As the world’s second largest economy, many had hoped that China would be at the forefront of leading the global post-pandemic economic recovery. What happens in China has massive implications globally for inflation, growth, etc. But while China’s economy is reporting positive growth, it has been growing at a slower pace than initially hoped for.

Underwhelming GDP figures in China showed the economy expanded 6.3% y/y in Q2 2023; albeit accelerating from 4.5% in Q1 2023, it was well below the expected 7.3%. Deflation risks intensified as CPI was flat (0% y/y in June), the lowest rate in more than two years. Frail growth and deflation risks put policy makers under pressure to deliver more stimulus to shore up activity. The data prompted analysts to revise lower their growth forecasts for 2023 as a whole, now ranging from approximately 4.5%-6.5%. The growth slowdown and rising pessimism around growth weighed on local stock markets in Q2, with Hong Kong’s Hang Seng returning -5.9% and the MSCI China delivering -9.6%, both in US$.

Extended regional lockdowns in China meant that investors were focused on the post-COVID re-opening, which is important for some parts of the services sector. China’s industrial economy was not in full lockdown for most of 2022, as manufacturing largely continued, so there wasn’t a significant bounce-back in activity like we’ve seen in other regions. Manufacturing is weaker than the service sector, which is very similar to the global situation as consumers remain hungry for services they were deprived from during COVID.

Chinese authorities cracked down on the local housing market by overtightening lending criteria, and could not reengineer it due to COVID, leaving the housing market crushed. The real estate sector is experiencing a very hard landing. We anticipate that housing activity will recover from a low base, but it’s unlikely to reach prior levels.

Infrastructure spending has been used to offset some housing weakness, but not completely. Recent data indicates that activity will remain very weak through 2023 and into the first half of 2024. The steel market has been weak in 2023 due to global weakness and reduced demand in a shift from iron ore towards recycled scrap steel.

China is shifting away from a real estate- and infrastructure-driven growth model to more consumption and high-end technology manufacturing and is transitioning rapidly to a greener economy. Further to this, China is well-positioned for growth against the backdrop of low inflation, easing policy restrictions, a persistent current account surplus and the high levels of savings they are well-known for.

Inflation is very low in China and the yuan relatively weak, so while demand from the West is low currently, when it does pick up, China will be very competitive.

Geopolitics at play

One can price economic factors into financial markets to a certain extent, but not geopolitics, like the Russia-Ukraine war, which has really weighed on Chinese risk. This geopolitical risk will persist, but China’s underlying economic ties are very strong.

Let’s take the rising tension between Taiwan and China. Even though Taiwan views itself as independent from China, the two economies are quite interdependent. Over the past decade, Taiwan has been the largest investor in China and China is a huge importer of Taiwanese goods. The Taiwanese appear to want to maintain their independence but not provoke conflict with China, which wishes to “unify” Taiwan with the mainland. Taiwan knows that China can squeeze them more effectively using economic measures, rather than through conflict.

Which leads us to another complex relationship between the US and China. But it will not be as easy for the US to isolate China as Russia, because it’s the largest trading partner in the world. Consider how much disruption was caused by the Russia-Ukraine war – if it were China, it would be 40 times worse. So, the approach is two-fold: the US is trying to maintain leadership in technology by focusing on specific areas, and the Chinese are buddying up with the UK and the rest of Asia.

The rest of Asia is completely connected into China’s economy. During the Trump tariff, a lot of production moved to Vietnam, but the components come from China, so the result was that inter-Asia trade increased substantially. Ultimately, if something negative were to happen in Asia, it would not be simply an Asian problem, as it would have massive global consequences for inflation, trade, growth, etc.

Prospects in China

China is the global leader in renewable energy and electric vehicle technology. The country is at the forefront of the energy transition and is poised to dominate the rest of the world in terms of renewable energy. They have massive scale and massive cost-advantage. China is home to the largest electric car manufacturer in the world, BYD, which produces more than twice as many electric cars as Tesla. China also has the largest solar manufacturing capacity. Renewable electricity generation (wind and solar) in China will increase seven-fold between 2020 and 2060.

Moderate growth, low interest rates and low valuations are typically a positive backdrop for equity markets. Many Chinese companies are responding proactively to a tougher economic environment through cost-cutting and share buy backs.

We believe that the valuations and shareholder returns are attractive in China. There are some great opportunities in the Chinese equity market at the moment through bottom-up stock picking: the risk premium is high, and valuations are very attractive in our view, as the fears are known and priced in already.

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