Estrategia y temas
June 26, 2023
Chinese growth disappoints but the outlook is not poor
Without inflation, households are not facing a rise in the cost of living
The authorities are supporting activity through a number of fiscal and monetary measures
Chinese equities are cheap and improve the risk/return ratio of portfolios

CHART OF THE WEEK: "Chinese equities underperform but have low correlation"


The end of lockdown in December 2022 was supposed to enable the Chinese economy to take off in 2023. Six months on, the reality is not living up to expectations. The recovery is struggling to materialise in sectors in difficulty, such as real estate, and is already running out of steam in those that are doing well, such as discretionary consumption. Aware of the difficulties, the Chinese government is now forecasting 5% growth this year, the slowest pace of growth since 1976. Leading indicators, whether compiled by Bloomberg (see Fig. 2), the Organisation for Economic Co-operation and Development (OECD), or the

National Bureau of Statistics (NBS), are now delivering a more optimistic message, in which government support and the implementation of a stimulus plan should enable growth to accelerate.

The Asian giant's economy is being penalised by a number of factors:

1. The global economic slowdown is weighing down demand for Chinese goods. While the services sector has rapidly normalised (see Fig. 3), industrial activity is under pressure due to a process of destocking and falling exports. In May, industrial production slowed to an annualised rate of +3.5%, while exports contracted by -7.5% (see Fig. 4).

2. Against a backdrop of uncertainty in the labour market, household consumption is contributing too little to growth (see Fig. 5). Job offers are drying up in the private sector, including in Shenzhen, nicknamed "China's Silicon Valley". Companies are being penalised by tighter regulations in the new 3 technology, property, and tutoring sectors. The slight fall in the unemployment rate in China's major cities, from 6.1% to 5.2%, is misleading. For example, it has just reached a record high of 20.8% among young people aged between 16 and 24 (see Fig. 6). This ratio could rise further in July, when 11 million new higher education graduates enter the labour market. Ironically, some will try to find work as civil servants. The most disillusioned will end up going back to school or, in extreme cases, will film themselves throwing their diplomas in the bin.

The vicious circle seems clear: companies are reluctant to hire because of weak consumer demand, while consumers are reluctant to spend because of a weak job market. After a strong technical rebound at the start of the year, retail sales, the main indicator of household consumption, are already slowing. Restaurant services, cars, communications equipment, and luxury goods have all expanded strongly. In contrast, consumption of food, beverages and building materials has fallen. For the time being, the savings of 5,000 billion yuan ($695 billion, see Fig. 7) accumulated by households during the three years of Covid-19 have been used only very little for consumption. Worse still, the savings rate is above its pre-crisis level and deposits increased in the first quarter.

3. The property sector, a traditional pillar of growth, is now one of its main obstacles. The Chinese used to invest in real estate, acquiring a second or even third property. The over-indebtedness of developers such as Evergrande, and the resulting implosion of the market, has resulted in significant capital losses for Chinese households. Their strategies for investing their savings are now less focused on this type of asset. Unsurprisingly, the slowdown in the real estate market intensified in May, with sales and house prices falling (see Fig. 8). Only the construction of new buildings continued to grow year-on-year.

Among the risks exogenous to the economic cycle, the two main ones are:

4. The deteriorating geopolitical environment between the United States and China. Tensions over Taiwan's autonomy, collaboration with Russia, and the sending of spy balloons continue to worry investors. The recent statements by Joe Biden, describing Xi Jinping as a "dictator", will not improve this feeling. The more Western countries seek to diversify their supplies, the more this will weigh on China's export potential.

5. Chinese and American regulatory restrictions holding back growth. When Beijing dismantles conglomerates like Alibaba or takes over certain sectors such as online education, its interference weakens the creation of added value and restricts the flow of foreign capital. Similarly, when Washington prevents the export of advanced semiconductors and chips, it slows down China's technological progress.

However, China has several trump cards up its sleeve:

  1. Unlike much of the rest of the world, inflation is very low. As the consumer price index has not risen over the past 12 months (see Fig. 9), Chinese households are not facing a cost-of-living crisis.
  2. The Chinese authorities have announced a number of budgetary support measures for businesses, including tax cuts and credit for small companies.
  3. The People's Bank of China (PBoC) is stepping up the easing of its monetary policy. By cutting its main key rates (see Fig. 10), it is encouraging commercial banks to lower their deposit rates. The aim of this strategy is to discourage savings and encourage consumer spending and capital expenditure.

China's economic objective is now "high-quality growth", notably through technology and innovation, income equality (shared prosperity), safeguarding financial stability, strengthening national security, and green transition. This multiple objective implies a strategic involvement of the State and greater tolerance of weak growth. At the same time, market mechanisms must continue to function. No policy aimed at directly supporting demand, nor any additional easing measures in the property sector, has been announced.

Over the last five years, China's stock market indices have delivered disappointing returns. The MSCI China index fell by -20% and the main stocks traded in Shanghai and Shenzhen, grouped together in the CSI 300, rose by just +8%. The Euro Stoxx and the US S&P 500 were up by 20% and 60% respectively over this period. Even within emerging equities, China underperformed (see Fig. 11).

Initially, the zero Covid policy and restrictive regulatory measures helped to explain the underperformance of Chinese equities. While these two factors seemed to have come to an end, the further decline over the past five months (see Chart of the Week) has finally dissuaded even the most patient investors. Now, only those with long-term objectives or who strategically allocate a minimum weighting to China are still invested. According to the latest data available, equities recorded marginal inflows in May and June, after a red month in April. Paradoxically, this drying up of capital flows is actually excellent news for the future, as it means that there are hardly any sellers left. Prices in the world's leading emerging market should therefore stabilise, paving the way for a sharp rebound on the slightest piece of good news.

On the forex market, the yield differential between China and the United States is weighing on the yuan. Since 13 January, the greenback has remained broadly stable against its main counterparts, such as the euro, the Swiss franc and the British pound. Over the same period, the Chinese currency has fallen from 6.7 to 7.2 to the dollar, a depreciation of -6.8% that has brought the exchange rate back to its autumn 2022 level. However, with the Fed set to halt its rate hikes, the downward pressure on the yuan will be felt less and less. Better still, if the dollar starts to fall again, the Chinese market will automatically benefit (see Fig. 12).

In terms of valuation, Chinese equities are trading at 10.8x earnings, a very affordable multiple. Many of the risks are factored into the price. By way of comparison, the US S&P 500 is currently trading at 22.5x earnings (see Fig. 13).

Finally, portfolio managers will note that the correlation of Chinese equities with developed country indices is very low (see Chart of the Week), helping to improve the overall portfolio's risk/return ratio.


To increase their exposure to Chinese equities, investors will need concrete evidence that economic fundamentals are improving and that property, diplomatic and regulatory risks are gradually dissipating. At that point, and probably as the dollar depreciates, capital flows will naturally gravitate towards Chinese equity indices, as they are very cheap and provide decorrelation.