China looks set for a rapid economic rebound in the first quarter after finally abandoning its zero-COVID policy. But will the recovery prove temporary as longer-term dynamics reassert themselves?
Read this article to understand:
- Why a rapid rebound in Chinese growth may prove short lived
- Why Chinese equities could recover further
- How events in China could impact other emerging economies
The Chinese economy looks to be on course for a brisk recovery as the country’s abandonment of its zero-COVID policy in late 2022 enables a rapid resumption in activity. The government is aiming for GDP growth of around five per cent this year, up from just three per cent in 2022.
With Beijing having signalled it is ready to take additional steps to stimulate spending and investment, and with households having been forced to save during last year’s extensive lockdowns, some commentators believe the government’s target is conservative.
According to Bloomberg, market economists are pencilling in growth of 5.3 per cent for 2023. David Nowakowski, senior multi-asset and macro strategist at Aviva Investors, believes the outcome could be stronger still, pencilling in growth of 5.6 per cent or higher.
Although the precise mechanisms by which the Chinese government will look to stimulate activity remain unclear, most expect it to focus on trying to boost household consumption and certain types of infrastructure investment. Economists polled by Bloomberg see retail sales growing eight per cent and fixed asset investment 5.8 per cent in 2023.
After a sluggish start to the year, when economic activity was held back by high rates of COVID infection, anecdotal evidence suggests a strong rebound is underway. High-frequency data points to activity being well above pre-COVID levels in a wide range of household and business activities. Meanwhile, manufacturing expanded at its fastest pace in more than a decade in February, according to the latest purchasing managers’ report.
Pent-up household demand
Nowakowski expects growth to be especially brisk in the first quarter, given pent-up demand from households and the fact this time last year numerous Chinese cities experienced lengthy lockdowns to prevent the spread of the Omicron variant.
Just returning to a normal trajectory means you get very strong short-term growth
“The first-quarter numbers are pretty much guaranteed to be impressive. Just returning to a normal trajectory means you get very strong short-term growth, maybe as much as ten per cent annualised,” he says.
The improved outlook has propelled Chinese equities sharply higher. The MSCI China Index, having slumped to its lowest level in more than a decade at the end of October, had within the space of three months surged 60 per cent in local-currency terms.
Will Malcolm, global emerging markets equity fund manager at Aviva Investors, says the strength of the rally reflects both the rapid pace of re-opening and the fact valuation metrics, such as price-to-earnings (P/E) ratios, had been driven to historically depressed levels in October.
“The pace of re-opening has been far faster than anyone would have expected,” Malcolm says.
That said, Chinese shares were arguably being priced too cheaply, even allowing for the combination of the zero-COVID policy and anxiety that China’s increasingly authoritarian regime was making the country uninvestable. “There was a compelling case for building stakes in several companies, especially those best placed to benefit from the re-opening,” he adds.
One such share was Tongcheng Travel. Even if the stock might at first glance have appeared to be trading at an appropriate P/E ratio, he says earnings expectations for the domestic travel company were too low.
“We felt the company was almost certain to see a big earnings recovery once people were able to get out and about and travel,” Malcolm explains.
Struggling to maintain state welfare and retirement plans, Beijing wants the private sector to take up the slack
AIA Group was another company seen as having an improving narrative. The stock’s valuation had fallen to a level not seen since Asia’s leading insurer had floated a decade ago. The fact AIA, unlike most of its domestic and international rivals, had maintained its workforce over the past two years despite lockdowns preventing face-to-face meetings between clients and agents, added to the attraction.
“Struggling to maintain state welfare and retirement plans, Beijing wants the private sector to take up the slack. We see AIA as being far better prepared to tap into growing private sector demand for pensions and insurance protection in the post-COVID world,” says Adrian Lewis, senior investment analyst at Aviva Investors.
Trend growth heading lower
However, Nowakowski cautions that even if the abandonment of zero-COVID prompts a rapid recovery in activity, it is important not to lose sight of the fact trend economic growth is heading inexorably lower. While the first half of the year may prove stronger than expected, the second half could disappoint.
“I think the real question is once you get that v-shaped rebound, what's the trajectory that follows? Looking ahead to next year, growth might be closer to four per cent than people expect,” he says.
It is important not to lose sight of the fact trend economic growth is heading inexorably lower
Several factors lead him to this conclusion, most importantly the ongoing weakness in the property sector. Even if there are some tentative signs the property market crash may be close to bottoming, evidence is far from conclusive. In any case, there seems a slim prospect of the property market resuming its role as the primary engine of the country’s economic expansion.
“Unlike the previous two deep economic slowdowns, the government is unlikely to look to the property sector to reinvigorate growth as it is not productive enough,” Nowakowski says.
Malcolm says while the re-opening of the economy may have brought some normality back to the property market, the fact remains buyers’ mindsets have changed after the government in recent years stressed housing is for living in and not for speculating and investing.
“While government efforts to ensure everyone has a home could help boost demand, there are a lot of properties being held for investment purposes that are likely to eventually find their way onto the market,” he says.
China’s size means the re-opening of economic activity is likely to reverberate far beyond its own borders. For instance, travel bookings by Chinese residents during the Lunar New Year holidays surged 640 per cent from the comparable period the year before, according to Trip.com Group’s Chinese-language booking website, Ctrip. Bangkok, Singapore, Kuala Lumpur, Chiang Mai, Manila and Bali were the top destinations.
Nowakowski envisages the recovery in Chinese tourist numbers will put upward pressure on inflation in western economies too.
Chinese tourism recovery is likely to have a pretty big impact on leisure and hospitality businesses in many countries
“Lots of Chinese people, especially among the middle class, have not been able to get out since the pandemic. Any recovery in Chinese tourism is likely to have a pretty big impact on leisure and hospitality businesses in many countries,” he says.
However, while the government may look to boost spending on public housing and other areas of infrastructure, such as renewable energy plants, it is unclear this will provide as much of a boost to global commodity markets as some anticipate.
Nafez Zouk, emerging-market sovereign debt analyst at Aviva Investors, says since the recovery looks like being consumption led, it is likely to impact other emerging bond markets in a very different way to previous spurts of Chinese growth.
“Increased consumer spending in China should provide a lift to countries dependent on Chinese tourism. But concerns over levels of debt mean Chinese authorities are likely to want to avoid pushing too hard on infrastructure or real estate spending. We would expect less of a boost to commodity exporting nations such as South Africa and Brazil than in the past,” he says.
Beware Beijing’s policy agenda
Malcolm and Lewis believe it is more important than ever for investors to be aware of Beijing’s policy agenda. For some areas, such as semiconductor companies, that could mean a more favourable environment as Beijing tries to build up its domestic capabilities as a means of circumventing US sanctions.
By contrast, other companies are going to be up against a more interventionist government. For instance, Lewis believes mortgage lenders may struggle as the government seeks to put downward pressure on mortgage rates to ensure households can keep up with payments and have more disposable income.
Investors should be discerning about their exposure to the Chinese market
Given the steep recent recovery in share prices, Malcolm believes investors should be discerning about their exposure to the Chinese market. However, he argues Chinese equity valuations are far from excessive, especially when one considers many large international investors remain underweight the market.
Even if the rapid recovery in economic activity proves to be only temporary, he believes there will continue to be investment opportunities.
“The universe is so deep and so broad there is always going to be an opportunity to stock pick. With China representing as much as a third of the global emerging-market equity universe, it is unlikely we are going to say China is uninvestable and in danger of becoming another Russia in the eyes of global investors,” he says.