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Investment Strategy

China Mid-year Outlook 2024: Waiting for policy

Jun 27, 2024
Authors: Alex Wolf, Julia Wang, Yuxuan Tang, Cynthia Chou


This July there are two important meetings in China that may provide further insight into the macro outlook: the Third Plenum and the Politburo meeting. The two policy areas we’ll closely watch are domestic demand and fiscal reform. The economy appears to be at an inflection point. The resilience of the manufacturing sector is a bright spot, while other parts of the economy look mixed, but could start to improve.

We retain a relatively cautious view on offshore China markets. The downside is limited, but the upside is capped by a mixed macro backdrop and earnings that have yet to show meaningful upside. We expect the A-share market to be relatively more resilient thanks to lower exposure to geopolitical risks (and foreign outflows), limited FX impact, and its ability to more directly benefit from the government’s supportive policies. The risk of escalating trade tensions with the U.S. and Europe could weigh on the Chinese yuan (CNH). Investors may consider hedging long CNH exposure, taking advantage of the carry, or using the currency as a funder for taking advantage of opportunities elsewhere.

 

China has been in a different economic cycle to the rest of the world. Over the last few years the economy has been under pressure from a historic housing downturn, but coming into 2024 some promising signs have started to emerge. In particular, outperformance in the manufacturing sector has contributed to economic stability and improved the growth outlook. High-end manufacturing such as electric vehicles, industrial automation, digitalization, together with supply chains are all growing at a fast pace. While these higher value-add sectors are a decade in the making, they are now having a bigger impact on the macro cycle.

HIGH-END MANUFACTURING SECTORS ARE HAVING A BIGGER IMPACT ON CHINA’S MACRO CYCLE

Industrial sector value-add, % YoY

Source: Wind, J.P. Morgan Private Bank. Data as of May 2024.
The bar chart shows the year-over-year growth of industrial sector value-add in percentage terms, for all industries and high-tech sector. Some other examples include auto, rail, shipping, aerospace and computers, telecom. Growth of industrial sector-value add for the mentioned sectors was shown for December 2023 and May 2024. The industrial sector value-add YoY growth for both Dec 2023 and May 2024 are: All Industries Dec 2023: 4.60% May 2024: 6.20% High-tech sectors Dec 2023: 2.70% May 2024: 8.70% Auto Dec 2023: 13% May 2024: 10.5% Rail, shipping, aerospace Dec 2023: 6.8% May 2024: 11% Computers, telecom Dec 2023: 3.4% May 2024: 13.8% Particularly, high-end manufacturing sectors are experiencing a higher growth rate for industrial sector-value add in May 2024 compared to December 2024. With high-end manufacturing growing at a fast pace, they are now having a bigger impact on the macro cycle.

Elsewhere, after two years of deceleration, a range of indicators are looking more mixed. This could be a sign of a bottoming out from a cyclical perspective (retail sales surprised a bit on the upside in May). While the overall state of consumption is weak, and “consumption downgrade” is still a clear theme, volume growth is staying resilient. Purchasing Managers’ Indexes (PMI) are still diverging – but with more cyclical components bottoming out. Exports have started to do better. In the housing market, we think policymakers are now more focused on preventing further slowdown. While structurally slower growth in the housing sector is still our base case, stability and marginal improvement are good news for the rest of the economy. So taken together, we think the economic cycle may be at an inflection point, but we will likely need more data to be sure.  

This July there are two important meetings in China that may provide further insight into the macro outlook: the Third Plenum and the Politburo meeting. Historically the Third Plenum has served as a forum for high-level decisions on economic issues, specifically around long-term institutional reforms. Broadly we expect this Third Plenum to reiterate existing priorities rather than change the existing framework. As the Third Plenum focuses on reforms, we can expect a reiteration of the long-term goal to transition to an innovation-led economy. In addition, the two policy areas we’ll closely watch are domestic demand and fiscal reform.

On supporting domestic demand – the focus will likely be on building the national market, rural-urban integration, household registration and social security reform. As China has already reached a 65% urbanization rate, at least on the headline level, the next phase will likely be more focused on redistribution – for example, broadening the access to social services and the social safety net, improving support for lower income families, alongside a further relaxation of household registration policies and the pension system.

