2018 was a terrible year for the Chinese stock market. Will 2019 hold the same fate?

A slowdown in growth combined with the threat of a looming trade war between the US and China sent markets down last year — but this year the CSI 300 index is up almost 300 percent.

The question is: will this growth continue?

More to the point, what investment themes will give investors a clue on the fate of the Chinese economy, and how will that affect different industries around the world?

 

1. The material of choice: Copper

 

Industry analysts, from Barclays to JP Morgan, have predicted a shortage in copper supply as demand grows (by 5-6 percent), but supply fails to keep up.

In China, the crunch could be even greater.

Category-7 copper scrap has recently been banned, and imports of Category-6 will be restricted from later this year. Outside China there is less processing capacity, and there are higher costs.

Chinese copper analyst, Yang Changhua, predicted demand would slow to 2.6 percent by 2020 from 4 percent in 2018. Inevitably this will mean higher prices, and that’s bad news for buyers, but good news for copper explorers.

READ: Which commodities are set to…rock?

The material out of favour? Aluminium.

While demand is expected to rise, the industry is still reeling from shutdowns of the industry. Yet this may be good news for Aluminium buyers outside of China (except for those buyers from America) as long as the trade war goes on.

 

2. Credit crunch among local governments

 

Chinese local governments have been key drivers of the infrastructure boom that has driven economic growth — but the good times can’t last forever.

The money underpinning that infrastructure boom is largely debt now sitting on their books — and the debt pile could be larger than the 15 trillion renminbi which has been publicly disclosed.

While this is well below China’s GDP, we will see this burden brought under control in coming months. They may have to increase local taxes, particularly on property.

We may even see defaults or otherwise, short term scrambles to repay them. While we have never seen a default, there have been close calls.

One local government vehicle, in the Xinjiang region, nearly defaulted in August last year but repaid its bonds quickly after the deadline.

With 1.1 trillion renminbi due in 2019, some others may not be so lucky. Although in some circumstances, Beijing may intervene it will be increasingly difficult the more local governments default.

 

3. Banking will become more mainstream

 

Have you ever heard of shadow banking? It’s where financial activities, such as peer-to-peer lending and investing, are conducted outside the mainstream industries. In China, shadow banking has been estimated to be over 60 trillion renminbi.

While banking is a source of finance, it’s not without risk for participants — and there have been several stories of middle class Chinese people suffering from its failures.

China’s largest banks have been more keen to lend to larger firms, so local governments have been reliant on shadow banking sources for its cash.

READ: China’s hold on large-flake graphite has started to slip

Now they will have to turn to larger firms for credit as smaller ones get wound down — but as big as they are, the major banks will lack capacity to eliminate the shortfall completely.

Now local governments will have to prove their creditworthiness to lenders, just like Australian lenders.

So it seems Australia is not alone in experiencing a credit crunch, China will too.

The difference is Australians will go from the big firms to the smaller less regulated ones while Chinese will go from shadow banks to mainstream banks.

 

4. Tier 3-4 properties could be a ‘silent bust’

 

Property is equal with local government as the biggest driver of investment – worth 35 percent of fixed asset investment in China. The last three years have seen a steady boom in the housing market, consistent across the market.

In recent months, however, restrictions on property sales have begun to bite the market. There has been a divergence between the larger (Tier 1 and Tier 2) and smaller cities (Tier 3 and Tier 4) – judged by population.

On one hand, Tier 1 and 2 markets have overall grown but been sensitive to regulation. On the other hand, Tier 3 and 4 markets have not been sensitive to regulation on them, but rather regulation on their peers in larger markets.

Hong Kong-based Huatin Holdings have predicted Chinese regulators will now ‘relax rather than stimulate’, which is more comforting than regulate.

Likely they will take a wait and see approach in the short term but be quick to respond if they can see substantial movement in the market.

Whatever happens with the housing market there will be a flow-on effect to several industries, particularly construction and mining. In turn, the housing market may be hurt by more environmental regulations even if demand for property is otherwise strong.

 

This content does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.