China’s Reopening Speeds Growth Along

The global economy shifted up a gear in Q1. Last year, a key engine component mostly sputtered as major Chinese cities dealt with an array of COVID restrictions. Growth slowed across most indicators, and Chinese GDP grew an anemic 3.0% in the full year.^[i] But now those restrictions are gone, monthly indicators are heating up and GDP has already reaccelerated to 4.5% y/y in Q1.^[ii] It may not soar from here, as the initial reopening rebounds tend to be short, but China should keep contributing nicely to global GDP, giving global stocks a nice assist.

While analysts expected 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%.^[iii] That makes the 4.5% growth rate one of the biggest beats we have seen in a while. Under the hood, it appears the positive surprise stemmed from the services sector. March industrial production grew, but at 3.9% y/y it missed expectations for 4.8%.^[iv] Meanwhile, exports soared 8.4% y/y in Q1.^[v] But retail sales’ 10.6% y/y growth smashed expectations for 7.0%.^[vi] Encouragingly, the reaction to this was largely dim—suggesting the pessimism of disbelief is alive and well. In addition to bemoaning industrial production’s miss, headlines warned that March purchasing managers’ indexes 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. Services also happened to grow 5.4% y/y in Q1, outstripping heavy industry’s 3.3% rise.^[vii]

If the largest piece of China’s economy is growing the fastest, that is good news. 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. That always seemed logical to us, considering China’s low-end manufacturing edge eroded long ago amid higher wages and shipping costs. Other developing nations are now carrying more of the “world’s factory” load while China’s economy matures and relies more on domestic demand for growth. That makes its contributions to global growth less circular—and boosts its clout as an end market for developed-world companies. That is great for earnings.

Domestic demand should continue improving. Maybe not at a gangbusters rate, considering the initial reopening boom is probably spent, but easing headwinds should help. For one, there is 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. 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.^[viii] Investment may still be declining modestly, but the backlog of sold-but-uncompleted housing units is clearing. Housing floor space completed soared an astounding 35% y/y in March, up from 10% in the prior 2 months combined.^[ix] 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. Finished construction implies property developers have regained liquidity, and enabling buyers to move in should ease sociological pressure. Moreover, as developers work through this backlog, it should set the stage for renewed investment to keep up with housing demand, returning the property sector as a modest economic tailwind.

So overall, it looks like global GDP should enjoy renewed contributions from one of its biggest drivers—and, thanks to pessimistic sentiment over heavy industry, it should still have some positive surprise power. That doesn’t seem likely to fade quickly, considering pundits 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. Fine with us. The more dour sentiment remains, the more it builds a wall of worry for global stocks to climb. When analysts are discouraged, we find it quite encouraging for stocks.