China is Not Imploding

Dr. Jim looks at whether or not the data in China presents a picture of impending economic catastrophe in China: The China outlook may be brightening

There is not a data release that comes from China in any form that is not also accompanied by a discussion about the veracity of the statistics and what this means for any conclusions drawn from them. This is problematic on the macro level, as it means economists and analysts are stuck either using data that they feel is incorrect or trying to estimate what they believe to be a more accurate number based on other indicators.

Both of these methods have obvious drawbacks, the first as you’re admitting up front that whatever conclusions you draw are only valid if the data inputs are and the working assumption is that they aren’t. And the second because any use of indicators to guide an estimate not only introduces more uncertainty, they also assume that the data used for the indicators are for some reason free from error or manipulation. That seems like a stretch given the working assumption.

However, once we ‘clean’ the data using the blueflag Machine Learning algorithm to find examples that look like previous frauds we get a different picture.

RoE is showing an interesting convergence.

When we filter out the most likely frauds we find that the ‘cleaned’ list has a very similar pattern to the overall population, although the growth is at a slightly slower pace. This is of course entirely in line with what would be expected if parts of the overall population may have overstated their figures. But perhaps of more general interest is that the RoE of the cleaned list is slightly rising, suggesting that the economy, for good companies, is in more reasonable shape than the pessimists might suggest.

For revenue we’re once again seeing an interesting development over the last few years. Overall, the two populations have moved pretty much in tandem as regards YoY developments, with revenues for the list with less fraud risk slightly outperforming the overall population. That is, until 2015 when we suddenly see a very sharp reversal of fortunes. Clean companies suggest the economy has slowed sharply.

There are several different ways to interpret these results. Later developments are weighted more heavily in our fraud detection algorithm and so a subsection of companies significantly outperforming the rest might have been flagged. It’s also entirely possible that what we’re seeing here is “new economy” companies that are still growing quickly being flagged as higher fraud risk. This is perhaps not without just cause as smaller fast growing companies have been dominant in previous fraud cases.

Another possible interpretation (and one that we would tend towards) is that revenues did indeed take a hit in the slowing real economy and that the growth reported in the macro numbers (and the full list of corporates) is nothing more than a mirage.

But of critical interest is the fact that, after faltering since 2012, company RoEs and cash flows appear to have stabilised in 2015 and begun to improve again. That is precisely the picture you would expect to see for companies being managed well into a downturn. Costs have been cut and, we suspect, activities curtailed.

BOTTOM LINE: The data do not paint a picture of impending economic catastrophe in China.

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