Financial markets are clearly losing confidence in China’s economic recovery. This doesn’t go just for equities – in recent weeks China’s government bond yields have declined, the currency has been weaker and the prices of many commodities, including iron ore and copper, have also fallen.1
After a generally strong Q1, the catalyst has been a significant weakening of growth momentum in April with the Manufacturing Purchasing Managers’ Index (PMI) falling back below 502 – a figure that suggests the sector is contracting.
There are also jitters in the housing market. While completions of suspended home-construction projects have accelerated – spurred by government support targeted at an area of social sensitivity – overall property sales in April 2023 were only 63% of the level in April 2019. Sales in March were 95% of those seen four years before.3
Chart 1: Copper price since China reopening at end October 2022 (rebased to 100)
Source: Allianz Global Investors, Bloomberg, as at 22 May 2023
The question, therefore, is whether this is the end of the recovery, or merely a soft patch. Our view is the latter.
As such, while equity markets were overly optimistic about the recovery earlier this year, now we see a mirror image with markets in danger of becoming overly pessimistic.
There is a different dynamic to this economic cycle, at least from a China perspective.
Previous recoveries have been reliant on property and infrastructure spending, where policy changes can be reflected rapidly in the macro data.
This time in China, the pick-up is being led by the consumer. And here the restoration of confidence – with the normalisation of spending patterns after the end of the Covid restrictions – is taking longer to happen.
Having said that, the increase in travel and domestic tourism during the recent Labour Day holiday suggests that consumer confidence is still improving, just at a lower rate than earlier in the year when “Covid relief” was in full swing.
One commonly asked question is whether we should expect significant further government stimulus.
With the Politburo meeting in April signalling little change to either fiscal or monetary policies, we think this is unlikely – at least for now. But some more targeted policy response does seem likely in two important areas – the first being property, and the second being youth unemployment.
Chart 2: CSI – performance of State Owned Enterprises (SOEs) compared to private companies since October 2022 (rebased to 100)
Source: Allianz Global Investors, Bloomberg, as at 19 May 2023
Youth unemployment hit a historic high of 20.4% in April – roughly double pre-Covid levels – and is likely to rise further with around another 11 million graduates in the months ahead.4 Not only does this impact overall consumer spending, it could even pose a risk to social stability.
The reason for the high youth unemployment is mainly cyclical. The service sector is a big employer of graduates. In 2020-21, this sector added only 3 million new jobs compared to 16 million in 2018-19. And while the data in 2022 is not available, very likely there was an overall contraction.5
The recovery in the service sector year to date should lead to more job creation as we move through the year. And the importance of this issue was highlighted by a recent announcement that stateowned enterprises (SOEs) would create 1 million internship positions for jobless graduates.6
On the topic of SOEs, one of the features of the China A market this year has been the significant outperformance of SOEs compared to private enterprises.
In total, SOEs account for around 43% of the MSCI China A Onshore Index.7 But within this, it is the “central” SOEs – those controlled by the national government such as large banks and telecom operators – which have been the strongest performers.8
The initial trigger for the current round of SOE outperformance was a speech in November by Yi Huiman, China’s chief securities regulator, in which he called for a “valuation system with Chinese characteristics”.
This was taken as code that the market should not put such a low valuation on central SOEs, which mostly trade well below stated book value. Yi also urged SOEs to increase their competitiveness and improve communication to shareholders.
While this official rhetoric provides a theme for local market participants, in practice we see SOE outperformance as primarily a reflection of the increasingly loose liquidity conditions combined with the uncertain macro environment.
Total credit growth has accelerated sharply so far this year and bank deposit levels continue to rise.9 This indicates that companies and households generally have plenty of cash to deploy.
And in an uncertain economic environment, the perceived safety of SOE stocks with their lower valuations and higher dividends is seen as providing a low risk way to play the recovery.
The SOE trend may have further to run. Bloomberg users can type in “central SOE” to get a flavour of the different indexes and ETFs – indeed, three central SOE shareholder returns ETFs were launched on 15 May.10
The takeaway for global investors is that domestic liquidity looks to be in good health – now the equity market needs an injection of macro confidence to produce broader based returns.
1 Source: Bloomberg, 23 May 2023 2 Source: China Federation of Logistics and Purchasing, 30 April 2023 3 Source: Gavekal, 16 May 2023 4 Source: Macquarie, 19 May 2023 5 Source: Macquarie, 19 May 2023 6 Source: Goldman Sachs, 22 May 2023 7 Source: Wind, 31 March 2023 8 Source: Bloomberg, 22 May 2023 9 Source: Gavekal, 10 May 2023 10 Goldman Sachs, 22 May 2023
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