The Chinese economy is on track for stronger growth in 2023
The Chinese New Year holiday ended on the 15th February. Initial concerns of an uncontrollable Covid outbreak and medical resources capacity constraints were abated. Instead, there has been a swifter than expected recovery, particularly in the travel industry. Travel and related spending climbed over the Chinese New Year holiday. Total passenger traffic volume by all transportation types returned to 53.5% of the pre-Covid level in 2019[1] with both railways and airlines reaching close to 90% of pre-Covid level. Sales revenue of travel agencies and related services also surged 130% year-on-year versus the Chinese New Year holiday period in 2022[2].
China’s broader economy continues to recover. China’s Caixin China services PMI in February rose markedly to 55.0 from 52.9 in January[3]. There are also signs of green shoots in the property markets with sales recovery in higher tier cities and home price stabilization. On the other hand, coal and steel prices remain low on the back of rising inventories.
Unlike past recovery cycles in China, this year’s recovery is not stimulus and investment driven. Services and consumption are expected to be the main beneficiaries. However, despite higher saving rates, consumption is not recovering as quickly as expected. The “revenge spending” seen in the US and Europe is not happening in China. Consumers remain conservative due to high unemployment rates, especially within the youth segment. There is an urgency to get back to work to increase income. Unlike in the West, there has been limited fiscal spending within China during the Covid-19 pandemic. The Chinese government did not provide handouts to Chinese citizens whose incomes were impacted by the strict zero-covid policies. Fading Covid infection risks and better income prospects should continue to drive the consumption recovery in China. The only exception to this is luxury spending which is picking up.
Earnings to drive returns from here
The MSCI China index bottomed in October last year and has since rallied close to 60%, before pulling back almost 15%. In the last month, the MSCI China has given back most of its returns from the beginning of this year[4]. This is largely to do with positioning and deterioration in geopolitics particularly around the balloon incident.
The Chinese equities market may consolidate after this strong rally as investors wait for data at the end of March /April and some nervousness going into the National Party Congress meeting in March as the Chinese government provides more clarity on its growth policies and GDP target. In addition, there are rising concerns over an escalation of geopolitics tension and sanctions between the US and China and the anniversary of the Russia Ukraine war.
With the reopening largely done, investors are looking for directions for the next leg of rally. The theme should gradually shift from reopening to recovery. Much of reopening has been priced in. The driver of the next leg of rally is likely to rotate from multiple expansion to earnings growth.
DWS believes there is still upside for Chinese equities over the next 12 months. Despite the strong rebound, the MSCI China still remains 41% below its previous high in February 2021[5]. In addition, investors positioning is still low with foreign funds largely underinvested in Chinese equities. However, geopolitical tension is likely to remain, and this will continue to drive sentiment. Geopolitical risks have increased the risk premium of Chinese equities recently and more geopolitically related stocks could be more volatile.
Going forward, instead of a broad index rally, selectivity is needed. Sectors such as domestic consumption, tourism and renewables sectors should benefit from government policy support and earnings growth. Property is looking slightly better and may surprise on the upside. Within the IT space, selectivity is again key as some e-commerce companies face rising competition and slower margin growth.
In relative terms, China remains a key overweight in regional and Emerging Market portfolios.
1. Source: Ministry of Transport of the People’s Republic of China, BofA Global Research
2. Source: State Administration of Taxation of China, Tax data shows consumption growth in China's Spring Festival holiday (chinatax.gov.cn)
3. Source: S&P Global as of 3rd March 2023
4. Source Bloomberg, as of 2nd March 2023
5. Source: Bloomberg. Calculated using YTD (23 Feb 2022) highest price of 75.78 versus Feb 2021 highest price of 129.78
