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Is China’s Economy Stalling?

Aaron Costello, CFA

No. Economic growth in China is likely to reach 5% this year, which is in line with government targets and consensus forecasts. Following a stronger-than-expected first quarter, recent economic data has softened, disappointing investor expectations of a sharper recovery after last year’s COVID-19 lockdown, but the Chinese economy is not on the verge of relapsing into recession.

China’s post-COVID recovery has been different than previous Chinese recoveries and the experiences of Europe and the United States. This recovery has been driven by household consumption and the services sector, not the real estate and infrastructure sectors, which turbo-charged Chinese growth in the past with the aid of excess credit growth. The government remains focused on containing debt risks, which is why it has shied away from large-scale fiscal and monetary stimulus, instead targeting a more muted 5% growth goal. The lack of stimulus is also why the Chinese recovery has been less sharp than what was seen in major Western countries. Chinese households did not receive fiscal transfers during the COVID-19 lockdowns last year, and thus have been rebuilding their savings and spending less than their Western counterparts, who came out of lockdowns flush with extra cash.

Still, households are starting to spend. Domestic travel spending is returning to pre-COVID levels and retail sales were up 18% year-over-year in April. The services sector purchasing managers’ index (PMI) hit near-record highs in March, and while it is trending lower, the latest release still implies growth. Manufacturing PMI numbers have come in much lower than expected, suggesting modest contraction. However, this partly reflects slowing global growth impacting Chinese export orders, not domestic demand. Overall, recent composite PMI data (reflecting both services and manufacturing combined) are at the highest level since 2020, indicating expansion. With that said, the housing market in China remains weak, but it is in much better shape than last year and will be less of a drag on growth this year.

The trend of steady, not stalling, growth is also reflected in corporate earnings, which are still expected to grow 18.5% in 2023 and have seen some positive earnings revisions recently. Yet, Chinese equities at one point had fallen nearly 20% from their late January peak, suggesting something other than bottom-up earnings is driving market sentiment.

Our sense is that geopolitics continues to have an outsized impact on Chinese equities. The peak in Chinese equity performance coincidently matched the appearance of a Chinese balloon over the United States, dashing any hopes of a near-term thaw in US-China relations. The combination of disappointing growth and worsening relations has heavily weighed on market sentiment, sending equity valuations back to levels similar to those seen last year before China abandoned its zero-COVID policy, despite a much better economic outlook at present.

As a result, there remains scope for the Chinese economy and Chinese equities to surprise to the upside, given all the pessimism despite an economic outlook that looks favorable compared to expectations of a mild recession in Europe and the United States. For investors willing to tolerate the volatility, we continue to recommend holding modest overweights to Chinese equities relative to global equities, as a relative value play. For investors who find the volatility and geopolitical headwinds to be too much to bear, there are other opportunities in Asia to consider, but none with as much valuation-upside potential as China.



Aaron Costello, Regional Head for Asia