Economic Contraction

Chinese economy: the 2nd quarter was bleak. What this means for his stock recovery.

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China’s economy is expected to have slowed in the second quarter.

STR/AFP via Getty Images

China is expected to register its worst economic growth since the depths of the pandemic in 2020. Investors should focus on consumer health and credit growth to assess whether the nascent recovery in equities can continue.

Most economists expect real economic activity to contract due to the severe lockdowns that paralyzed Shanghai and Beijing in the second quarter and continued difficulties in the property market. The consensus estimate calls for a 2% contraction in GDP in the second quarter.

A shrinking economy has not been a problem for the Chinese stock market. The

iShares MSCI China Listed Index Fund

(MCHI) is up 15% since early May as containment measures eased and Chinese policymakers pledged to stabilize the economy by May 20e Party Congress and end the crackdown on the private sector that has rattled investors for the past two years.

But some fear the Chinese rally is on shaky ground. It’s not just that official statistics are unlikely to signal a contraction. Acknowledging a severe recession would contradict the Communist Party’s goal of avoiding the blockbuster stimulus spending that got it into trouble after the global financial crisis, says China Beige Book’s Shehzad Qazi. The higher the official GDP figure, the less stimulus policymakers are likely to put in place, Qazi says.

Instead, GDP might be the wrong number to watch. What investors need to see are signs of renewed credit growth in China and indications that consumers are ready to spend more freely. Instead of GDP, the data economists consider more telling relates to consumption and credit growth.

“The most significant indicator is credit growth; it’s hard to see a very strong sustained recovery, either in equities or the real estate market, unless you get more recovery there,” says Arthur Kroeber, head of research at Gavekal per e -mail.

Next on the watch list: real estate sales and construction, which will be announced in the coming weeks. Although home sales had a strong June, the data so far this month has been disappointing as credit growth is yet to pick up significantly and there is still uncertainty over future new covid lockdowns. For a more sustained economic recovery and for the recovery in equities to be stronger, analysts believe that long-term household and corporate borrowing must increase more substantially.

Investors should also watch consumer appetite for durable goods like autos, one of the metrics from this week’s retail data worth watching, says Derek Scissors, senior research fellow at American Enterprise Institute. Car sales rose last month, but this month’s data can indicate whether that was just pent-up demand after the shutdowns or whether demand will be more sustainable.

The other challenge for China is that its exports have helped its economy, but as recession fears grow in Europe and the United States it could lose that momentum – and the ongoing talk of multinational companies displacing parts of their supply chain outside of China could also darken in the longer term. long-term outlook for exports, with Kroeber noting a negative shift in sentiment among multinationals over the past seven to eight months.

Most expect the economy to improve in the second half, although they see little chance that China can meet its 5.5% economic growth target for the year. TS Lombard’s Rory Green expects a major infrastructure stimulus, but it is likely to stabilize rather than reaccelerate growth. While Green thinks the worst is over, he expects China’s recovery to be slow – with the possibility that more Covid lockdowns and the collapse of its property market will offset any stimulus or easing of the crackdown of technology.

Investors are lukewarm. BlackRock’s Investment Institute said this week it was neutral on Chinese stocks even as activity picks up. Among his concerns: Economic growth in 2022 appears to be falling short of official targets and geopolitical concerns, including China’s ties to Russia.

The fines imposed on

Tencent Holdings

(700. Hong Kong) and

Alibaba Group

(BABA) this week, even after policymakers indicated weeks ago that their crackdown on the tech sector was coming to an end, also halted the recent rally in internet stocks. “We have received yet another reminder that government, not corporate executives, can decide the economic fate of any company,” says value manager Laura Geritz, who runs Rondure Global Advisors. “Given the relatively large weight of these stocks in the index, the recovery is over, at least in the short term.”

Although Geritz says she is finding more quality stocks in China cheap enough to provide a margin of safety, she says the near term could be bumpy with a tough earnings season for companies focused on domestic demand.

Those looking to see if it’s safe to enter may want to look beyond GDP to see if the consumer is willing to spend and borrow. When they start turning, so will the market.

Write to Reshma Kapadia at [email protected]