China Macro:Oct data,Strong but unsustainable

Today, China released macro data for Oct, which is in line with the marketexpectation. The data suggests that the economy is on track to 6.7% yoyGDP growth in 4Q16. Power output grew by 8% yoy, the fastest pace sinceDec 2013. Meanwhile, inflation also picked up and market concern is quicklyshifting from deflation to inflation. In our view, what’s more important is thatthe property sector is cooling on the recent tightening measures and that thisis starting to impact related sectors like auto sales. Overall, the economy islikely to slow again early next year and the current reflation trend could peakin 2Q17. The policy stance could turn more expansionary at that time.

    Property is cooling: 20+ cities tightened property policies in early Oct. As aresult, property sales growth slowed to 26% yoy in Oct from 34% in Sep. Dueto slower property sales and the high base last year due to tax cuts, autosales growth slowed to 9% in Oct from 13% in Sep. As a result, retail salesdropped to 10% growth in Oct from 11% in Sep, because auto is the largestcomponent in consumption. Looking ahead, property sales could softenfurther due to the base effect and policy tightening. In Jan-Oct, investmentand new starts rose by 7% and 8% yoy, compared with +1% and -14% in2015. Both could slow notably entering 2017.

    Strong industrial production but unsustainable: Industrial production (IP)growth was flat at 6.1% yoy in Oct (consensus: 6.2%). Key products such aspower, cement, steel and auto are all running at a robust pace. That said,entering Nov, coal consumption at major power plants has been slowing.

    It’s likely that IP growth will start moderating in Nov and the months ahead.

    Meanwhile, Fixed asset investment (FAI) growth was stable, up 8.3% yoy forJan-Oct. Other than the 13% yoy growth of property investment, infrastructureand manufacturing investment grew 15% and 3%, respectively. Lookingahead, infrastructure FAI could further ramp up to (partly) offset the slowdownin property FAI.

    Private investment continued to recover: During the recent summer, themarket was quite concerned about zero growth in private investment.

    Encouragingly, private investment rebounded in recent months, to 6% yoy inOct. Our channel checks suggest that it was helped by the reflation trend andimproved end-user demand. Earnings growth for China’s industrial companiesaccelerated to 13% yoy in 3Q16, compared with -2% in 2015. We expectearnings growth to further accelerate in 4Q16 but moderate after that.

    Taking stock: With the Oct data, we see the economy achieving 6.7% GDPgrowth in 4Q16 before moderating in 1Q17. Reflation should continue in thenext few months but peak in 2Q17. Property investment and new starts couldhold up for the rest of this year, before slowing notably entering 2017. Exportslook fine for now and could recover to low single-digit growth in 2017.

    However, uncertainty increased after the US presidential election. In theupcoming Central Economic Work Conference, policy makers might fine-tunetheir growth targets for next year, as China’s growth could slow to 6.4% in2017 from 6.7% this year. The tricky part is currency. The better-thanexpectedFX reserves data in Oct suggests that the PBoC is intervening less,leading to the recent accelerated depreciation. But the jury is still out onwhether the PBoC’s goal is to engineer higher volatility and kill depreciationexpectations (our view), or to manage a 5% depreciation each year (themarket consensus).