China’s slowing growth could end up being very good for Chinese stocks

As China's economy slows, its central bank is taking action. And that can only be good for Chinese stocks, says John Stepek.

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The People's Bank of China has just cut interest rates expect more action to come.

This weekend, China's central bank cut interest rates for the second time in three months.

In common with many other countries, China is living in fear of deflation. Producer prices (prices at the factory gate) have been falling for three years now. Meanwhile, the consumer price index rose by just 0.8% year-on-year. Hence the rate cut.

But things could get a lot tougher before they get better.

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And oddly enough, that could be good news for investors in China.

How currency wars are making life difficult for exporters

But that's becoming an increasingly unusual position. Europe and Japan are still very near the start of their money-printing experiments both are widely seen as likely to print more money before too long. Elsewhere, interest rates are being slashed to record-low levels. Australia has started cutting again, for example.

The slide in oil prices has left inflation at record lows in many areas. That's given central banks all the excuse they need to trim rates.

But there's something else going on in the background currency wars'. Two of the biggest, most powerful exporters in the world are currently hammering their currencies. Japan's money printing programme has devalued the yen rapidly. And on the other side of the world, fear over Greece and European Central Bank money printing have ensured that Germany gets to use a currency that is far weaker than its own economic strength justifies.

If you're an exporter in any other part of the world, this is horrible. If your country depends on selling goods to other nations, you've got a big problem here. You might not be able to compete on German quality, but you can certainly compete on price.

That's no longer the case. A weak and falling euro has made Germany hyper-competitive.

That's pretty grim news for anyone with a large export sector. China is trying to move towards more of a consumer-led economic model, but it still has a large manufacturing sector which is currently shrinking. And last year, the annual pace of growth in China slowed to the worst level since 1990.

So it's little wonder that the People's Bank of China (PBoC) the central bank cut interest rates on Saturday. The one-year lending rate has been cut by 0.25 percentage points to 5.35%.

The PBoC also made it slightly easier for banks to compete with one another for deposits from savers "a key step towards interest rate liberalisation", notes Julian Evans-Pritchard of Capital Economics.

Evans-Pritchard adds that the February manufacturing sector data was actually better than expected. Although the official data suggested that the manufacturing sector shrunk again in February, the reading edged up compared to January.

Yet, "even after Saturday's rate cut, policymakers will need to do a lot more to prevent growth slipping next quarter."

The problem is that this "rate cut is unlikely to result in much looser monetary conditions." It might help companies that already have debt, by lowering the rate on that debt a little. But "the binding constraints on bank lending are quantitative restrictions such as loan-to-deposit ratios and official lending quotas. As a result, rate cuts do not in themselves do anything to boost lending."

In short, expect more action by the PBoC.

Why you should hang on to China

And while Chinese stocks have rallied strongly over the past year or so, that could certainly continue if the central bank decides it needs to act more aggressively to tackle deflation. So you should hang on to any investments in China you have and get exposure to the market if you don't already.

In the next issue of MoneyWeek magazine (out on Friday), Jonathan Compton looks at China's woes, and what it's likely to do about them and how you can profit from it all. If you've not already subscribed, find out how to get your first four issues free here.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.