Yoshikami: Stop Being Pessimistic about China

China's growth remained strong in the first quarter of this year defying market concerns about a slowdown in domestic demand. Meanwhile, inflation undoubtedly continues to be the major concern leading to fears that measures to tame inflation may not be working.

China's Q1 GDP grew at 9.7% year over year. On the price front, CPI inflation rose to 5.4% yoy from 4.9% in February with both food and non-food inflation increasing, while PPI inflation remained at 7.3% yoy. The numbers point to continued risks of more persistent upward price pressures. Considering the government's official full year CPI target is 4%, it is no wonder that Beijing has put fighting inflation as one of its top priorities.

The Chinese authorities have adopted a series of measures to try and help cap runaway prices including hiking interest rates and raising the reserve requirement ratio for its banks. But are any of the measures working at all? In my most recent visit to China, according to business leaders in China, they do see signs that the war against inflation may show some progress in the next 2 quarters. They point to a muting of future business activity based on order flow.


There is no doubt inflation will continue to be a threat, and the continued strength of food price inflation will remain a concern. However, we feel that it will be successfully tamed by what appears to be a very prudent and responsible Chinese monetary policy. The government's tightening measures seems to be taking more time to impact real economic activity, and might take a few more quarter to show it's effectiveness.

While some say that efforts to reign in inflation will lead to a huge equity downturn, we disagree. It is a preferred problem to have strong growth rather than attempting to stimulate a near recession economy (see Europe).

China in February became a net importer, and this represents the current trend of China as world superpower rather than China as world low-cost employer. China's domestic demand grew strongly and resulted in stronger import activity. Chinese domestic consumption contributed 5.9 percentage points to growth in Q1, up from 3.9 points in all of 2010. This implies that there is acceleration in consumption growth and that is certainty a key step towards economic re-balancing.

In the coming months we expect further reserve requirement ratio and interest rate hikes, and continued credit controls. Government spending could also be reigned in or delayed if inflation expectations worsen. These are all positive proactive steps.

Earlier this month, HSBC upgrade its rating on China to "overweight" saying it believes inflation will peak in June. Citigroup joined the optimism by urging investors to buy China stocks, while Goldman Sachs upgraded its China equity stance to overweight from market weight, favoring banks, and the often quoted bubble risk sector, property.

We agree. Those that have counted out China are just as short sighted as those that counted the United States 2 years ago.

Tune In: Mr. Yoshikami will be a guest on CNBC's Closing Bell, Friday April 15 at 4pm/et to discuss this topic plus the Markets rise on continued stimulus and rebound in retail consumption.

Michael Yoshikami, Ph.D., CFP®, is CEO, Founder and Chairman of YCMNET's Investment Committee at YCMNET Advisors. Founded in 1986, YCMNET is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutional investors and individual investors. The firm works with clients around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009 and 2010. He oversees all investment and research activities of the firm and is actively engaged on a daily basis in the firm's securities analysis activities and determines the macro tactical asset allocation weightings for client portfolios. He works with YCMNET's investment team in integrating behavioral investing strategies with the firm's core fundamental perspective. Michael holds a Ph.D. in education, other advanced degrees, and holds the Certified Financial Planner® (CFP) designation.