Last night we got the May figures for the Chinese FX reserve balance showing yet another decline and indicating continued capital flight from the world’s second largest economy (chart 1). The drop in FX reserves is the 18th in the last 23 months and the 9th in the last 12 months. What more, when we convert the FX reserve balance into CFETS (Chinese Foreign Exchange Trade System) units to mitigate the effect of the weakening USD, the trend in capital flight becomes even more apparent. Using this measure, FX reserves have declined in 11 of the last 12 months (chart 2).
These latest data show that the capital exodus out of China is still very much alive and well, begging the question of the broader impacts of the trend. Our work suggests that as long as capital is moving out of China, counter cyclical stocks should outperform cyclical stocks. The final chart below shows the 1 year percent change in Chinese FX reserves (red line, right axis, inverted) plotted against the relative performance of counter cyclical stocks versus cyclical stocks (blue line, left axis). In an environment in which capital is no longer committing itself to the cyclicality of the Chinese investment binge (meaning the red line staying high or going up in the chart), cyclical stocks struggle and counter cyclical stocks perform relatively better (meaning the blue line also going up).