China's Reopening Speeds Growth Along

Has the global economy shifted up a gear in Q1? Last year, gross domestic product (GDP) in China—a key engine component of the global economy, in our view—mostly sputtered as major Chinese cities dealt with an array of COVID restrictions.^[i] (GDP is a government-produced measure of economic output.) Growth slowed across most indicators, and Chinese GDP grew an anaemic 3.0% in the full year.^[ii] But now those restrictions are gone, monthly indicators are heating up and China’s GDP has already reaccelerated to 4.5% y/y in Q1.^[iii] It may not soar from here, as Fisher Investments’ research shows the initial reopening rebounds tend to be short, but in our opinion, China will likely keep contributing nicely to global GDP, which we think is likely to give global stocks a nice assist.

Whilst economists’ consensus projections were for China’s GDP to accelerate in Q1, the magnitude surprised. Consensus estimates were for growth to speed from Q4 2022’s 2.9% y/y to 3.4%.^[iv] That makes the 4.5% growth rate one of the biggest beats we have seen in a long time. Under the bonnet, it appears the positive surprise stemmed from the services sector. March industrial production grew, but at 3.9% y/y it missed analysts’ expectations for 4.8%.^[v] Meanwhile, exports soared 8.4% y/y in Q1.^[vi] But retail sales’ 10.6% y/y growth smashed economists’ expectations for 7.0%.^[vii] Encouragingly, the reaction to this from commentators we follow was largely dim—suggesting a phenomenon we call the pessimism of disbelief, in which commentators mostly dismiss or ignore good news during a young stock market rally, is alive and well. We have found this to be a common feature of new bull markets (long periods of generally rising stock prices). In addition to bemoaning industrial production’s miss, publications we read warned that March purchasing managers’ indexes (monthly surveys that track the breadth of economic activity) indicate Q1’s export boom probably won’t last—implying heavy industry is China’s economic engine. But in reality, services has that distinction, as it is the largest economic sector in China.^[viii] Services also happened to grow 5.4% y/y in Q1, outstripping heavy industry’s 3.3% rise.^[ix]

If the largest piece of China’s economy is growing the fastest, that is good news, in our view. It also fits with the government’s long-running goal of services generating most of the economy’s growth, on the presumption that this is more sustainable in the long run than heavy industry powering everything.^[x] That always seemed logical to us, considering China’s low-end manufacturing edge appeared to begin eroding long ago amidst higher wages and shipping costs.^[xi] Other developing nations are now carrying more of the world’s factory load whilst China’s economy matures and relies more on domestic demand for growth.^[xii] In our view, that makes its contributions to global growth less circular—and potentially boosts its clout as an end market for developed-world companies. We think that is probably great for companies’ future earnings.

Domestic demand appears likely to continue improving. Maybe not at a robust rate, considering the initial reopening boom is probably spent, but we think easing headwinds are likely to help. For one, we see mounting evidence that the regulatory crackdown stymying Tech and Tech-like companies in recent years has eased, which should enable the high-tech portions of China’s economy to continue contributing to growth.^[xiii] Two, the property sector appears to have turned the corner. Home prices, long-beleaguered, have started recovering: New home prices rose on a month-over-month basis in 55 of 70 major cities in the combined January and February period, and that figure jumped to 65 in March.^[xiv] Investment may still be declining modestly, but output growth in both real estate and construction suggests the backlog of sold-but-uncompleted housing units is starting to clear.^[xv] In our view, unfinished apartments were one of the biggest manifestations of real estate’s economic drag, as they represented the sector’s lack of funding and property buyers’ deep frustrations. More construction implies property developers have regained liquidity, and enabling buyers to move in appears likely to help ease sociological pressure. Moreover, as developers work through this backlog, we think it likely helps set the stage for renewed investment to keep up with housing demand, potentially returning the property sector as a modest economic tailwind.

So overall, we think it looks like global GDP is likely to enjoy renewed contributions from one of its biggest drivers—and, thanks to commentators’ pessimistic sentiment over heavy industry, it likely retains some positive surprise power, in our view. We don’t see a high probability this fades quickly, considering many observers we follow are already talking down Q2 GDP growth, warning that any acceleration then will probably just stem from a depressed base, courtesy of Shanghai’s lockdowns a year prior.^[xvi] Fine with us. The more dour sentiment remains, the more we think it builds a proverbial wall of worry for global stocks to climb. When analysts are discouraged, we find it quite encouraging for stocks.