Chinese Equities: The month of December in review

Highlights in this article reveal:   

• That Chinese companies are rapidly innovating and moving up the value chain in various technology sectors, presenting an opportunity for continued economic progress despite facing challenges. 
• The factors that are favouring China’s Growth. 
• How analysts suggest China can avoid ‘Japanification’ through prudent fiscal and monetary policies. 

During the December annual Central Economic Work Conference, China’s leadership emphasised the significance of high-quality growth and reaffirmed their commitment to supportive fiscal policies. However, despite these efforts, they fell short of providing specific growth targets or concrete policy action.  

Towards the end of the year, regulators released a consultation letter seeking to curb excessive spending in the online gaming sector which raised concerns about another wave of regulatory scrutiny in big tech and prompted a market sell-off. In response to the market turmoil and industry anxieties, the government swiftly adjusted its stance by approving new game titles and expressing a willingness to consider feedback on its plans. Consequently, shares of technology stocks managed to recover some of the lost ground in the subsequent trading days. For the month, the MSCI China and MSCI China A Onshore indices were down 2.4% and 1.3% respectively. 

China should continue to grow, although at a lower rate 

China has grown at a remarkable 9% p.a. since 1978, benefiting from the ‘catch-up premium’, where emerging markets grow quickly as they adopt successes and innovations from developed countries. However, many countries fail to progress beyond a certain point often known as the ‘middle income trap’. This is where a country can no longer compete internationally in standardised, labour-intensive goods because wages are too high, but it also cannot compete in higher value-added activities. Examples include Brazil, Argentina, and the Philippines. 

China finds itself at this junction, and the pivotal question is whether it can continue its economic progress into the future. 

China finds itself at this junction, and the pivotal question is whether it can continue its economic progress into the future. Innovation is key: create new products to ascend into a developed market or fail to innovate and remain stuck. China’s potential to advance rests on several, promising factors: 

• An opportunity to enjoy the ‘catch-up premium’ through a sorter innovation cycle: Chinese companies are rapidly innovating and closing the gap with developed nations in various technology sectors. They are moving up the value chain and producing cutting-edge products like MRI machines, advanced machinery, and semiconductors, competing directly with established players in developed markets. 
• A large and eager entrepreneurial class: China boasts the world’s largest number of ambitious entrepreneurs driving new business ventures, and, as a result, sees vibrant venture capital success, delivering robust returns despite geopolitical and economic headwinds. 
• The largest manufacturing hub and consumer base: Chinese companies benefit from serving the world’s largest consumer market, and China, as the global manufacturing hub, significantly influences supply chain dynamics across multiple industries. 

Many economists believe that the country could potentially achieve a 5-6% annual growth rate, despite challenges such as heightened geopolitics. 

Considering these factors, many economists believe that the country could potentially achieve a 5-6% annual growth rate, despite challenges such as heightened geopolitics. While this marks a slower pace compared to its past and other emerging economies like India, this growth, applied to the world’s second-largest economy, could contribute an additional 1% to global GDP annually! 

Is China heading into ‘Japanification’?

Despite the promising growth factors listed earlier, the Chinese economy is lagging, and stock markets are struggling to recover. Many believe China is potentially facing challenges similar to Japan’s long-standing struggles, marked by shared issues like real estate, debt, and demographics. Yet, we believe that China can steer clear of ‘Japanification’ for the following reasons: 

1. Japan’s property and equity bubble far exceeded China’s, with its real estate market valued significantly higher relative to its size and population. 
2. China’s debt has stabilised after a prolonged deleveraging campaign, aligning with levels in other major economies, but with higher savings rates for both corporates and households. 
3. While some attribute Japan’s economic challenges to an ageing population, Professor Justin Yifu Lin argues that Japan’s struggles stemmed from stalling innovation, contrasting with China’s prioritisation of innovation supported by founder-led private enterprises and government initiatives. 

However, according to Alpine Macro, an economic think tank, China may follow in Japan’s footsteps if it doesn’t rectify its fiscal and monetary policies. They believe that self-imposed policy constraints risk a sustained growth downturn and a deflationary environment. 

Spending willingness has decreased, with nearly $6 trillion added to savings over the past three years. 

Despite an earlier-than-expected reopening in late 2022, Chinese consumer confidence remains low due to lingering COVID effects. Spending willingness has decreased, with nearly $6 trillion added to savings over the past three years. Corporations are cautious about investment and expansion amid economic and geopolitical uncertainties.  

Typically, in such situations, one would expect the government to implement strong countercyclical stimulus measures, such as increased fiscal spending and a more accommodative credit environment. Without adequate policy support, the economy may endure an extended cleansing process, or even significant economic and social hardships in extreme cases.   

For now, the Chinese government has adopted a restrained approach, implementing measures incrementally to stabilise the economy rather than delivering a substantial boost. 

For now, the Chinese government has adopted a restrained approach, implementing measures incrementally to stabilise the economy rather than delivering a substantial boost. The graphs in the report illustrate that China is still in a tightening phase, where the economy is in the doldrums. In 2023, fiscal expenditures dipped below the 2022 level, despite enhanced fiscal revenue. The pace of rate cuts was much slower than the decline in inflation, resulting in higher real interest rates, even surpassing those of the United States. Home purchase restrictions and down payment ratios in major cities remain highly stringent compared to global standards, despite recent relaxations. 

Why is China refraining from aggressive stimulus measures?

Some asset managers propose that China is currently undergoing an economic transformation, shifting from quantity-driven to quality-driven, and pivoting from property-driven growth to a technology-led approach. China’s success in electric vehicles (surpassing Japan as the world’s largest car exporter), dominance in the global solar panel supply chain (where it controls over 80% of the global supply chain), and leadership in 5G infrastructure, high-speed trains, industrial robots, and medical devices support this transition. Even in the semiconductor supply chain, China has significantly enhanced its self-sufficiency in recent years.  

During this transition, some short-term pain is inevitable, but China is determined not to revert to relying on the property sector as the driver of economic recovery. 

During this transition, some short-term pain is inevitable, but China is determined not to revert to relying on the property sector as the driver of economic recovery. Despite below-trend GDP growth, the Chinese government has not yet encountered high unemployment or related social unrest, which helps justify their policy stance. Currently, China has 740 million employed individuals, and the overall unemployment rate stands at around 5%, close to the pre-pandemic level. One secular factor that can explain the resilience in employment is the slowly shrinking labour force, influenced by China’s demographic structure.  

However, it is worth noting that President Xi’s populist leadership may prompt policy shifts, and the government to step up its efforts, if social tensions continue to escalate. We have previously witnessed abrupt policy shifts in China, such as the COVID reopening. Therefore, monitoring China’s macroeconomic data, including its 2024 growth target, is crucial amid potential policy changes moving forward. 

In conclusion 

We have attempted to present a balanced view of the Chinese economic landscape as such, we don’t believe that China will end up like a Japan. The Chinese are trying to transition from an economic model that relies on infrastructure and the property market which has caused considerable pain in the short-term. Therefore, government policy is going to be critical for the medium term, just as it was across the world during and after the pandemic. 

Subscribe to our monthly China commentary report for a detailed and insightful analysis of the state of the Chinese equity market.