What a difference a few months make. In 2018, Chinese equities had their worst performance in a decade, with the Shanghai Composite Index down by
25 per cent. Last week, the Shanghai benchmark had its
best weekly performance since mid-2015, which lifted the index to bull market territory. So far in 2019, Chinese equities have significantly
outperformed other emerging and developed markets peers.
Sentiment has played a big role in driving the rally. Positive news in recent weeks has helped boost market optimism in China. The first sign was the notable
upside surprise in China’s January credit growth data. The surge showed that policymakers are stepping up their efforts in monetary easing to counter a slowdown in the economy.
The more responsive policy action also relieved some market concerns that stimulus measures may be too little, too late. Confidence in China’s policy easing was further boosted when officials signalled a stronger emphasis on stability of growth in a recent Politburo meeting.
Another key driver of the improving sentiment has been the positive developments in the US-China trade talks. Last week, the US trade representative confirmed that the
scheduled tariff increase from 10 per cent to 25 per cent on US$200 billion of Chinese goods on March 2 had been postponed.
Even more importantly, President Donald Trump has floated the
possibility of a summit with President Xi Jinping soon, to conclude a trade agreement. However, the market may have neglected the possibility of tough negotiations ahead, as structural issues, intellectual property rights and forced technology transfer, in particular, remain important sticking points.
Given that the stock market tends to be forward-looking, is the recent strong rally a signal that China’s economic cycle is about to turn?
Recent economic data coming out of China has not been that encouraging. Retail and tourism spending during the Lunar New Year holiday period grew at its
slowest pace in a decade. In addition, the
disappointing official purchasing managers’ index still shows cautious sentiment in both the manufacturing and services sector in February.
If we look at the main growth drivers from an expenditure perspective, there are likely to be more weaknesses in the next few months. China’s export sector is facing stiff headwinds in the near term. To get ahead of expected tariff rate increases, Chinese exporters
front-loaded their shipments to the US in late 2018. This activity is likely to taper and reverse in early 2019,
whether or not a trade deal is reached.
At the same time, weakness in the economy seems to be spreading into the labour market, posing challenges for household consumption. There has been a
sharp rise in internet searches for unemployment-related words in China, suggesting growing worry about the jobs market.
Investment appears to be the only bright spot. It has been an important policy lever for Chinese policymakers in the past to shore up the economy, and this time is no exception. Despite China’s rebalancing towards consumption, investment still accounts for more than 40 per cent of the economy.
Within the major categories, infrastructure investment is expected to do the heavy lifting as policymakers
ramp up funding for projects. One major source is likely to be special-purpose local government bonds, which are directly related to projects such as roads. Local governments were allowed to issue the bonds
from January this year, earlier than the usual March start. Moreover, the government increased the total amount local governments are allowed to issue, from 1.35 trillion yuan (US$200 billion) last year to 2.15 trillion yuan, at the National People’s Congress meeting this week.
Further easing in monetary policy will also help: investments in many infrastructure projects are carried out by local government funding vehicles, which rely heavily on shadow bank and bond financing.
Meanwhile, the outlook for property investment appears to be less upbeat. Home sales momentum is
losing steam, mostly due to
weaker sales in lower-tier cities. The outlook in the manufacturing sector also looks murky, as
falling profit growth and lingering concerns about the future of the US-China trade relationship is likely to dampen investment demand.
Stitching it all together, as stimulus measures start to gain traction, the Chinese economy should slowly begin to pull out of the current weak patch, with infrastructure investment the main driver. However, given the near-term headwinds, improvement is more likely to happen in the second half of the year.
We will probably have to live with a disconnection between bullish market sentiment and weak Chinese economic data for some time.
Patrik Schowitz is a global multi-asset strategist at JP Morgan Asset Management
This article appeared in the South China Morning Post print edition as: China’s stimulus plan will lift economy, just not right away
