Positive China data validates recovery, despite trade tensions

It’s hard to believe it’s only six months since China first clearly indicated it was set to reverse course and re-open the economy after Covid. Despite the worst fears of some analysts the re-opening has gone relatively smoothly and the economy is now gathering momentum.

There are still skeptics out there but the recent economic data has been positive. Q1 GDP growth was recorded at 4.5% year on year and places the second largest economy in the world comfortably on track to reach the stated official goal of 5% growth for 2023 without any further easing of monetary policy or additional fiscal stimulus. The underlying data was uneven with retail sales and fixed asset investment growing strongly but industrial production only up a tepid 3.9% year on year. That was blamed on weak demand from Europe and the US, which was also reflected in export figures for March with strong growth in exports to ASEAN countries (+18.8% year on year) offsetting weakness to Europe (down 7%) and the US (down 17%).

Other indicators show growth is likely to gather momentum in Q2 and beyond. China's March Manufacturing PMI reached 51.6 and non-manufacturing surged to 55.0; both continuing to expand and coming in stronger than consensus. In addition, March power usage increased by 5.9% year on year to 736.9 billion kilowatt-hours, accelerating markedly from January and February growth rates.

From our perspective it’s weak growth in Europe and the US that’s reflected in this data, with China (domestically) and ASEAN outperforming. This confirms our view that China’s economy is on track for solid if unspectacular growth and that explains recent equity market strength that has seen the Shanghai Composite rise 8.7% in the year to 16 April 2023.

Residential property sales increased 7.1% year on year in Q1 compared to 3.5% in Q4 2022, indicating a sales recovery is finally gaining traction and the market is functioning again. The sales data is also reflected in prices, which eked out a 0.5% month on month gain in March 2023, supporting our thesis that the bottom is in.

This doesn’t mean anything immediate in terms of overall construction activity as the sales growth is accounted for by unsold inventory, but it’s a clear first indicator of normalization. We also monitor land acquisition data in major cities which is showing signs of increasing demand. Though there is usually a lag between land acquisition and construction, it will still lead to an improved construction demand from the property sector. This in turn will have important implications for business and consumer confidence going forward.

As in the rest of the world, travel has been at the leading edge of recovery after the Covid constraints were released, closely followed by luxury consumption. In China the two often coincide and the indications ahead of the golden week holiday (in the first week of May) suggest the trend will continue.

Macao hotel rates will surpass pre-Covid levels, while occupancy rates based on pre-bookings will be higher than in 2019.

This is good news for listed casino companies which are enjoying earnings revisions but the glow of recovery is also being felt across the whole domestic travel sector. China’s online travel agent Trip.com told us domestic hotel room nights and air ticketing volume are tracking at low-teen growth vs. 2019 levels, a very positive indicator.

As a result we have positioned in travel-related companies and mass consumption goods including brewery businesses to ride this strong trend in leisure-related consumption.

The most obvious overhang in terms of investor sentiment towards China is the current friction over trade. This is real in the semiconductor space, where the US CHIPS Act and restrictions on export of chipmaking technologies to China announced in October 2022 are already having a material impact on operations and planning. China’s retaliation has so far been limited – consisting of launching a cybersecurity investigation into US memory chip giant Micron Technologies, and there hasn’t yet been a spillover to other sectors.

In our view, outside the semiconductor sector, the trade issue is currently being exaggerated in terms of its tangible effect, and we hope there isn’t any escalation, as the economic impact would be severe on both sides of the Pacific.

The movement of manufacturing to ASEAN nations and India has also been framed as a negative for China which, ceteris paribus, it is. However, we believe this is a long-term process and more related to China’s manufacturing competitiveness vis-à-vis Vietnam and the other destinations. China’s tilt towards quality of growth while moving up the value chain, and a rise in wage levels is the structural underpinning of this trend, rather than geopolitics.

The offshoring trend was given a further boost by the Covid pandemic when the benefits of having a distributed supply chain with some redundancy built-in became obvious. This is a clear benefit to China’s neighbours, but it does not spell the end of China’s economic development, and is comparable to the gradual offshoring of US manufacturing to Mexico and China which happened over decades.

The trade tension and geopolitical worries are here to stay, but this new normal could settle into an uneasy equilibrium, rather than worsen. China needs foreign investors as Chinese authorities made clear at the China Development Forum in Beijing in March, a conference attended by numerous multinational CEOs including Apple’s Tim Cook. "Investing in China is investing in the future," said Zheng Shanjie, head of the National Development and Reform Commission at the conference. ¹

It will take a lot to convince wary global investors to be that bullish, but in our view the positive drumbeat of economic data should underpin investor confidence in China. The recovery is real and it’s accelerating, with China likely to account for 30% of global growth this year, according to the IMF.

Given such a macroeconomic environment, we have positioned for a consumption revival while continuing to favor long-term themes where we believe value lies, including the green economy, technology innovation, and the technological upgrade of China’s industrial base. China’s equity market is trading at attractive valuations below its historical level, and earning revisions could be a driver going forward.

Footnote

¹Key takeaways from China Development Forum 2023 – Xinhua – March 29 2023