In a nutshell
Credit growth is about to peak, although monetary policy tightening is not yet in sight. Government bond yields have risen since the second-quarter data, but may be range bound at between 3.0% and 3.5% in the coming year. A non-inflationary moderate growth environment with supportive policies should be positive for Chinese stocks in 2021.
China’s growth recovery should benefit global growth. The IMF expects China to be the only major economy to show positive growth in 2020 and its contribution to global growth would increase from an estimated 26.8% in 2021 to 27.7% in 2025. Despite this, we believe China is unlikely to boost commodity and energy prices significantly as demand for these products has entered a secular slowdown.
How different is this recovery?
The recovery is on track and broadening out after a first half in which production was the sole growth driver. However, demand is recovering sluggishly: retail sales rose by only 3.3% YoY in the third quarter, which was less than half the growth pace of production and investment.
China’s economy has now regained the output lost due to the COVID shock. That is why the authorities are happy with the pace of the recovery and have stopped easing.
China’s quick recovery is a product of its stringent lockdowns, massive testing, infection tracing, as well as a large domestic economy supported by fiscal and monetary stimuli. Export growth is a bonus, but it is not expected to outperform for long. Domestic demand is expected to be the main driver in coming quarters, with growth in the services sector and consumption catching up.
Crucially, the recovery has come with relatively restrained policy stimuli. Beijing has focused on targeted easing with much less public investment than in past cycles. Efforts to boost sectors such as technology, services and consumption upgrading have helped make the recovery sustainable.
Impact beyond China’s borders
China’s imports have benefited the global economy, with the impact spanning Asia, Europe and the US (see exhibit 1). Commodities and capital goods imports, including iron ore, oil, copper, agricultural products and mechanical & electrical goods have rebounded thanks to domestic demand.
However, the market should be realistic about China’s demand for commodities. Economic restructuring has moved the economy from industrial-based investment-led growth to services and tech-based consumption-led growth. Commodity and energy demand should recover along with the economy, but super-strong growth rates as seen in the 1990s and 2000s are gone for good.
Assuming 2.2% GDP growth this year, overall Chinese energy demand would grow by just 1.2% YoY versus 4.2% growth in 2019. Furthermore, most of the demand will come from renewables such as wind and solar on the back of government policies.
Policy and market outlook
If economic growth disappoints, there will be more policy easing (with a 20% probability, in my view). Disinflationary steady growth is positive for Chinese equities. Recent market research shows an increasing willingness by Chinese households to increase their equity exposure. Foreign portfolio inflows to China are expected to continue after the addition of Chinese stocks and bonds to international benchmarks. This should help improve market sentiment towards Chinese assets.
Current Chinese bond yields take into account steady growth allowing Beijing to resume its deleveraging policy and its retreat from implicit guarantees to let zombie companies exit the system.
In our view, the central bank’s policy is to facilitate financial reform while containing systemic risk and preventing bond yields from moving beyond the 3.0-3.5% range in 2012.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. The views expressed in this podcast do not in any way constitute investment advice.
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