Updated information from

Investor Notification

24 January 2014

 
WAM Capital
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Dear Investors

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Bourse beaten-up
Markets globally were spooked by worse than expected manufacturing figures released by China on Thursday. The latest HSBC Manufacturing Purchasing Managers’ Index (PMI) reading of 49.5 indicates China’s manufacturing industry is contracting. The PMI figure sent equity markets lower with the S&P/ASX All Ordinaries Accumulation Index falling 1.2% for the week driven lower by a sell-off yesterday and today. The local equity market was also impacted by higher than expected inflation figures out on Wednesday – see further discussion below. 


China: the Good, the Bad and the Ugly – Part II
Our Chief Investment Officer Chris Stott and Equity Analyst Matt Haupt have just returned from their trip to China gathering insights into the country’s economic drivers. Here we share more of their views and outlook for the world’s second largest economy in, China: the Good, the Bad and the Ugly – Part II.

 

China's economy
Overall, our current outlook for China is bearish – a view underscored by yesterday’s PMI figure. Although the consensus forecast for China’s GDP growth in 2014 stands at 7.6-7.8% (2013 estimate: 7.6%), we think it could surprise on the downside. China’s new regime is focused on implementing reforms to set the Chinese economy up for its future growth. These reforms will make the economy more sustainable over the longer-term, but in the meantime the country will be in an adjustment phase which will see lower growth than previous years.

The Good
China’s controversial population control measure, the one child policy, was recently relaxed allowing couples to have two children if one of the parents was a single child themselves.  With the policy change implemented in November last year, demographers are ‘expecting’ to see births increase by 1.6 million a year as a result. This is good news for manufacturers and retailers of baby-related products with sales (which are already booming) forecast to grow by more than 10%.  


The Bad
Macau, one of China’s two Special Administrative Regions, has a thriving gaming and tourism industry – both key contributors to the local economy. The Monte Carlo of the Orient, Macau is the world’s third largest gaming centre pulling in US$45 billion last year alone. With gambling outlawed in all other parts of China, Macau’s industry has boomed in recent years (revenue jumped 19% in 2013) with an influx of Chinese tourists. In a negative for gaming operators and the local economy, the government is cracking down on illegal VIP gaming junket operators which could lead to a fall in gaming tourism.


With the new Chinese government focused on achieving structural change to create sustainable and long term economic growth (rather than short term ‘fast’ growth), further easing in monetary policy is not anticipated in 2014.  Another round of ‘easy’ money from the world’s second largest economy could have positive impacts on equity markets globally, although this is not looking like a possibility.  

The Ugly
There has been much talk in the media recently about the risks associated with China’s shadow banking system which has grown significantly due to tight restrictions on the traditional banking system. China’s shadow banking system is made up of banks and finance companies that loan money outside the regulated financial system and it accounts for approximately 50% of all lending. Some are concerned that the opaque shadow banking system has driven up Chinese debt levels with the government announcing plans to reform non-traditional lending.


The Chinese government last month released draft regulations aimed at increasing the regulatory supervision of shadow banking, while recognising its positive impact on the economy. The risk for China’s financial system is that the government takes action too hard and too soon that causes panic. The official introduction of the reforms in mid-2014 could cause volatility in global equity markets in our view.

 

To read, Part I of ‘China: the Good, the Bad and the Ugly’ go to the link below.

 

Rate cut ruled out
Higher than expected inflation data out this week reduced the odds of a further cut to interest rates. Latest Consumer Price Index (CPI) figures revealed inflation rose 0.8% for the December quarter, ahead of economists’ consensus of 0.5% and taking the annual inflation reading to 2.7% - at the upper end of the RBA’s target inflation band. We believe the possibility of further rate cuts has now dissipated with the RBA likely to hold fire for the time being. If inflation edges above 3%, the Reserve Bank will have little choice but to raise rates. This prospect spells bad news for businesses with the cost of capital potentially rising, but good news for savers wanting a better return on their cash.

 

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WAM Capital

China: the Good, the Bad and the Ugly - Part II

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Kind regards,

The Team at Wilson Asset Management


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