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Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
China’s bumpy recovery is still preferable to the chaos of a US recession and default
- The start of a sharp, albeit uneven rebound in China after three years of self-imposed isolation has more upside than an increasingly vulnerable US economy and financial system
- Investors should be less wary on China, and less complacent about the US
Is a stronger-than-expected rebound in China’s economy sufficiently appreciated in financial markets? Official figures released on Tuesday showed faster-than-anticipated growth in the first quarter of this year. China’s economy expanded 4.5 per cent year on year, compared with a forecast of 4 per cent, yet this was met with indifference in stock markets.
The CSI 300 index of Shanghai and Shenzen-listed shares rose a meagre 0.3 per cent while the Hang Seng Index fell 0.6 per cent. To be sure, Chinese stocks experienced a rapid rise between November and January and are up 6.5 per cent this year.
Even so, sentiment over the past few months has been volatile. This is indicative of a market that is sceptical about the strength and durability of China’s post-pandemic recovery.
The scepticism stems partly from concerns over the unevenness of China’s rebound. The 10.6 per cent surge in retail sales last month – the sharpest monthly gain since June 2021 and the driving force behind the rebound – received almost as much attention as the weaker-than-expected rise in fixed-asset investment and outright contraction in property investment in the quarter as a whole.
In a report published on Tuesday, Nomura said it saw “weakness and inconsistency” in the data, in part because of the low base effect of last year’s ruinous lockdowns in Shanghai and other cities, as well as the continued rise in youth unemployment.
Other economists have pointed to muted inflationary pressures in China, the negligible impact of the reopening in commodity markets – in stark contrast to previous Chinese recovery cycles – and the absence of cash handouts for households.
However, there are other, more important factors at work. Overseas investors, in particular US funds, remain wary of China. The loss of confidence caused by President Xi Jinping’s assault on private enterprise, his zero-tolerance approach to Covid-19 and his backing of Russia following its invasion of Ukraine continues to weigh heavily on foreign sentiment.
Although the balance between pragmatism and ideology in economic policy shifted to the former when China ditched its zero-Covid strategy, non-economic factors hold sway among more geopolitically sensitive US investors.
The results of a client survey conducted by JPMorgan at last week’s spring meetings of the International Monetary Fund and World Bank revealed that investors were more concerned about geopolitical tensions and the current leadership direction in China than they were about the country’s economic fundamentals.
The mistrust of China on the part of overseas investors will be difficult for Beijing to shake. Yet, foreign funds need to ask themselves at what point do lingering concerns about investability become a liability if China’s recovery continues to gather momentum and risks elsewhere in the world become more pronounced.
China’s rebound has already exceeded expectations. The China component of a global index of economic surprises compiled by Citigroup, which measures how often data come in above or below expectations, has just hit a 17-year high.
While the real test of the recovery will come in the third quarter when base effects fade and a clearer picture of underlying demand emerges, China’s consumption-driven rebound is an underappreciated theme in markets. It looks even more undervalued when viewed in the context of the vulnerabilities in US markets.
Can China’s red carpet for foreign investors calm nerves?
Can China’s red carpet for foreign investors calm nerves?
Investors might be too circumspect about China. However, such caution pales in comparison with the excessive complacency and mispricing of risk in US equity and debt markets.
It is bad enough that markets failed to anticipate stresses in the financial system – particularly among loosely regulated regional banks – caused by the most aggressive monetary tightening campaign in decades. Yet just six weeks after the failure of three midsize lenders and clear evidence a credit squeeze has begun, US stocks are surging while high-yield “junk” bonds are rallying.
Government debt markets, by contrast, are predicting a full-blown recession that will force the US Federal Reserve to cut interest rates towards the end of this year even though underlying inflationary pressures have yet to abate.
The uncertainty over the outlook for the US economy is so pervasive that it is not even clear whether the mispricing is sharpest in equity or bond markets. The only thing that is clear, as Morgan Stanley noted in a report published on April 16, is that while the bank failures did “seem predictable”, investors “did not see the failures coming, which leads to the question what other surprises may be coming”.
The threat that is just as foreseeable yet is so far of little concern to markets is the stand-off over raising the US federal debt ceiling, which could come to a head as soon as June. Although a disorderly US default is unlikely, the political brinkmanship itself is dangerous and could contribute to more severe financial stresses.
China’s post-pandemic recovery was bound to be bumpy, but everything is relative. The start of a sharp, albeit uneven rebound in the world’s second-largest economy following three years of self-imposed isolation has more upside than an increasingly vulnerable US economy and financial system. Less caution on China and more vigilance on the United States is likely to be a more profitable investment strategy this year.
Nicholas Spiro is a partner at Lauressa Advisory
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