Summary: China’s recovery from the COVID-19 crisis remains uneven, with state investment and production leading a relatively weak consumer recovery. However, the Chinese property sector is roaring back and this might be one of the most important signals for the global economy.


Investment Implications: It is still early, but if this trend continues, it could have upside implications for companies exposed to positive trends in the property sector, as well as commodities and resources. 

Spotlight

Is the “old economy” coming to the rescue? 


As China’s recovery chugs along in a steady but uneven fashion, two important trends are emerging that provide insight into both the near term growth trajectory and how the investment landscape might shape up.

1. The property sector is showing signs of life after laying dormant for the last few years. Sales have rebounded strongly in the last few weeks and could be on the way to reaching new highs.

2. Transportation is in a deep contraction. Representing roughly 5% of GDP, it will be difficult for China’s economy to fully recover until this sector normalizes.

Let’s dig into each.

First, why is the recent property upturn so important?

At the risk of overstating its impact, the Chinese property sector is not only the most important sector in China, but is also one of the most important sectors in the world when considering its role in global commodity demand (China consumes 70% of global iron ore supply and 40% of global copper supply). Housing alone is more than double the size of total infrastructure construction, and the broader property sector nearly three times as large.  

As a result, swings in housing and property demand can have an outsized impact on new project starts, the pace of construction for projects in the pipeline, and thus overall commodity and industrial demand in the economy. And that’s not even counting the important influence property has over the sales of autos, appliances, and construction materials (i.e. new home sales tend to drive appliance and auto sales). In total, the property sector and corollary industries account for nearly a quarter of China’s GDP. Emphasizing this point, the property market has been the essential component of every previous stimulus round in China; in 2009, 2012, and 2015 it was a housing boom that turned the economy around. Given its sheer size in the economy it’s likely going to be difficult to meet any realistic growth goals without having a renewed housing rally. In other words, this sector will be a very important factor in China’s economic growth over the coming year, as well as how the Chinese economy impacts the global economy. 

Moreover, residential demand is a privately determined variable; official policy plays a role, but so do things like market sentiment and expectations about the future. Thus, the property sector can give a better indication of private sector sentiment than other factors, such as infrastructure investment or industrial production.

This leaves the question: does this surprising upside for Chinese property lead us to be more optimistic about commodities, resources, and by extension, those related equities? While China’s import of raw materials picked up in recent months, we think it’s likely still too early to call it a trend, unless we see this data continue to improve and reach new highs over the coming months. If it does, this housing cycle could provide a boost similar to the previous housing-led stimulus cycles of 2015, 2012, or 2009. 

Despite the recent pick up in property and other supply-side drivers, the overall economy is still likely negative in year-on-year terms. Although China has been “first out” of the COVID crisis and the government is pumping large amounts of credit into the financial system, the economy is still struggling to get back to last year’s activity levels (even after four full months into the recovery). Why is this?

This brings us to our second trend: China’s recovery has hit a roadblock amid continued weakness in the transportation sector.

The transportation sector remains in deep contraction, and weakness is almost entirely from passenger travel—which was still down nearly 60% year-over-year in May. 

International borders remain firmly closed, but even more importantly, domestic travel is still muted despite most internal restrictions being lifted in March and April, as people remain wary about leaving their home cities and provinces. Unexpected flare-ups of the virus mean travelers could still run the risk of getting caught in a new emergency quarantine situation (as we recently saw in Beijing, where a sudden flurry of new cases forced the government to abruptly ban all travel in and out of the city). 

The result is that domestic transportation, hotels, entertainment and other related industries are under pressure and could be for some time.

As mentioned above, this weakness could be offset by a housing rebound, but at the time of writing, it’s still unclear if that trend is going to be sustained. Even if it is, it’s also not clear whether it would be sufficient to return China close to a sustainable mid-single digit growth trajectory.

Of course, China’s economy is far more complex than to be determined by just these two sectors, but with the consumer under pressure from higher unemployment and sluggish exports due to a weak global economy, the push and pull of property and transportation are likely going to be the swing factors that determine the outlook. Reducing the drag from domestic travel and/or supporting a renewed rally in housing could provide an upside surprise in the near term. Though not without risks. The property sector is famously vulnerable both in terms of high housing prices but also oversupply. And pushing for a rebound in domestic travel could bring second wave risks. All in all, to understand China’s growth trajectory, these two sectors are a good place to start. 

All market and economic data as of July 6 2020 and sourced from Bloomberg and FactSet unless otherwise stated.

For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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