Why Slowing Chinese Growth Shouldn’t Spook Investors

Last Friday, China reported Q3 GDP grew 6.0% y/y, decelerating from Q2’s 6.2% pace.^[i] Headlines bemoaned the figure as the “slowest growth in nearly three decades,” which, technically, it was. But this doesn’t mean China’s economy or the global expansion is on the rocks, in our view. Rather, we think it (alongside other recent data) shows China’s economy is slowing, but not slumping—a long-running trend that needn’t sink global stocks.

In Q3, services growth set the pace at 7.0% y/y, while agricultural output rose 2.9% and manufacturing 5.6%.^[ii] Services’ leadership exemplifies the trend of heavy industry and exports gradually giving way to services and consumption as the Chinese economy’s primary drivers. Through 2019’s first three quarters, consumption accounted for 60.5% of GDP.^[iii] In 2010, it was 49.5%.^[iv] Consumption’s gaining primacy is normal as developing economies mature. It is also normal for rapidly developing countries’ growth rates to slow over time. This doesn’t inherently reflect fundamental weakening, but rather, math. The larger the base, the harder it is to maintain super-high growth rates. Chinese nominal GDP was $5.1 trillion in 2009.^[v] Last year, it was $13.6 trillion.^[vi] A double-digit growth rate off the latter strikes us as unrealistic.

Many blame the US/China trade tiff for Chinese economic weakness this year, pointing to flagging exports. While it is fair to say tariffs have had an impact—either directly, or by discouraging some foreign investment in China—we think a little context might help investors assess whether headlines are too dour. Chinese shipments to the US fell -21.9% y/y in September and -15.1% in Q3.^[vii] But exports to the US represented just 3.5% of Chinese GDP in 2018.^[viii] Presuming 25% tariffs on the full amount—and perfect enforcement—the cost would be about $120 billion, or 0.9% of Chinese GDP. But the true figure is likely much smaller. Surging shipments to many Asian nations—particularly Vietnam, Taiwan and the Philippines—alongside rapidly growing US imports from those countries suggest many companies are rerouting shipments to avoid tariffs. Rerouted trade has helped keep overall Chinese exports from cratering. Rather, they fell just -0.8% y/y in Q3.^[ix]

As for domestic demand, we think the primary headwind has been the negative side effects of the Chinese government’s earlier efforts to rein in debt—particularly in the so-called shadow banking sector, which includes financing outside typical bank lending. Since big, state-owned banks typically lend to big, state-owned firms, the latter didn’t bear the brunt of it. Rather, the crackdown disproportionately hurt the small and mid-sized firms that comprise the bulk of China’s vast private sector. The government has implemented a range of measures this year aimed at restoring credit access to these small and medium-sized private firms, which are China’s main growth engine.

Credit data suggest these measures are having an effect: Most recently, new yuan loans rose to 1.69 trillion in September from August’s 1.21 trillion.^[x] New total social financing, a broader measure of credit, notched 2.27 trillion yuan, bringing the year-to-date total to 18.7 trillion.^[xi] In January – September 2018, it was 15.4 trillion yuan.^[xii] Lastly, M2 money supply growth (8.4% y/y) accelerated for the second consecutive month in September, suggesting money is moving through the economy.^[xiii]

Importantly, the new financing appears to be reaching its targets. At a September 24 press conference, People’s Bank of China Governor Yi Gang noted small and micro-sized businesses’ loan balances rose 23% year-to-date y/y in August.^[xiv] While it takes more than one or two months to make a trend, other data suggest these loans are fueling economic activity. Retail sales and industrial production growth accelerated in September to 7.8% y/y and 5.8%, respectively.^[xv] Since sustaining growth is central to the government’s goal of preserving social stability, policymakers likely continue intervening when needed to keep a sharper slowdown at bay.

Global markets have been processing Chinese hard landing worries for years as Chinese GDP growth gradually decelerates. Past scares over trade or manufacturing weakness have spurred occasional volatility but didn’t end the bull market. We don’t believe this time will prove different. Rather, the fact so many see China as a disaster waiting to happen and miss its substantial contributions to global growth likely stores up positive surprise, in our view.