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Why China’s bear case economic growth will hurt dry bulk stocks (Part 5)

Xun Yao Chen, Industrials Analyst

Continued from Part 4

Has the market priced in?

While China’s economic growth may weaken further in upcoming months, as the government tolerates lower economic growth, the market could have priced in lower growth, whether in full or in part. Just as interbank repo rates and prices for credit default swap put in a recent top in June 20, the iShares FTSE/Xinhua China 25 ETF (FXI), a popular exchange-traded fund (ETF) that mostly tracks mega Chinese financial stocks, bottomed at ~$32. Whether this is a short-term bottom or a long-term bottom is open to debate.

(Read more: Diana Shipping: the most undervalued dry bulk shipping company)

China Government 5Y Credit Default Swap 2013-07-16

Credit default swap prices topped before

Last year, when China’s economic growth fell to 7.5%, prompting the central bank and government to lower interest rates and announce stimulus plans to energize the economy in mid 2012, the ETF also bottomed at ~$32. If you take a closer look back at August and September of 2012, when economic growth was just starting to slow, share prices also hit $30 shortly because of fear. That was also the month when credit default swap made a major top. This means that even if credit default swap continues to stay elevated, as long as fundamentals don’t substantially worsen than what the market currently perceives (which is slightly lower growth) there will likely be buyers at $30.

(Read more: Shipping recovery continues with additional purchases, long-term opportunity)

Interbank repo rates stood high because of high inflation

Interestingly, while credit default swap made a top in 2013, interbank repo rates stood high. This was because the central bank was trying to reign in an inflation rate of 6.0%, driven by agriculture and industrial raw materials. If the government can keep growth at its target of 7.5% this year, the market will likely stabilize, but if the party is thinking of tolerating economic growth that may hit 7.0%, as Finance Minister Lou Jiwei recently said China can support, dry bulk shipping companies such as DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE), Navios Maritime Partners LP (NMM), and Safe Bulkers Inc. (SB), which are sensitive to China’s economic growth, will face weaker demand. If a situation like this does happen, the $32 price we now expect the FXI to put in a bottom over the next few months is unlikely to be the bottom.

(Read more: Dry bulk shipping rates rise due to restocking, but likely downside looming)

Learn more about China’s outlook and its significance for dry bulk companies

Check back next week for Bull case of China’s economic outlook.

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