China could return to growth after a difficult 2022, but its growth largely depends on the consumer.
In 2001, China entered the World Trade Organization (WTO) and thus became the factory of the planet, orchestrating what was to become the economic miracle of the century. Ten years later, China opened its doors to foreign investors, who flocked to the country in the hope of benefiting from the new economic miracle: the consumer. Although today’s markets are vastly different from those of 2001, and investors are pondering the rationale for investing in China after a tough time, the long-term story remains unchanged. China still has a place in a global portfolio because of its size, as well as its growth prospects and differentiated risk and return factors.
Let’s dispel the uncertainty of 2022
In 2022, three obstacles to growth and economic openness have nevertheless come together: the zero-COVID policy, the deterioration of relations between the United States and China, and the real estate taper tantrum. China started 2022 with a clear mandate from its government to revive growth, and its aggressive stimulus campaign began to bear fruit in the first quarter of 2022, as economic data such as the director indices (PMI) and Fixed Asset Investments (FAI) in real estate, manufacturing and infrastructure have started to stabilize and pick up again.
However, a serious lockdown in Shanghai in April, and subsequent lockdowns in other major cities, halted progress. At the same time, the impact of regulatory changes affecting the real estate development industry has been longer than expected, despite the government’s commitment to stabilize the sector. Had it not been for these major COVID-related lockdowns or a big year in politics, China’s economic data and potentially currency performance might have told a whole different story in 2022, one that she could still tell in 2023.
The rapid rise of the US dollar in 2022 has wreaked havoc on most international currencies, including the Renminbi.
The end of the NPC and the re-election of President Xi along with a new Standing Committee and Politburo should give the Chinese government more leeway to make the tough decisions needed to move forward. Encouraging signs already show that China is back in business: it reopened its economy after the major lockdowns of 2022, supported the recovery of the real estate industry and worked with US regulators to resolve the audit dispute that had caused put its major Internet companies at risk of being delisted from US stock exchanges.
The end of the outperformance of American assets
The rapid rise of the US dollar in 2022, driven by the Fed’s most aggressive rate hikes ever, has wreaked havoc on most international currencies, including the Renminbi. This could mark the end of the outperformance of US assets over the past 15 years, and the benefits of US investors’ home bias, established over the past two years, could be eroded in 2023, when the dollar peaks and the United States will enter a recession, which will make country diversification more important.
While offshore equities, representing mainly internet companies, suffered from sectoral regulations and geopolitical risks, the A-share market, mainly consumer staples, healthcare as well as clean technologies, benefited from the measures of recovery and support policies. A split between onshore and offshore China could provide exposure to the potential return to growth in 2023, while controlling risk.
The year of the rabbit… and of the consumer
China could return to growth in this year of the rabbit after a difficult year 2022, but its growth depends largely on one variable: the consumer. As external demand declines due to a looming recession in the West, China’s economy is becoming more consumer-oriented. Furthermore, emerging industries such as cloud services and semiconductors, while promising, could take years to contribute significantly to the Chinese economy. Fortunately, the reopening and a fresh influx of capital into China’s property development sector has the power to boost consumer confidence significantly, which would be a catalyst for Chinese markets in 2023. Xi Jinping’s unprecedented third term in office has given investors a certain apprehension about their investments in China.
For all that, and for now, it seems that the pragmatists are winning out over the ideologues within Xi’s administration. Xi himself has shown a return to pragmatism by easing his cornerstone zero COVID policy. Therefore, its next flagship policy may be focused on the economy. In 2023, investors will need to take a holistic view of China’s capital markets, including onshore and offshore stocks and bonds in any envelope, to manage risk and gain exposure to as many opportunities as possible.
If the issue of zero COVID and real estate is addressed now, other issues will take longer to resolve. An improvement in US-China relations will require increased pragmatism from both sides, which is unlikely in the near term. However, one can hope that in the long term, the economy will win out over scaremongering and politics.