China released Q2 gross domestic product (GDP, a government-produced measure of economic output) data Friday, and—please stay with us—we think the data were arguably the least interesting thing about it. No, we aren’t dismissing the sharp slowdown to 0.4% y/y, which missed economists’ consensus forecasts and reflected the economic damage from this spring’s COVID restrictions.[i] Nor are we glossing over continued real estate weakness, which remains a challenge. But, in our view, the press release itself was a tour de force in political messaging that, when you understand the context, appears to augur well for economic policy—and growth—over the rest of this year. We also think that, in turn, argues for economic fundamentals likely continuing to support Chinese stocks’ rebound off March’s lows.[ii] Let us discuss.
In our experience, in countries with strong institutions and independent statistical agencies, economic releases are usually pretty dry. Based on the scores of releases we have read over the years, most won’t even reference government officials, never mind sing their praises. But China is different. So the official release for Q2’s economic data begins not with a dry summary of the results, but with what we think is a rather poetic statement: “Faced with extreme complexities and difficulties, under the strong leadership of the Central Committee of the Communist Party of China (CPC) with Comrade Xi Jinping at its core, all regions and departments deeply implemented the decisions and arrangements made by the CPC Central Committee and the State Council, responded to COVID-19 and pursued economic and social development in a well-coordinated manner, stepped up macro policy adjustments, and fully implemented a package of pro-stability policies and measures. As a result, the resurgence of the pandemic was effectively contained, the national economy registered a stable recovery, production and demands saw improving margins, market prices were generally stable, people’s livelihood was protected sufficiently with robust steps, the momentum of high-quality development was sustained and the overall social stability was maintained.”[iii]
It is entirely unsurprising to us to see such a statement now, as this autumn’s National Party Congress approaches. Xi, reportedly, is seeking an unprecedented third term as party leader, which many observers argue would effectively cement him as president for life. We think simple logic suggests this is easier said than done when the government’s zero-COVID policy and its many social and commercial disruptions complicate everyday life.[iv] Logically, we think the situation therefore creates two urgent tasks for Xi: easing COVID frustration and helping the economy rebound as quickly as possible without storing up debt problems later. We read this press release as a preliminary declaration of success. The official message seems to be that lockdowns, whilst difficult, were successful and therefore worth it, and the payoff of a swift economic rebound is here—aided by fiscal stimulus, under Xi’s watchful eye and careful guidance.
Whatever you think of that messaging, or our interpretation thereof, the data do suggest a strong rebound took hold in June as Shanghai, Beijing and other major hubs reopened. In Q2, heavy industry grew 0.9% y/y, whilst services declined -0.4%.[v] But those year-over-year figures mask some considerable volatility. The press release describes monthly activity as having “plunged” in April, followed by a decline that “narrowed” in May and a “stable recovery” that took hold in June.[vi] You can see this most visibly in the (relatively new) Index of Services Production: It fell -6.1% y/y in April and -5.1% in May before flipping to a 1.3% rise in June.[vii] Industrial production’s recovery began even earlier, flipping from a -2.9% y/y decline in April to 0.7% growth in May and 3.9% in June.[viii] In our view, the disconnect between this and services is easily explained: Factories had an easier time adjusting to lockdowns, as they were able to continue operating in a bubble-type environment.[ix] In-person services had no such flexibility. But we think that also primed them for a big, easy rebound once officials let life return mostly to normal.
Stimulus also offered an assist, which we can see in fixed investment data. The National Bureau of Statistics reports fixed investment on a year-to-date, year-over-year basis, and the growth rate accelerated from 1.8% in April to 4.6% in May and 5.6% in June.[x] That acceleration includes an outright drop in real estate development, which fell -5.4% y/y in the first half.[xi] What is picking up the slack? Infrastructure, manufacturing and high-tech services, which got some prominent attention in the release. We think the message seems to be that the old model of property development and urbanisation driving growth is passé—tech is the future, and those who dwell on weak real estate are missing the real growth engine. We always suggest taking marketing fluff like this with many grains of salt. That said, we think the Chinese economy’s ability to rebound despite the struggling property sector does suggest sentiment—which seemingly still dwells on residential real estate—remains out of step, which, in our view, implies there is a hefty amount of positive surprise potential for stocks.
Looking ahead, we think more stimulus appears to be in the offing, and not just because the passage we quoted earlier seems to tee it up. Lending data released a few days before the GDP release showed that total social financing—the broadest measure of credit—accelerated to 10.8% y/y in June from 10.5%.[xii] That isn’t huge, but there were some positive, noteworthy developments under the bonnet. The structure of corporate bond issuance changed markedly, and to us, for the better: In recent months, most issuance was short-term, but long-term loan demand returned with gusto in June.[xiii] Local governments continued front-loading bond issuance as well, with the percentage of the full-year quota fulfilled jumping from 55.7% in May to 93.3% in June.[xiv] In our view, this is consistent with the government’s directive to fully deploy infrastructure funds by August (in time for an autumn economic boost), as local governments tend to be the conduit for most of this funding. We think it further implies a rumoured pull-forward of next year’s targets is probably happening in order to keep growth humming through year-end.[xv] Additionally, Bloomberg reported this week that another round of special-issue local government bonds to fund infrastructure is in the offing, which would provide a pretty major second-half boost.[xvi]
In our view, it all seems consistent with prior reports that China’s central government has stressed the need to meet this year’s growth target of around 5.5% at all costs.[xvii] We suspect it probably isn’t just about getting the usual growth boost to aid sentiment in the closest thing China has to an election year, but—from our vantage point—trying to help society move on from the pain of lockdowns as quickly as possible, lest social unrest linger into the autumn. After all, economic stability is generally key to social stability, and social stability is key to maintaining one-party rule. A big infrastructure push may not be the most efficient way to stoke growth at this stage of China’s development, but to the extent it gets more money moving through the private economy, we think it likely should help grease the wheels, keeping the long-dreaded economic hard landing at bay once again.
[i] Source: National Bureau of Statistics of China and FactSet, as of 15/5/2022.
[ii] Source: FactSet, as of 18/7/2022. Statement based on MSCI China return with net dividends in GBP, 15/3/2022 – 15/7/2022.
[iii] “Strong Measures Adopted to Counter the Impacts of Unexpected Factors and National Economy Registered a Stable Recovery,” National Bureau of Statistics of China, 15/7/2022.
[iv] “What Is China’s Zero-COVID Policy?” Shakeel Sobhan, Deutsche Welle, 9/5/2022.
[v] “Strong Measures Adopted to Counter the Impacts of Unexpected Factors and National Economy Registered a Stable Recovery,” National Bureau of Statistics of China, 15/7/2022.
[ix] “Most Factories in Shanghai Resume Work as Covid Controls Ease, Ministry Says,” Evelyn Cheng, CNBC, 14/6/2022.
[x] “Strong Measures Adopted to Counter the Impacts of Unexpected Factors and National Economy Registered a Stable Recovery,” National Bureau of Statistics of China, 15/7/2022.
[xii] Source: FactSet, as of 15/7/2022.
[xiii] Source: People’s Bank of China, 11/7/2022.
[xiv] Source: FactSet, as of 15/7/2022.
[xv] A pull-forward effect refers to the economic targets that would normally exist in a given quarter or year are happening earlier, they are pulled forward because of an external factor.
[xvi] “China Readies $1.1 Trillion to Support Xi’s Infrastructure Push,” Staff, Bloomberg, 13/7/2022. Accessed via Yahoo! Finance.
[xvii] “China Sets GDP Target of ‘Around 5.5%’ for 2022,” Evelyn Cheng, CNBC, 4/3/2022.
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