by Joseph V. Amato, President and Chief Investment Officer—Equities, Jonathan Bailey, Head of ESG Investing, Neuberger Berman
The lifting of China’s last COVID-19 restrictions at the start of the year enabled me to take a long-delayed trip to Beijing, Hong Kong and Shanghai earlier this month.
It was great to catch up in person with our colleagues and clients in China, but I found that many were cautious on the economy and the market.
The contrast with sentiment at the start of the year is quite stark, so it is worth taking a closer look at what has been happening. Are China’s long-term growth prospects still exciting? Are U.S.-China relations going to drag down both countries’ growth rates? Might global allocators of capital benefit from rebalancing back into China, given current relative valuations?
Reopening
Late last year, we were cautious on China’s economy—due to “uncertainty around the zero-COVID policy,” as we put it in our fourth quarter Asset Allocation Committee Outlook—but saw it as an important component in global growth. As the likelihood of an aggressive reopening grew, by January our view on China’s economy and its wider impact had become more optimistic.
Like many of our peers, we felt that with the U.S. and other developed economies expected to slow due to tightened monetary policy and financial conditions, China’s reopening could serve as a nice boost to overall global growth.
After an initial spurt of activity, China’s reopening momentum has surprisingly slowed. Last week’s industrial production figures for May slightly undershot expectations that were already muted after economists’ hopes for double-digit year-on-year growth in April were dashed.
After a promising start in February and March, the official Manufacturing Purchasing Managers’ Index (PMI) has now fallen back into contraction. Exports dropped in May. Producer price inflation has been dropping steeply, suggesting weak demand and limited pricing power. The real estate sector continues to be a headwind—and, as the Global Financial Crisis reminded us, real estate booms and busts can weigh on an economy for multiple years. Against that background, it is no surprise that growth in fixed asset investment has been lackluster and declining.
In the meantime, most of the developed world has seen inflation slow and its economies exhibit surprising resilience, so far at least, in the face of much higher interest rates.
Year-to-date, Japan’s TOPIX Index, the U.S. Russell 1000 Index and the STOXX Europe 600 Index are up by 23%, 16% and 9%, respectively. The Shanghai Composite languishes at less than 6%, after declining during the second quarter while the others began to pull away.
Optimism
Where might some optimism come from?
There may be some green shoots in U.S.-China relations in the near term. With Taiwan elections and U.S. elections slated for 2024, relations are facing a potentially more challenging political environment, but at press time for this piece, U.S. Secretary of State Antony Blinken is on his way to visit China. More constructive engagement by the leaders of both countries would be helpful in so many ways, appreciating that competition between these two powerful economies will likely remain fierce.
In developed economies, post-COVID demand shifts continue to translate into soft manufacturing data, but stronger retail and services data, and we see some of that in China, too. Last week’s retail sales painted a brighter picture than the industrial production data, marking four months of growth. Services PMI has been firmly in expansion all year, while also exceeding economists’ expectations.
Stimulus
Most importantly, however, China is in a very different cycle than the developed world.
Inflation is almost nonexistent, which enabled the People’s Bank of China (PBOC, China’s central bank) to cut two of its benchmark lending rates last week, after holding fast for nine months. The government also announced a series of measures to support businesses, including tax breaks and targeted loans.
There is growing anticipation of further stimulus among market participants, including a potential cut to the PBOC’s reserve requirement ratio and fiscal measures, coincident with the government’s political process. China’s cabinet is reportedly canvassing economic advisors for policy proposals, and announcements are expected from the next Politburo meeting in July. Home-buying and credit restrictions may be eased to help the real estate sector, and local government bond issuance is expected to pick up over the summer to give impetus to infrastructure projects.
While the 2023 growth outlook for China is slowing from earlier enthusiastic levels, it will likely remain at a fairly robust rate, with the consensus around the 5% level. With the Shanghai Composite’s valuation metrics sitting at low 2019 – 20 levels, and some good news potentially on the way, it may be time to look past the disappointment that has built up since the start of the year and refocus on the medium-term opportunity.
