China Exports Rising – How Happy Should We Be?
The market seemed to like the news that China’s exports had increased dramatically in December. But should we be that excited or should we be concerned?
In all of our recent work, including our 13 picks for 2013 piece we highlighted one specific risk that we think trumps all others in 2013 and that is price competition and price declines. With that risk in mind, how good should we feel about increased exports from China, are they being pushed out or are they being pulled out – the difference is very important.
One month does not make a trend and inventory swings and shipping dates can impact a single data point so we should not start digging the bunker quite yet, but should this rate of growth continue, you have to ask yourselves the obvious questions:
- Where is it going?
- Who, if anyone is being displaced?
- What are the price implications for everyone?
If the product is being pulled out of China because global demand growth needs is, then we have a similar status quo to most of the last decade, where China can increase its trade surplus, absorbed into a growing world. Industries in other regions continue to see enough demand growth to maintain market stability – and most important – pricing. But if it is being pulled, how does the demand growth implication associated with that statement fit with a “slow growth” world, as predicted by economists and corporate alike. Where is the increased consumption?
Remember, in almost any product or process there is an efficiency gain over time – machines run longer; waste is reduced; raw materials are used more efficiently. GDP growth of 1% does not mean 1% demand growth for new machines, for new plastic, for paint and for other materials – 1% growth is probably not enough to prevent an overall decline in demand for most products.
So what if it is a push? What if China has slower domestic growth (well documented) and the export increase is a result of production surpluses and manufacturing over-capacity? Then the increase in exports become destructive as they have to force their way into a global market – more specifically Europe and the US – at the expense of domestic or other global suppliers. The only way they can do this is through price.
From a raw material perspective, the only raw material that is expensive today is crude oil, and products based on crude oil. Metals are cheaper than they have been in a long while. So there is room to reduce prices. If we look at the return on capital for the US Industrials and Basic Materials sectors they are high – at the highest level in 20 years – there is plenty of room to cut pricing in order to defend market share.
If the December trade number is a one-time correction/anomaly, we would not be too concerned, if it is repeated in subsequent months then we have real risk that estimates across the board are too high for 2013 and that the two to three year trend of above normal returns on capital for the group are at risk.