China’s underwhelming recovery this past year is leveling expectations for the world’s second-largest economy. It is neither imploding nor roaring back, and remains likely to muddle along, say observers.
Beijing’s steady stream of stimulus could set up the economy for a middling cyclical recovery into the first half—providing a lift to the country’s cheap stocks, with the
MSCI China
index down 12% so far this year, and trading at around nine times forward earnings.
But any rally could be short-lived. China’s longer-term structural issues persist, and apprehensive investors may use a market recovery to trim holdings. That apprehension ratcheted higher after Beijing proposed curbs on online gaming, sending shares of
Tencent Holdings
and
NetEase
tumbling on Friday as the short reprieve from concerns about Beijing’s technology crackdown was broken.
China’s economic recovery has sputtered after an initial jolt of activity as people rushed to restaurants and travel after years of Covid-19 restrictions. While parts of the economy have come back, momentum is slowing, and still-struggling property market looms.
“With the consumer-spending recovery starting to run out of steam, much of next year’s performance will depend on the property market finding a floor,” says Shehzad Qazi, managing director at independent research firm China Beige Book. “But big bang stimulus isn’t in the cards. Instead Chinese policy makers will continue providing enough support to help the property sector stabilize and help the economy recover. This scenario sets up markets for far more uncertainty than some recent bullish outlooks suggest.”
Another concern: China is facing deflation in marked contrast to the inflation that much of the rest of the world faced as Covid restrictions eased. That may challenge earnings, and could curb consumer spending—especially on homes—since prices could be lower tomorrow.
Businesses are also wary of increasing spending: Average hours worked, for example, hit a record, indicating companies would rather have employees work more than hire more people.
“What we have seen already in stimulus would have been enough to kick start a rally in stocks in the past, but it’s barely created a bottom, suggesting confidence is so damaged that signs of stimulus have to be bigger or economic performance has to materially surprise to the upside,” says Rory Green, head of China and Asia research for TS Lombard.
Policy makers in December vowed to be more proactive with fiscal measures to support semiconductors, electric vehicles, and infrastructure, while promoting affordable housing. But there were no signs more-aggressive efforts are on the horizon to tackle the fallout from the property slump, and the resulting debt problems for local governments—a concerning sign for Houze Song, a fellow at MacroPolo, the Paulson Institute’s think tank, where he focuses on China’s economy.
The worst of the real-estate downturn itself may over, but Song sees localized government debt troubles just starting—and possibly taking five years to work through. Beijing has leaned on banks to roll over debt to avoid bankruptcies. However, local governments are facing a solvency, not liquidity, issue as their income has dried up as land sales have been cut in half, Song says.
The mismatch in debt and income could be as big a drag on China’s economic growth as the real-estate bust.
“China’s growth rate will get progressively slower in coming years—and with significant downside,” says Song. “So far, China has avoided a major financial crisis, but the local government debt crisis brings significant more risk.”
Investors are already worried about China’s aging population, and a transition away from being the factory of the world and relying on debt-fueled property booms to get out of downtowns to becoming more domestically driven and self-reliant as geopolitical tensions rose. On top of that, President Xi’s approach to dealing with these challenges is adding to investor wariness.
“There are reasons to be apprehensive. Things have changed,” says Michael Kass, manager of the Baron Emerging Markets Equity fund. “We have a breakdown of the traditional transmission mechanism from the technocrats making policy recommendations to those implementing it.”
Though Kass is still selectively invested in China, he notes a near-moratorium among global investors looking to commit additional money to China amid the fractious U.S.-China rivalry that shows little sign of changing meaningfully.
While China could see a cyclical recovery that sparks a modest earnings rebound that would make its already-inexpensive stocks “ridiculously cheap,” Kass says investors are likely to demand a higher risk premium—essentially willing to pay less—for those stocks than prior to Russia’s invasion of Ukraine.
The geopolitical risks could rise further on two election cycles. Taiwan, the island nation China claims as its own, heads to the polls in January, while American candidates of both parties look to highlight tough-on-China credentials. U.S. tariffs could also resurface as the Biden administration decides whether to keep duties on $300 billion of goods implemented during the Trump administration. Part of that review could include raising tariffs on Chinese electric vehicles, according to a report in The Wall Street Journal.
Even then, some global investors see a reason to keep a toehold in China for the simple reason that China’s too big to ignore. Pockets of its economy remain vibrant, including electric vehicles and advanced manufacturing. The country is about to become the world’s largest exporter of autos.
Those looking to tap a potential recovery in Chinese stocks may want to be nimble.
“We could see something similar to the rally after Covid restrictions were eased. We could have a couple months of decent economic data and an uptick in the market and then see it roll over as the economy doesn’t get follow-through,” Green cautions.
In other words, China may not be a buy-and-hold market.
Write to Reshma Kapadia at [email protected]
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