Why China’s economic downturn warrants more than a shrug from global investors
- Investors may claim they are increasingly concerned about China, but important measures of sentiment suggest otherwise
- The failure to reckon with a much sharper than expected slowdown in China is a grave mispricing of risk at a time when global growth is slowing sharply and central banks are preparing to tighten monetary policy
Are Chinese risks being assessed and priced accurately? It is a question that has been posed many times as China’s integration into the global economy has deepened over the past two decades.
Since the Covid-19 pandemic erupted, China has been a game of two halves. Last year, it was all about the country’s swift and vigorous recovery, underpinned by Beijing’s successful containment of the virus.
In a sign of the degree to which China is perceived much more negatively by international investors, it is now the second-most important “tail risk” in markets after inflation, according to the findings of the latest Bank of America fund manager survey published on October 19.
Yet, quite often what worries markets does not translate into declines in asset prices. The MSCI World Index, a gauge of stocks in advanced economies, is currently trading close to a record high, the average spread on JPMorgan’s Corporate Emerging Market Bond Index (CEMBI) has risen less than 20 basis points in the past three months, while the VIX Index, Wall Street’s “fear gauge”, is only slightly above its historical low.
Global investors may claim they are increasingly concerned about China, but some of the most important measures of sentiment strongly suggest otherwise.
Although markets have proved remarkably resilient to all sorts of pre- and post-pandemic threats, the failure to come to terms with a much sharper than expected downturn in China constitutes a grave mispricing of risk at a time when global growth is slowing sharply and leading central banks are preparing to tighten monetary policy.
First, China’s growth is hugely important to the world economy. Over the past two decades, the country has been the single most important contributor to global growth, accounting for a much bigger share than either the United States or the European Union.
The world has grown accustomed to Chinese annual growth rates in excess of 7 per cent for most of the past 20 years. A steep deceleration is a shock for China, but an even bigger one for the rest of the world.
Second, China’s downturn is mostly policy-induced. While this is a source of comfort to those investors who believe Beijing will soon be forced to take action to stimulate growth, it is also the main reason economic risks in China are being underpriced.
As JPMorgan noted in a report published in August, industrial and regulatory policies in China are no longer supporting macroeconomic ones in order to prioritise structural and financial objectives. This makes it much less likely that Beijing will ease policy significantly, increasing the scope for a sharper slowdown.
There are many examples of asset prices being disconnected from fundamentals. The one that is the most concerning right now is the mispricing of Chinese economic risk in global markets.
Nicholas Spiro is a partner at Lauressa Advisory