In April, business activity in China slowed dramatically, following a contraction in March. This development is of global importance to policymakers and investors. The Chinese economy is the world’s second largest, behind only the US economy. While China had limited trade in the 1970s and early 1980s, it has since become the world’s largest exporter.
The most important of its exports are manufactured goods such as information and communication technology equipment, industrial machinery, and clothing, with the US and the EU being its most important markets. It plays a key role in supply chains for firms around the globe. Seven of the globe’s ten biggest container ports are in China. Note that 90% of global trade volume travels by sea. China also has become the second largest oil consumer and a very important consumer of many other commodities.
The sharp contraction in economic activity is due to China’s approach to dealing with outbreaks of Covid-19 through severe lockdowns, highway controls, mass testing, and quarantine centers — President Xi Jinping’s zero-Covid strategy. The highly infectious Omicron variant has proven to be a great challenge to such an approach, leading most countries to recognize that a zero-infections objective is unattainable. China’s situation was made worse by a less effective domestic vaccine, an unwillingness to obtain Western vaccines, and limited vaccinations of aged members of the population.
The placing of hundreds of millions of people under strict lockdown and the severe disruption of domestic and port logistics took a toll on both demand and supply indicators in April. Retail sales slumped 11.1% year-on-year to a two-year low, following a 3.5% fall in March, with auto sales contracting 31.6%. Imports fell slightly by 0.1%. Industrial production fell 2.9% to a level that is the worst since data became available in 1990. Exports were weaker, and auto production dropped 31.8%. Reflecting weak construction activity, cement output fell 18.9%.
We expect the data for the second quarter will be weak, as the economic disruption will continue at least through May and the global economic fallout from the Russia-Ukraine war will impact exports and investment. On the other hand, there are some positive developments. The recently announced Covid strategy modification “societal zero Covid,” which aims to stop the spread outside quarantine areas, should speed up the lifting of restrictions. Also, the severity of Covid infections nationwide appears to be easing, although there is a growing outbreak in Beijing, where restrictions are tightening.
China has announced a major fiscal stimulus package in the form of $21 billion in tax cuts, mainly to business. Tax rebates to companies and cuts on passenger-car purchase taxes are part of this package. Steps to improve policies to help supply chains function better were also announced. These new measures follow the People’s Bank of China’s announcing a 15-basis-point reduction in borrowing costs on outstanding mortgages, the strongest move to date to support the troubled property sector. The benchmark rate for mortgage lending to first-time borrowers was cut by 20 basis points last week. The need for such action was underlined by a 42% fall in retail sales by floor space in April. In addition to these measures, we expect heavy infrastructure spending to play a major role in shoring up growth. Exports will face some difficult headwinds going forward because of weak growth in China’s markets in both emerging markets and advanced economies, as well as supply chain problems that will take considerable time to resolve. The economic stimulus measures announced to date look unlikely to be able to lift growth to the official target of 5.5% for 2022. We see a slower recovery, with annual growth of 4.0–4.5. Further spread of Covid in China is an important downside risk, as is the Russia-Ukraine war.
Future developments in US-China relations will be an important factor for investors. President Biden’s comment that the administration is considering reducing or eliminating the Trump administration’s tariffs on imports from China is a positive note. Those tariffs contribute to inflation and have proved to be harmful to many US firms. There also have been promising developments with respect to the threat of widespread delisting of Chinese firms from US exchanges. China’s regulatory crackdown on the technology and communications sectors stripped trillions of dollars from the market values of Chinese companies. There are indications the authorities intend to provide some support to tech companies and to repair some of the damage done. There continue to be intense internal debates between those seeking to restore the strength of the economy and those who give priority to protecting security and strengthening Communist Party rule. The economy versus security debate is common also to the US and other advanced economies.
After suffering steep declines earlier this year, Chinese stocks recently have been recovering. Shanghai stocks, though still down 13.5% year-to-date May 23, are up over 1.9% over the last month. Shenzhen stocks are up some 3.6% over the same period. When the Covid shutdowns are eventually eased, economic activity is likely to accelerate, boosting business and consumer confidence and encouraging a return of foreign investors to the Chinese equity markets. At Cumberland Advisors we are maintaining an underweight position in China equity ETFs, which could change rapidly depending on developments.
William H. Witherell, Ph.D.
Chairman & Chief Investment Officer
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Sources: Financial Times, Oxford Economics, Bloomberg.com, kraineshares.com, barcap.com, cnbc.com
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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
