing that RMB devaluation will only bring a currency war. Since the surprising devaluation on Aug 11, the majority of EM currencies have depreciated even more than the RMB. Given the turbulent global environment, Beijing might increasingly value a stable environment. USD/CNY could be range-bound at 6.4-6.5 toward the year-end. MER even sees some risk that the RMB could strengthen from the current level of 6.40 as a way to reduce capital outflows. For next year, MER marks to the market by forecasting further depreciation to 6.60. But it’s a low conviction call due to huge uncertainties around it.

Source: Macquarie Research - 31 Aug 2015