The Inflation Lotto

Sales of lottery tickets in China rose by an annualised 33.3% in the first four months of the year to almost Yuan 65 billion ($10 billion) with the official explanation being the popularity of new quiz-type lottery games and trial sales on-line.

Gambling by China’s Government is less endemic. It tends to adopt a more pragmatic and empirical approach (some commentators call this ‘trial and error’). Nonetheless, in what has been a difficult week (the worst drought in 50 years, probable power shortages, explosions and a falling equity market), it is tenable that Hu, Wen and Zhou must be longing for a win. However, the only betting success for the central authorities, at this time, is the ‘Inflation Lotto’.

According to Huachuang Securities the inflation rate may increase to as much as 5.5% in May, which follows 5.3% in April, the fastest pace since 2008. Huachuang says that this is being driven by vegetable prices in southern China which has been impacted by the drought. Vegetables account for about 20% of food costs which, in turn, makes up about 30% of consumer prices.

Other commentators believe that Q2 could well be the peak for inflation and that it may then subside, a view which could also keep further interest rate rises at bay. However the Shanghai Composite had its biggest weekly drop (4.7%) this week since June last year. This also takes May’s deficit (with two trading days to go) to 6%, which is also the worst June 2010; and for the year-to-date, the short-fall is now 2.6%. Investors are worried that the tightening is overdone and concerns have widened to a slowdown in earnings and economic growth – and not just inflation, says Jingxi Investment Management. “The market is still trying to find a bottom”. ICBC Credit Suisse concurs.

Meantime, the Lex Column in the FT says private investors, who dominate the 159 million registered trading accounts in China, see property as a better bet for returns right now than the stock market. Soufun also said that house prices in Shanghai and Shenzhen rose in the week ending 22 May (although they declined in Guangzhou). Note, too, that the property tax introduced in two or three conurbations has had little impact in reality; in Chongqing, for example, it has raised just $120,000 since January.

For is part, Barings Asset Management says stocks may rally after the central bank ends its tightening policy, possibly by as soon as the end of the third quarter. “Once it peaks, the market will have a very strong bounce” and “investors will come back to China at the end of third quarter or fourth quarter”. Barings likes consumer and health care companies but says investors should wait before investing in “cheap” property and banking stocks. In the same vein, HSBC says that share prices in China could rise by 20% by year-end, while UBS sees no hard landing. Similarly, while Goldman Sachs would not rule out a correction of up to 5 to 10% near term, triggered by earnings per share cuts, it would buy on such dips given low earnings risks, valuations and the likely policy inflection. Goldmans expects inflation to peak in June and forecasts normalisation of policy sometime in Q3 2011. It has, however, downgraded steel, aluminium and industrial stocks to “underweight” from “neutral,” while keeping property and bank shares as top picks.

Industrial profit growth also shows that the medicine is working, as it slowed in the first four months of the year to (a still remarkable) 29.7% - down from 32% a year ago (and 34% in January and February). And, China is ranked first among 22 emerging Asian economies as the country most likely to maintain steady and rapid growth over the next five years, according to the Bloomberg Economic Momentum Index for Developing Asia (India is two).

The money market agrees and the repo rate fell for the first time in a week today (off 64 basis points to 4.37%) as Citigroup and Societe Generale forecast that Yuan 550 to 600 billion ($85-92 billion) could flow into the market by way of maturing bills and repurchase agreements. Finally, even the Yuan is playing ball as it touched its highest level (6.4858 to the US dollar) since July 1993.

“You know you're gonna live through the rain. Lord you gotta keep the faith” – Jon Bon Jovi


SHANGHAI COMPOSITE
Today: -0.21% to 2,709.95 at close
This week: -4.27%
March: -0.8%
April: -0.6%
May (to date): -6.0%
YTD: -2.6%
Since 05/07/10: +15.8%
Since 08/11/10: -13.4%

HANG SENG:
Today: +0.95% to 23,118.07 at close
This week: -0.35%
March: +0.8%
April: +0.8%
May (to date): -2.5%
YTD: -1.4%
Since 25/05/10 +21.8%
Since 08/11/10: -7.4%

OIL FUTURES: $100.64
GOLD FUTURES: $1526.80
(new ‘immediate delivery’ high of $1577.40 on 2 May 2011)
EURO/$ SPOT: 1.4202


HEADLINES

ECONOMY
• Industrial profit growth slows
• China is ahead of India as the most likely to grow
• China will invest some $955 billion on transport infrastructure by 2015; plus $615 billion in water conservation projects through 2020

MONEY
• Money market rate declines by the most in a week as bills mature
• Yuan heads for a weekly gain and hits strongest level (6.4858) since July 1993
• China FX reserves climb by $138 billion in Q1

EQUITIES
• China still offers value; and no hard landing says UBS
• A further 5 to 10% correction in China share prices is likely, says Goldman Sachs
• Slumping Chinese stocks may extend their decline, says ICBC Credit Suisse AM
• Anhui Conch is a “buy” on affordable housing build

DOMESTIC
• Explosions in Jiangxi Province kill two people, including the bomber
• Worst drought in 50 years begins to impact Shanghai
• China's April lottery sales up 32.2% in April; and 33.3% in first four months of 2011

REAL ESTATE
• China faces difficulty extending pilot property tax, says senior housing official
• Jim Chanos is even more bearish on Chinese property

INDUSTRY
• Coal production up 11.1% in first four months
• Automobile sales may fall 10% this year, says China Automotive
• Toy prices rise as wages in China increase

INTERNATIONAL
• China faces losses on $18.8 billion of Libyan Contracts, says Economic Weekly
• North Korea’s dependence on China for trade rises; as Kim completes his third visit in a year

HONG KONG
• Hong Kong’s April inflation accelerates to a 32 month high on food and housing