China’s Second Bounce

June 26, 2023

The world continues to provide a multi-crisis economic backdrop, making equity investing challenging. The biggest news has been the instability in Russia, the largest nuclear power in the world. ¹

Assuming cooler heads prevail as domestic instability in Russia unfolds, the real focus should be on the second largest economy in the world, China. ²

Right now, China is in the midst of shaking off the aftereffects of a prolonged Covid lockdown. The re-opening trade earlier in the year has fizzled and China’s domestic equity market is reflecting some macroeconomic challenges. ³

China never delivered direct-to-consumer stimulus like we did during the Covid outbreak. They focused on stimulating small and medium-sized business and providing foodstuffs to consumers. As a result, China is not facing the same inflationary challenges as we are.³

Unfortunately, that lack of consumer stimulus is creating a soft pocket in their economy. Both industrial output and retail sales pulled back in May. While year-over-year growth is strong, China is bouncing off a low base from the 2022 lockdown. ⁴

Chinese citizens are voracious savers, perhaps as a reflection of the long-standing minimal retirement and healthcare system. In any case, the Chinese consumer goosed up their savings when they were not purchasing homes. Only recently has that trend reversed. ⁵

Consumer confidence also bounced off the lows set during the 2022 Covid lockdowns. Interestingly, the Chinese consumer’s confidence is highly correlated to their price of second-hand homes (used homes). ⁵

Further sentiment improvements can be found in both income and employment expectations going forward. ⁵

Expectations were for the consumer to shift from saving and investing to consumption, but that trend has not yet materialized.⁶

Overlay this with continued bullish expectations for GDP growth by the government at 5% growth and economists at over 5.5%. In fact, current GDP forecasts suggest an 81% chance China grows their economy at over the 5% target. ⁵

It’s clear to the CCP that more stimulus is going to be needed. Just look at the headlines: ⁷ ⁸

Current stimulus has been focused on the housing and property sector in addition to tax breaks for small businesses.

Recent Stimulus Actions (with more to come)

Cut the 1-year Loan Prime Rate (LPR), 5-year LPR, and the Medium-Term Policy Rate by 10 bps
Announced a $72.3 billion package of tax breaks over four years for electric vehicles
Announced that small businesses with monthly sales of less than 100,000 yuan ($14,000) would be exempt from value-added tax for 2023

We can expect more direct-to-consumer stimulus and a strong second bounce in Chinese equities.

Tim Phillips, CEO, Phillips & Company

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