On fiscal reform, we expect various topics such as revenue sources, spending priorities and redistribution to be discussed. The current policy design dates back to the 1990s when China was at a very different developmental stage. Given the changing nature of the economy such as digitalization, an ageing population, and a transition from housing to manufacturing upgrades, major reforms are likely. For example, local governments may need a greater share of tax revenue and more options to monetize state assets, even if the central government balance sheet expansion will likely have to do the heavy lifting in the short-term. There may also be discussions to re-direct fiscal spending from investments to social security spending, alongside some pension reforms. Lastly, value-added tax (VAT) codes still need fine-tuning, so investors may expect further consumption tax and individual income tax changes to be delayed until then.

Meanwhile, the Politburo meeting (also slated for July) will likely be more focused on near-term policymaking. In recent months there has been a shift to macro policies focusing on the demand side. We think further policy measures are likely coming to stabilize the property sector, support the equipment renewal/upgrade cycle and reform capital markets to encourage innovation. In the property sector, following the destocking policy in mid-May we have observed some signs that the pace of contraction has started to ease, led by a marginal improvement in Tier 1 and 2 cities. We think further policy support measures are likely to expand on existing schemes.

THE PROPERTY SECTOR’S PACE OF CONTRACTION HAS STARTED TO EASE

Daily housing sales, 10,000 square meters, 30 cities 7-day moving sum

Source: Wind, J.P. Morgan Private Bank. Data as of 25 June 2024.
The line chart shows the 7-day moving sum of China’s daily housing sales per 10,000 square meters in 30 cities for both 2023 and 2024. In 2023, China’s 7 day moving sum of daily housing sales was at 270 in January 2023, which later fell to 6.69 in February. From February 2023 to March 2023, daily housing sales spiked to 469 but this was quickly followed by a general decline of China’s daily housing sales which fell from 469 in March 2023 to 72 in October 2023. From October 2023 to December 2023, China’s daily housing sales rose from 72 to 379 by the end of the year. In 2024, China’s housing market has continued to come under pressure year to date, with daily housing sales for each month below 2023 levels, except for the last few weeks of January. China’s 7 day moving sum of daily housing sales were at 170 in January 2024 and remained relatively flat before plunging to 5.22 in February 2024. This was followed by a steep increase from 5.22 in February 2024 to 321 in April 2024, albeit still below 2023 daily housing sales from February to April. However, from April to May 2024, China’s daily housing sales continued to decline, from 331 to ~80 in May 2024. However, the property sector’s pace of contraction has started to ease in recent months, daily housing sales rebounded from a trough of 80 in May to 243 in June 2024. The gap between daily housing sales in 2023 and 2024 has started to narrow, signaling more stabilization in the real estate sector.

On monetary policy, the PBoC has recently pushed back expectations for a China-style quantitative easing (QE) campaign. Overall, we think monetary policy will likely stay accommodative, with targeted easing more likely than aggressive broad-based stimulus.  

We think the Third Plenum and Politburo meetings are likely to be both modestly growth-positive. The Third Plenum’s focus on improving domestic demand through reforms is potentially helpful for supporting income and consumption growth, though we continue to stress that actions matter more than words. A restatement of pro-market or pro-reform policies is welcomed, but the gap between talk and action has been a source of disappointment. Reforms to fiscal policy are more about making economic growth more sustainable over the medium-term. Meanwhile, the Politburo meeting will likely reinforce the earlier policy shift, with a bigger focus on stabilizing the housing sector and private sector confidence.

In this cycle, policymakers have largely abstained from conventional stimulus, and are instead focusing more on allowing the economy to find a more sustainable pace of growth, as key drivers shift away from housing. Compared with conventional stimulus like the multi-trillion-RMB infrastructure spending in 2008, or direct housing market rescues in 2015, policy measures are slower and more indirect in terms of impact. Therefore, it’s important to watch implementation as well as the results by closely examining  economic data and micro and macro developments.

The economy appears to be at an inflection point. The resilience of the manufacturing sector is a bright spot, while other parts of the economy look mixed, but could start to improve. Whether these new growth drivers create more broad-based economic benefits would be interesting to see. At a time when the economy is going through major structural transitions, such as a secular decline in the housing sector – as well as entrenched geopolitical tensions – manufacturing upgrades could play a role in stabilizing business confidence.

A key feature of China’s growth in advanced manufacturing has been the continued divergence between supply and demand. The growth in manufacturing capacity and production, largely driven by external demand has been a key driver of growth. But this reliance on external demand also sets the economy up to be more vulnerable to trade tensions.

