Barclays Capital is getting more cautious about China.
The investment bank that has been mildly bullish on China for much of the last 12 months said investors should proceed with caution heading into the second quarter.
The reasons?
The soft January-February data and news flow from the National People’s Congress
support a more cautious view on China’s growth recovery, urbanization drive and reform.
Core inflation surprised on the upside because of food prices this week. Barclays said investors should expect neutral monetary policy with a bias toward tightening liquidity through open market operations.  The bank regulator, the CBRC, is already tightening regulations around wealth management products and local government lending.  The reigns are being pulled closer to the chest.
Industrial production growth in China slowed to 9.9% year over year in the January-February period, in contrast to the general expectation of a pick-up (consensus was 10.6%). It was also lower than the 10.3% recorded in December and the 10% recorded in the fourth, suggesting there may be some destocking due to the Chinese New Year holiday.  In that case, restocking on the back of a recovery in end-user demand should support a rebound in industrial production and the PMIs in March, if all goes swimmingly well.
China retail is still humming along.  Although the hum is not as loud as it once was.  Compared to much of the rest of the world, China still looks like a boom town. Retail sales growth decelerated to a 2-year low of 12.3% (Barclays estimated 14.5% and consensus estimates were even higher; 15.2%).  In December, China retail sales rose 15.2% December and 14.9% in the fourth quarter.
On the other hand, fixed asset investment (FAI) growth re-accelerated to 21.2% on the year, more in line with market forecasts and above last year’s average of around 20%. The government is back to spending on railroads and — as the bears might say — Chinese bridges to nowhere.
The breakdown in China FAI shows that infrastructure and property investment remained strong, which offset a further slowdown in the manufacturing sector.  The build-out in real estate continues as China assumes the urbanization trend has years to play out. Around 50% of Chinese live in cities, compared to around 75% of Americans.
Meanwhile, Barclays warns that Beijing will need to curb the investment enthusiasm of local governments, as two thirds of them have set 10%-plus growth targets for 2013.  Barclays thinks they’re being overly bullish.
“We will monitor how the central government promotes its ‘urbanization drive’,” said Barclays economist Jian Chang in a note to clients on Friday.  That urbanization trend will impact the investment and consumption outlook for years to come.  The question is whether some cities have overdone it, meaning the boom will end sooner than expected as second and third tier cities look to fill in vacancies at residential and commercial developments before they mix more concrete to build more.
China shares have been disappointing.  The iShares FTSE China is down 7.4% year-to-date ending March 15.  The MSCI China index isn’t doing much better. It’s down 5.7%.
Major China stocks trading on the NYSE have suffered all year as well.
Search engine Baidu (BIDU) is down 15.17%.  Sina Corp (SINA) is down 3.8%, a winner by most estimates. China Mobile (CHL) is off 9.43%.  Medical equipment maker Mindray (MR) is a standout, though.  It’s up 17.37% year-to-date.
Audrey Kaplan, a portfolio manager at Federated Investors and manager of Federated InterContinental (RIMAX) told me two weeks ago that China may be down, but is not out.
“It’s a disappointment. But we are okay with that. You can buy China at a discount, which is great for long term investors,” she said, adding that China is a stock pickers market for those who have the patience.