At the start of 2023, the pendulum had swung toward optimism about China’s economy, following the abandonment of “Zero Covid Policy” in December. Expectations for 6% GDP growth this year were floated around, Chinese equities had rebounded 60% from their late October lows and equity multiples were in line with their averages. Fast forward to today, the pendulum has swung in the other direction: pessimism about China’s short and long-term outlook. Consensus now expects 5% GDP growth this year, equities have corrected 23% since late January and multiples are 12% below average. Can China turn its economy around? While growth has disappointed this year, it is key for investors to realize that a recovery has taken place, policy makers have pivoted toward growth-stabilization mode and economic data has improved since August. Long-term, China faces important growth headwinds, including challenging demographics and difficulties with deflating the housing boom; however, select investment opportunities exist in key priority areas in which earnings growth could exceed overall economic growth.

China’s economy has been recovering this year, growing 5.2% year-to-date – a step up from last year’s 3.0% pace. However, consumption has not been as strong or as broad as expected, despite a normalization in mobility and elevated household savings. A key issue has been low consumer and private business confidence. As shown in the graph below, home price declines and uncertainty about the labor market have weighed heavily on household sentiment. Policymakers have taken a series of measures to improve confidence, including:

• Relaxation of national housing policy: Lowered rates and down-payment requirements for all first and second homebuyers; widened definition of “first home” so more buyers can receive better mortgage rates and pay smaller down-payments.
• Increased engagement with the private sector: Created a special bureau to support the development of private enterprises; announced the conclusion of investigation of prominent technology firms.
• More favorable tax policies: Increased the deduction quota for individual taxpayers who have children or elderly family to support; extended favorable tax treatments to annual bonuses until 2027.
• Increased fiscal spending: Allowed additional central government bond issuances worth CNY1 trillion, increasing this year’s fiscal deficit from 3.0% to 3.8% of GDP.

The cumulative impact of the government’s policy measures is becoming more noticeable in the data: 3Q GDP growth surprised positively growing 4.9% y/y, September retail sales picked up to 5.5% y/y vs. the prior month’s 4.6%, and the household savings rate finally decreased to 29% in 3Q from 32% in 1H23. If this momentum is sustained in 4Q23, the government will likely achieve its “around 5%” GDP target for 2023. Still, markets have not responded strongly as skepticism remains about the cyclical and structural direction of China’s economy. 

For investor confidence to improve it will be key to monitor: household confidence, home prices, private business investment and hiring, earnings revisions and dialogue between the U.S. and China. Historically, Chinese market recoveries can be fast and furious, highlighting the risk of being too underweight China when pessimism is already elevated. Longer term, China’s economy will likely continue to slow down (our new 2024 LTCMAs project an average annualized growth rate of 3.8% over the next 10-15 years); however, investment opportunities exist in the “new new economy” sectors of business innovation, green technology and domestic consumption.

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