On the surface, exports’ contribution to GDP growth has been small in recent quarters, subtracting 0.2pp in Q423 and adding 0.8pp in Q123 year-over-year real GDP growth. However, the headline statistics understate exports’ importance to China’s economy. For example, looking at domestic value-added (DVA) content of Chinese exports, exports accounted for 19% of China’s total DVA, and real export growth contributed 2.4pp of the 5.3% y/y real GDP growth in Q1. If the spillovers from export-related manufacturing activity to manufacturing investment were taken into consideration, then it’s likely that more than half of the 5.3% y/y real GDP growth was driven by exports. It is fair to say that exports have been the largest driver of Chinese growth this year, while domestic demand growth has been weak underneath the solid headline growth number.

Whether you’re looking at capacity utilization, the gap between production and demand, or simply China’s net manufactured goods exports it’s clear that the focus on manufacturing upgrade is adding capacity that isn’t matched by growth in domestic demand. Trade tensions with Europe has been rising as a result, and with the U.S. election campaign starting to heat up, the risk of trade restrictions on Chinese exports becomes a more acute risk. We have addressed some of implications of these trade tensions.

We continue to expect depreciation pressure on the Chinese yuan (CNH). For the currency to reverse its current weakening trend, several conditions need to be met: 1) a meaningful improvement in the domestic economy that improves sentiment and triggers a reversal of capital outflows; 2) a reduction in trade tensions and/or a strong rebound in global exports; 3) a marked decline in global interest rates to offset the carry disadvantage.

On the first and second points, the risk of escalating trade tensions with the U.S. and Europe could increasingly weigh on the currency as we approach the U.S. elections – a factor that appears to be underpriced at the moment. Recent currency weakness has occurred amid a strong exports backdrop, which highlights how impactful the other forces – notably capital outflows – have been. It also emphasizes the outsized risk to the currency from a trade downturn, either driven by tariffs or weaker global demand.

In addition, it could take some time for incremental improvements in certain sectors of the economy to translate into a more meaningful boost in overall China sentiment. Before that happens, the prospects for sustained capital inflows remain uncertain.

As for the third point, our baseline scenario for the Federal Reserve suggests that U.S. rate cuts are unlikely to commence until the tail-end of this year and into 2025, and even then, they will likely proceed at a gradual pace. Consequently, the CNH is expected to remain a funding currency for an extended period.

Thus, investors may consider hedging long CNH exposure and taking advantage of the carry. In addition, a weak and low-yielding CNH also opens the door for using the currency as a funder for taking advantage of opportunities elsewhere.

We retain a relatively cautious view on offshore China markets. The downside to equity markets is likely limited, but the upside is capped by a mixed macro backdrop and earnings that have yet to show meaningful upside. Low expectations heading into the Third Plenum could offer a short term bounce, but the sustainability of such a move is likely to be short-lived. We believe a structural improvement in real estate, employment and consumer spending is needed to drive a more sustainable turnaround in China equity markets. Before that happens, we would continue to expect HSI and MSCI China to trade range-bound. We believe opportunities can be found in high-dividend state-owned enterprises, and consider buying pullbacks in the communication services sector.

Meanwhile, we expect the onshore A-share market to be relatively more resilient and less volatile, thanks to its lower exposure to geopolitical risks (and foreign outflows), limited FX impact, and its ability to more directly benefit from the government’s supportive policies in the capital market. That being said, the recent crackdown on the financial sector in China has also dampened sentiment in the A-share market.

All market and economic data as of June 27, 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under US laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

This material has not been prepared specifically for Australian investors. It:

  • may contain references to dollar amounts which are not Australian dollars;
  • may contain financial information which is not prepared in accordance with Australian law or practices;
  • may not address risks associated with investment in foreign currency denominated investments; and
  • does not address Australian tax issues.

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To learn more about J.P. Morgan’s investment business, including our accounts, products and services, as well as our relationship with you, please review our J.P. Morgan Securities LLC Form CRS and Guide to Investment Services and Brokerage Products

 

JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.

 

Please read the Legal Disclaimer for key important J.P. Morgan Private Bank information in conjunction with these pages.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

Bank deposit products, such as checking, savings and bank lending and related services are offered by JPMorgan Chase Bank, N.A. Member FDIC.

Not a commitment to lend. All extensions of credit are subject to credit approval.

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