China is heading for Stagflation

 

 

Economists use the term �stagflation� to describe an economy that experiences high inflation while its growth falters�a paradoxical term, as inflation and economic growth are usually positively correlated. When it comes to China, the term is even more paradoxical as the country has been growing by leaps and bounds.

Statistics coming out of China recently confirm that the country may be heading to some sort of stagflation. Economic growth is slowing down, while inflation remains high.  Last Saturday, The China Federation of  Logistics and Purchasing (CFLP) announced that nonmanufacturing sector slowed down sharply, with the non-service Purchasing Manager�s Index (PMI) dropped from 57.7 in October to 49.7 in November.

The slow-down in the non-manufacturing sector follows a similar slow-down in the manufacturing sector, as announced last Thursday; the manufacturing PMI dropped to 49 in November from 50.4 in October� a contraction that comes at time inflation is still running above 5.5 percent.

China�s stagflation complicates economic policy, posing dilemmas to policy makers.  An effort to stimulate economic growth by raising bank reserves and by boosting infrastructure spending will worsen inflation (as it is currently underway), while an effort to curtail inflation will lead to slower growth. But what does Chinese stagflation mean for investors?

For investors in Chinese equities, stagflation isn�t good, especially when expectations run high. Slow growth certainly affects negatively corporate sales and profitability. High inflation is usually positive for corporate revenues, but only for companies that can raise prices ahead of cost�usually State-Owned Enterprises like PetroChina (PTR) and Sinopec (SHI).

For investors in commodities, a prolonged Chinese stagnation means lower demand and prices for commodities, especially industrial commodities.  This means that the rally in commodities may have to pause for a while, if not end, at least in the near term. Conservative investors may want to trim positions in commodity ETFs like GLD,SLV, OIH, and FCX, especially after their recent run up. Aggressive investors may want to establish short positions.

Disclosure: Active investor. May take long or short position in any stock or fund mentioned.

Also read, Why China�s Red Big Bubble is Ahead of US