Last week, the report that China’s official Purchase Managers’ Index (PMI) for May came in below expectations was seen as evidence of weakening economic momentum in the second quarter. Investors had expected an uptick, but instead the manufacturing index fell for the second month, to 48.8, remaining in the contraction area below 50. The non-manufacturing PMI remained in expansion territory at 54.2 but also slowed more than expected. More than four months into the recovery of the Chinese economy following the end of the country’s Covid lockdowns, this report added to mounting evidence that China’s economic “reopening” is more modest and uneven than had been expected. Reports from China’s trading partners, both in the region and elsewhere, all indicate very limited impact from the reopening thus far.
Later in the week, the Caixin PMI for May gave a somewhat more positive reading for the Chinese economy. The Caixin Manufacturing PMI rebounded to expansionary territory at 50.9. The Caixin Manufacturing New Orders reading was the second highest in two years. The Caixin Services PMI also rose in May, continuing to signal for the services sector a healthy recovery that was well above expectations. Note that the survey for the official PMI covers large and state-owned companies while the Caixin PMI survey is considered a better indicator of the private sector since it covers medium- and small-sized companies. The Caixin PMI may also better reflect downstream sectors and southern and coastal regions. It includes more consumer and export-oriented firms. The heavy-industry firms covered in the official PMI survey are being affected by the deteriorating situation in the property development sector and the weakness in investment and consumer demand for discretionary and durable goods, in particular, automobiles and household appliances. Indeed, with the Chinese economy in the process of transition from being export- and investment-oriented to domestic consumption-oriented, the disappointing weakness in domestic consumption is an important headwind for the reopening.
A factor acting as a drag on the domestic economy is the worsening risk of defaults by local government financing vehicles and by property developers. The Chinese government is expected to take focused regulatory actions to support the property market. Also, the Peoples Bank of China is expected to cut deposit rates and reserve requirements in the second half to alleviate domestic credit strains. Yet the banking system is already flushed with liquidity. The problem is the weakness of demand factors. High youth unemployment is depressing consumer attitudes, as is the property-market crisis. Broad fiscal stimulus measures appear unlikely in view of the conservative government budget and the policymakers’ preference for focusing on structural measures.
The latest export data provide little basis for optimism. China’s goods exports fell 7.5% y/y in May, reversing most of April’s 8.5% gain. Exports to the US plunged 18.2% y/y, extending the chain of monthly declines to 10 months. China’s exports are not likely to be a source of strength going forward, with growth in the global economy, and in the US economy, in particular, projected to slow from the more-robust-than-predicted first half of 2023. The tighter US rules on exporting advanced chip equipment to China and the tense geopolitical relations are further negative developments, impacting, in particular, the investment climate. The 4.5% decline in imports was significantly less than the expected 8%, possibly an indication of some continued reopening boost to demand.
On the positive side, a number of factors should permit the Chinese economy to register an annual growth rate of 5.4% for the year 2023 and over 5% in 2024 as well, according to the OECD. These are the continued strength of the recovery in the services sector (some 50% of the Chinese economy) and in the small and medium-sized firms covered by the Caixin PMI survey – indications that supply bottlenecks have ceased to be a problem –, and government actions taken to address property market and local government financial stresses. This anticipated growth would be less than the strong reopening burst that seemed possible during the opening months of this year. Yet it would be second only to India’s projected 6% growth rate this year.
Investors have retreated from their first-quarter reopening optimism about Chinese stocks. The Shanghai Stock Exchange is down 5.3% over the last month, reducing its year-to-date June 7 gain to just 4%. Along with the weakness of the economic reopening, increased geopolitical tensions have elevated the perceived risk premium. Offsetting these concerns for some is the consideration that Chinese stocks now are relatively cheap, based on earnings valuations. A move by the government to provide stimulus to the economy or signs of an easing in the tensions between China and the US would likely lead to a strong positive market reaction.
Other Asian economies and stock markets are affected by developments in China, the globe’s second largest economy and a major geopolitical force. However, the economic boost expected for the reopening has been disappointing, indeed not at all evident thus far. There have been marked differences in the performances of stock markets in the region.
If we look at the economies with the strongest expected economic growth aside from China – India (6%), Indonesia (4.7%), Malaysia (4.5%) – the year-to-date stock market returns are all below the All Country ex-US Index (7.3%). Specifically, the returns are India, Nifty Fifty (2.9%); Indonesia, IDX (4.8%); and Malaysia, KLCI (-8.1). Other Asian markets with negative year-to date returns are Hong Kong, Hang Seng (-4.9%); Australia, ASX 200 (-2.4%); Singapore, Straits Times (-2.0); and Thailand, SET (-6.5%).
The three outperforming markets are all expected to have economic growth this year of 2% or less, similar to the 1.3% growth projected by the IMF for the advanced economies and the 1.4% growth projected by the OECD for its membership. South Korea’s economy is projected to grow at a 1.5% pace this year despite little if any measurable boost thus far from China’s reopening. Note that mainland China is the country’s largest export market. The first quarter saw a revival of positive growth, with healthy increases in consumption and exports. Korean stocks have outperformed, with the KOSPI up 16.7% year-to-date. The global boom in tech stocks has been a factor, with Korean technology firms having a significant advantage. Investors see the potential for gains if the China economy gains momentum.
The second outperforming Asian stock market is Taiwan, where the economy is projected to grow by 2% this year. Taiwan’s economy is even more predominately driven by the technology sector than is South Korea’s. In May, Taiwan’s stock market attracted a huge inflow of $4.4 billion, even larger than the $3.1 billion inflow to the South Korea market. Technology stocks, particularly those connected with semiconductor chips and artificial intelligence, were the attraction. The Taiwan market is up 18.4% year-to-date. This trend is impressive, particularly in view of the rising geopolitical tensions with respect to Taiwan.
Perhaps the most surprising outperforming Asian market is Japan’s, where the Nikkei 225 is up 21.3% year-to-date, hitting its highest closing level in 33 years. Japan’s deflationary environment has ended; and with the return of inflation, corporate profits are reaching records. The economy is projected to grow at a 1.3% pace this year, which would be above the 10-year average for Japan. Also, the government finally is pushing forward corporate governance reforms, and they are significant. Rising geopolitical concerns globally have helped defense and technology stocks. The Japan market also appears to have gained funds that have been withdrawn from China, as investors view Japan as having a more favorable investment environment.
To conclude, Japanese, Taiwanese, and South Korean stock markets are leaving other Asian stock markets in the dust this year. Chinese stocks, in particular, have fallen far short of the gains anticipated earlier in the year. This picture could change significantly at any time. At Cumberland Advisors we continue to include Japan, Taiwan, and South Korea in our International and Global Equity ETF portfolios. We also have maintained a small position in China and are closely monitoring developments.
William H. Witherell, Ph.D.
Vice Chairman & Chief Global Economist
Email | Bio
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Sources: Oxford Economics, Goldman Sachs Economic Research, Financial Times, oecd.org, imf.org, chinalastnight.com, Bloomberg, cnbc.com
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