The already-strong parts of China’s recovery are likely to remain strong—the industrial sector is growing at a faster pace than pre-COVID days—and we expect this to persist.
Global markets continue to gyrate as investors work to digest rising U.S. interest rates. While Asia has been spared the worst of the correction (compared with Brazil or Turkey), the sell-off has shaved off a lot of stocks’ year-to-date gains. The MSCI China Index is down -2.4% year-to-date, and the CSI 300, a benchmark for the domestic A-share market, is down -1.6% year-to-date. In fixed income, Chinese credit is down modestly, buoyed by higher coupons and shorter duration (though that’s not to say it hasn’t been a bumpy ride in high yield). Meanwhile, the RMB has remained resilient and is basically unchanged vs. the USD on a year-to-date basis.
As investors look ahead, many are asking: Is now the time to add China exposure?
Our short answer: While we certainly cannot rule out the possibility of more near term volatility, we believe the underlying macro picture is still pretty solid.
In today’s Top Market Takeaways, we examine this dynamic through the lens of three questions.
1) Is China’s tepid consumer rebound a concern?
We don’t think so. The already-strong parts of the recovery are likely to remain strong—the industrial sector is growing at a faster pace than pre-COVID days, with broad-based strength, and we expect this to persist. Remember: China’s industrial activity is generally geared to global trade, which looks set to recover at an even faster clip in the second half of the year. Robust industrial activity also bodes well for increased manufacturing capex this year.
Further, we don’t think the more gradual domestic consumption recovery is necessarily a bad thing; to us, it just means the recovery is gradually becoming more broad-based. The resurgence of COVID in some cities in early 2021 has temporarily held back consumption, particularly in travelling and dining, but we think this is beginning to normalize. Further, given income growth has already recovered, it seems natural that consumption growth should soon follow. It’s also important to note that the consumer rebound has been organic, in line with the employment rebound—which differs from the stimulus-aided rebound in the U.S.
Last, a quick point on inflation. Low inflation should not be misconstrued as a lack of demand. China’s fiscal stimulus has been quite measured, and more skewed towards supporting businesses to stay open, rather than supporting household consumption. That said, businesses were able to keep up and actually grow the supply side of the economy, while the demand side is still gradually playing catch-up. Taking out base effects, inflation is roughly where we’d expect it to be, and consistent with the picture of steadily recovering growth.
2) Will policy tighten further?
As we noted in our NPC takeaways, policy normalization should be gradual. The stated goal is for broad credit supply to be broadly consistent with nominal GDP growth. Given the latter is likely to be 10-11% this year, it is not implying a whole lot of tightening ahead. Depending on how one measures broad credit growth (policymakers probably look at a range of indicators), we are either already in the range or very close to it.
3) Could China’s massive trade surplus invite fresh geopolitical frictions?
As we’ve written before (and mentioned above), China’s exports have been extraordinarily strong and a key aspect of China’s recovery. With overall global trade fairly weak, China’s trade boom implies enormous market share gains in a very short period of time. This has largely been due to the pandemic shock on global production, putting Chinese exporters in a strong position to capitalize when the world was closed as well the unusually strong demand for electronic goods.
With another round of U.S. stimulus providing a further boost to U.S. consumer spending (and thus China’s exports), and quarantine restrictions keeping tourism and investment capital at home, China’s current account surplus is likely to continue rising in 2021. As the U.S. and other major economies run ever larger trade deficits with China, investors need to be aware that tensions around trade and the currency could return.
So, what does this mean for investors?
Given a still-resilient macro picture, we believe Chinese equities stand to make new gains this year, even if we experience further short-term volatility along the way. We particularly like long-term trends like consumption, industrial upgrading, and new infrastructure. In fixed income, we think that CGBs are a good way to get some extra yield with low volatility and low correlation with other EM markets—not to mention the benefit from inflows due to index inclusion expected later in the year. Last, fundamentals support the RMB and political pressure could mean more appreciation ahead.
The MSCI China Index captures large and mid-cap representation across China H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs). The index covers about 85% of this China equity universe. Currently, the index also includes Large Cap A shares represented at 10% of their free float adjusted market capitalization
The CSI 300 Index is a free-float weighted index that consists of 300 A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges.
All market and economic data as of March 29, 2021 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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