Macro Monday China:Quickened capital outflows despite better economic fundamentals

Markets extremely cautious: Risk appetite was very low ahead of the USpresidential election. The S&P 500 has already dropped for nine sessionswhile the VIX, a measure of market jitters, jumped to the highest since theBrexit vote. The FOMC meeting last week and the payroll report last Fridaybolstered the case for a Dec hike. The RMB gained 0.3% against US$ as thedollar index weakened. Meanwhile, interbank liquidity conditions eased as 7-day repo rate dropped to the normal after the surge in the previous two weeks(Fig 39). This came as the PBoC injected liquidity through MLF last week.

Eventful weeks ahead: The coming Nov 10 marks the one year anniversaryof China’s supply-side reform, which has significantly boosted the prices forsteel, coal and cement (Fig 26-28). Before 2016 concludes, it remainseventful for the weeks ahead. This Tuesday (Nov 8), finally the US will havethe presidential election, whose result could have a huge impact on the globalrisk appetite. Going into December, it’s widely expected that the ECB wouldextend QE on Dec 8. One week later, the chance is very high for the Fed tohike after the FOMC meeting on Dec 13-14. Both could cause the dollar indexto strengthen again and weigh on the RMB. Last but not least, China will hostthe annual Central Economic Work Conference in Dec, which will set thepolicy tone and key tasks for 2017.

Capital outflows quickened in 3Q: China released 3Q16 Balance ofPayment (BoP) data last Friday. By breakdown, China’s surplus in goodstrade remains elevated, but the deficits in service trade rose to the new high,as service trade has been increasingly used as the channel for capitaloutflows. Net net, China still ran a US$71bn Current Account Surplus in 3Q16,but its Capital Account deficit was also high at US$207bn. As the result, FXreserves declined by US$136bn in 3Q after falling US$35bn in 2Q. It’s not toosurprising though, given the RMB has resumed the depreciation against theUS$ since May. Due to the rising depreciation expectation recently, outflowpressure is set to linger. Combined with the negative valuation effect, Octheadline FX reserves (to be released today) could decline US$40bn or more,after falling US$19bn in Sep.

Best PMIs in more than two years: PMI data released last week beatmarket expectations, as both NBS and Caixin manufacturing PMIs jumped toa 27-month high of 51.2 in Oct (our comment). The data clearly point toimproved business confidence and growth momentum. GDP growth is ontrack to 6.7% in 4Q16. It is also in line with what has been reported byChinese companies in 3Q16. According to the summary by our strategist,“China equities turned in what we believe to be a perfect report card for 3Q16.

Sales revenue growth rebounded, profitability and cash flows surged, debtlevels declined, dividend payouts reached record levels and privateenterprises outgrew SOEs.” Specifically, A-share market earnings rebounded19% YoY in 3Q16, with only one sector (utilities) reporting an earningscontraction. Commodities’ sector earnings were 6x higher YoY, followed byconsumer (+38%), “new industrials” (+33%), property & construction (+33%),transport (+31%), media (+31%) and pharmaceuticals (+29%). Theheavyweight financials sector (+3% YoY) resumed growth for the first timeover the past year, with the insurance (+8%) and brokerage (+6%) sectorsresuming earnings growth.