Key Context for China’s ‘Disappointing’ Data

Is China’s economic recovery going into reverse? After April’s monthly indicators showed slower-than-expected growth, May’s official Purchasing Managers’ Indexes (PMIs, monthly surveys that track the breadth of economic activity) inspired more pessimism amongst financial commentators we follow. In the month, manufacturing’s contraction deepened from 49.2 to 48.8 and services slowed from 55.1 to 53.8 (readings over 50 indicate expansion, below 50, contraction).^[i] In turn, headlines in publications we cover questioned China’s post-pandemic reopening bounce, arguing the expected boost is fizzling. But in our view, China is following a pretty normal reopening course: returning to long-term trends after an initial, short-lived boom, with the boom getting smaller in each cycle of lockdown to reopening. Perhaps some investors’ projections were too high entering this spring, but with pessimism quickly returning now, we think a slow-growing China will likely be fine for stocks.

In our view, most of Wednesday’s PMI commentary lacked meaningful long-term context. The articles we read looked back, but only to 2020, comparing now to the rebound from the first wave of lockdowns.^[ii] Then, manufacturing stayed positive for over a year before slipping back into contraction as the autumn 2021 COVID wave prompted fresh restrictions.^[iii] When the rebound from that and successive waves waned, commentators we follow blamed the COVID recurrences in Shanghai and other major metro areas—seemingly setting expectations for a lasting boom now that China has abandoned Zero-COVID.^[iv]

That expectation has long seemed a bit off base to us, as our research suggests it differs from the developed world’s experience. In the US, UK and eurozone, the first reopening brought the biggest boom simply because it followed the most draconian lockdown—and when society hadn’t learned how to live with restrictions and keep them from hampering commerce as severely.^[v] That is key context, in our view. When restrictions returned later in 2020 and 2021, activity didn’t fall as much as in February and March 2020, so we don’t think there was as much ground to regain when things reopened.^[vi] Accordingly, the subsequent rebounds were smaller and shorter, with longer-term trends reasserting themselves swiftly.^[vii]

This seems to us to be what China is now experiencing. Exhibit 1 shows this with the official Manufacturing and Services PMIs. These indicators emphasise larger companies, so they aren’t a complete indicator of how all Chinese businesses are doing. Caixin’s PMIs include smaller and private businesses, and their release Thursday morning saw Manufacturing perk into expansionary territory.^[viii] Regardless, we think the official PMIs are a solid look at the long-term trends. Manufacturing, you will see, has been in and out of contraction for the past decade, with long stretches below 50. Services growth has been much steadier since those data start in mid-2016, but it has rarely topped 55, and May’s reading is in line with the pre-COVID average of 53.6.^[ix]

Exhibit 1: Putting China’s PMIs in Context

Source: FactSet, as of 31/5/2023. Official Manufacturing PMI, May 2013 – May 2023, and official Services PMI, June 2016 – May 2023. Note: The Non-Manufacturing PMI, which includes Services, has a longer history but is sometimes skewed by mining and oil drilling, so we use Services here for a more focussed look.

So we don’t agree with the criticism that China’s economy is lapsing into an unprecedented weak spot with high local government debt and weak demographics weighing on output.^[x] Those might seem like convenient scapegoats, but they ignore the longer history, in our view. In proper context, it looks to us more like China is returning to its longer-term trend where heavy industry continues giving way to services and consumption. Our research suggests this is right in line with both the normal course of economic development and the government’s ambitions. We have long seen officials suggest export-driven manufacturing is an unreliable economic engine, too subject to the rest of the world’s ups and downs to generate long-term prosperity and the economic mobility necessary to support continued one-party rule. Services-led growth that harnesses domestic demand has long been the solution, and services has grown and thrived alongside struggling manufacturing for many years now.^[xi]

We think that combination has been just fine for the global economy. Low-cost manufacturing has shifted more to Vietnam, Mexico and other nations.^[xii] Meanwhile, rising Chinese consumption has boosted demand for companies the world over.^[xiii] The world’s second-largest economy has added nicely to global GDP, helping support developed-world stocks.^[xiv] If China’s modest services growth and contracting manufacturing didn’t derail global markets in the 2010s, we don’t see a logical case for their being suddenly a major negative now.^[xv] Rather, we see the disappointment over May’s PMIs as a helpful sentiment reset that should make expectations easier to top.