China hints at potential stimulus, but will it follow through? (Part 3)

Market Realist

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The government sees a growth threshold to deploy stimulus

Premier Li Keqiang was quoted by Xinhua News Agency saying that the 7% will be the least accepted growth threshold, given that China must continue its prosperity path through 2020. It seems pretty clear that stimulus will be used if growth is falling below 7%.

(Read more: Why recession in Brazil is not imminent, but the short term will hurt)

Q2 GDP growth came in at 7.5% after street consensus was closer to 7%. Nonetheless, continued weakness in the second half of the year could cause a quarterly growth below 7%.

The recent drop in exports caused widespread concerns, and the 7.5% GDP growth for Q2 is starting to convince investors that the government may take action.

Lower limit may be higher this year

There was some confusion over whether the 7% applied to 2013, given that previously, the government stated a 7.5% estimate for 2013. Analysts at both Bank of America and Mizuho interpreted the statements implying a 7.5% floor for 2013 and 7% through 2020. If this is the case, then it seems very likely that sometime in Q3, the government will have to take action. The June PMI was disappointing, falling to a nine-month low. The Flash PMI is due later today, and most analysts expect further weakness.

Bad news is good news

Since the export data was released on July 11, Chinese equities (FXI) have reversed their negative trend and started to climb higher as expectations of stimulus build up. More negative data out of China may not trigger stimulus, but it’s still very likely to further fuel investor expectations of financial stimulus. The potential focus of the stimulus on consumers and small and medium businesses may position the iShares MSCI China ETF (MCHI) better than the more widely traded iShares FTSE/Xinhua China 25 (FXI). Another option could be Claymore/AlphaShares China Small Cap (HAO), which focuses on the smaller and usually more consumer-oriented companies.

(Read more: Brazil’s Q2 starts stronger than expected, but can it keep it up until year end?)

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