Investors have been scared about the prospect of an economic collapse in China. After being the last economy in the world to re-open post-COVID, growth has been far more sluggish compared to other countries. And investors are now scared about the Chinese economy. At best, investors fear it won’t return to pre-COVID growth rates (if ever). At worst, the crisis in the property market will cause economic armageddon.
Is the answer one of these extremes, or somewhere in between? In our view, it’s too early to tell, but not unreasonable to think the former scenario (namely, the country not returning to pre-COVID growth rates consistently) is realistic.
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Is an economic collapse in China really happening?
We think the short answer is no, not in the broader economy. But it wouldn’t be unfair to state there is the risk of a collapse in the property market and this would inevitably hinder the economy. As we noted above, this has been driven by sluggish post-COVID growth in the broader economy. This is not to say there hasn’t been growth – the country is targeting 5% this year. But this rate, the third straight year of 5% growth or below, not just is slower than pre-COVID but any era since Mao Zedong’s demise. And even the 5% target is at risk now.
Will China enter a period of stagnation as Japan has been trapped in for over 3 decades now? This is arguably what investors fear. The overheating in the property market has given significant cause for concern because it has been a major driver of China’s growth.
What’s happening with China’s property market
For so long, China couldn’t build apartments quick enough so borrowed and built excessively. And if debt was a concern, just borrow more to pay it off. While there is more to the economy than property, it is no doubt a major part of it given all the sectors reliant on property from construction to banking. Even local government is reliant on property given it sells land to developers and uses money to pay for municipal services. But most importantly, lenders who lent developers money run at risk of losses and they have faced just this.
Since 2020, it has been more difficult to secure credit in China and over 50 developers have defaulted, according to S&P. One of these was Evergrande Group and Country Garden could well be next. Bank lending has not been weaker in 14 years.
Beijing has made some modest gestures such as cutting interest rates and relaxing mortgage requirements, but have stopped short of a major rescue package. In fact, the interest rate cuts announced by the People’s Bank of China (PBoC) were quite paltry, at just 10 basis points for the one-year loan prime rate.
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Property market doesn’t tell all the story
Even if there are no spillover effects into the rest of the economy, property will no longer the key driver of economic activity. So what will take its place? Certainly not international tourism if the current numbers (both in and outbound) are anything to go by.
Exports generally are 14.5% down year on year. Youth unemployment is at record levels. And births have not taken off in the way the country expected post the abolition of the one-child policy.
Most importantly for stocks with business in China, from A2 Milk (ASX:A2M) to Fortescue (ASX:FMG), if consumer spending is weak, these companies’ profits (at least from China) will not be returning to pre-COVID levels. And it could impact global markets as well.
What does all this mean for investors?
It will depend on how the situation transpires. But if you assume a period of stagnation is forthcoming, it should only affect stocks that have put all their eggs in the ‘China basket’. A widescale economic catastrophe in China (let’s say a GDP retreat of at least 5% from peak to trough) could well cause a significant impact on global equity markets generally. But even if a 5-10% correction to the major indices is realistic, we do not think a 40-50% retreat (as during the GFC and Corona Crash) is – barring a spillover into the global economy more broadly.
Overall, we don’t think investors should be too worried as long as they own stocks with significant exposure to China – say over 40% of revenues. Especially if they are exposed to the Chinese property market!
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