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Market Looks Toward China for Next Directional Cue

Michael Santoli

Tired of gazing toward Washington to study every hint and feint of politicians in the on and (mostly off-again) budget negotiations?  So are the financial markets, which is why they will likely turning their eyes far, far to the east.

China will release an important slate of economic data over the weekend, numbers that will show whether the world's second-biggest national economy has regained its stride in the way investors here have been eagerly anticipating.

The popular take on China this year has been that the Chinese economic authorities have been executing a soft economic landing followed by an engineered re-acceleration, absorbing the recession in the key European export market and compressing the growth spring just in time for its once-a-decade leadership transition, completed last month.

A Conspicuous Laggard

Confirmation of this view has been a bit slow in coming, and the bellwether Shanghai Composite stock index has been a conspicuous laggard all year, even as developed-market stocks have put in decent gains. U.S. industrial stocks — tightly dependent on China as a demand source and as a signal of global growth trends — have been held in check as investors seek assurance that the China growth engine has re-engaged.

In recent weeks, tentative signs of this hoped-for pickup in activity have emerged. China's official manufacturing purchasing managers' index hit a seven-month high this week. And the Shanghai Composite just completed its best week in 13 months, rising 4.1%, albeit from its lowest level since January 2009.

That sort of bounce implies the market is at least anticipating that fresh data will lend support to the "growth is stabilizing" story. When released Dec. 9, China's industrial production for November is forecast to show a third straight month of acceleration, to 9.8%, and retail sales growth is seen reaching a six-month high above 14.6%, according to estimates compiled by Bloomberg.

For now, results in the vicinity of the consensus forecasts that ratify the Shanghai market's recovery attempt should also help the cyclical, export-oriented sectors of the U.S. market. Morgan Stanley research has highlighted that the S&P 500's machinery and technology hardware — excluding Apple Inc. (AAPL) — have shown record levels of sensitivity to the movement in the Shanghai Composite the past couple of months.

A Stubborn Worry

Even a strong run of industrial and spending data won't soon banish the stubborn worry about feared structural weaknesses in China's banking system. For years, the economic play callers there have generated much of the country's speedy growth with easy credit directed at infrastructure and urban-development projects, in the service of political stability. This can go on for a long time, though not forever, as it creates an unbalanced economy with a huge banking sector, insufficient domestic consumer demand and much misallocated capital.

As pointed out by China Financial Markets blogger Michael Pettis — a senior associate at the Carnegie Endowment for International Peace and a finance professor at Peking University's Guanghua School of Management — "So far Beijing has succeeded largely because of its ability to collect and control the total savings of the country, and unleash waves of investment whenever necessary." As it does so, analysts hail the Communist Party's deft hand on the growth throttle, and markets are cheered.

Accelerating growth this quarter would be welcomed by the markets and will insulate the global economy from an even tougher road ahead as Europe struggles and the U.S. flirts with fiscal "anti-stimulus," even if it would say little about whether a larger reckoning will soon approach.