By Aaron Puthan
Chinese economic output is expected to reach pre-COVID levels this quarter, well ahead of other major global economies. The recovery so far has been led by production and trade, but domestic consumption is starting to catch up. This supports my constructive view of Chinese assets.
China’s production recovery
The Chinese economy, particularly its industrial sector, has benefited from the ‘first in, first out’ effect and effective containment of COVID-19. In addition, early reopening and fast recovery of production led to an impressive rebound in exports. China’s exports grew north of 5% year-on-year in July and August, and now makes up around 20% of global exports (up from 15% pre pandemic).
China’s consumption recovery
While industrial production already rebounded to roughly pre-pandemic level in April, the recovery of domestic demand for goods and more significantly for services has been lagging slightly. This lag has raised concerns that COVID-19’s impacts on the labor market could result in a multi-year drag on consumption, which affects growth. However, recent data have painted a more optimistic picture.
Data from China’s annual week-long National Day holiday, a.k.a the “October Golden Week”, shows a strong recovery in overall consumer activity. Top tourists sites saw 640 million visits, roughly 80% of last year’s level. Given that some major tourist sites have a 75% capacity limit in place, this number is pretty impressive. Furthermore, passenger transportation, which has lagged the recovery the most, likewise rebounded, indicating citizens are regaining comfort in travelling following the dramatic drop in transportation during the crisis.
Even those consumers who didn’t travel over the holiday still consumed other goods and services. Retail and restaurant spending was going strong and had a growth of 5% compared to the holiday in 2019, which was a sharp rebound from the 6% decline in August. Together, this data indicates that consumer demand for services, though still lagging demand for goods, has also started to rebound, increasing the breadth of the overall economic recovery. This rebound in consumption suggests that consumer balance sheets are healthy and that the lasting damage of the crisis on the labor market may not be as bad as people initially feared.
Less worries about the “lasting damage” in the labor market
One thing many were concerned about was the “lasting damage” caused by COVID, i.e. permanent job losses due to lockdowns causing lasting weakness in household income, which leads to weaker consumption and overall growth. While the Chinese labor market has structural issues as a result of labor shortages in central and western regions, I think the cyclical recovery is stronger than perceived. Following the effective containment of COVID-19 in China, many sectors in the economy have normalized over the last few months, capping the permanence of job losses. As many as 50 million migrant workers returned to urban areas by Q2, who initially did not return following the Chinese New Year due to lockdowns. Furthermore, the hours worked by the broad urban workforce recovered to pre-COVID levels in August. Meanwhile, the official surveyed unemployment rate for urban areas (for 35 cities) has also eased from 5.9% in May to 5.7% in August, but remains 0.5% above year-end 2019 levels. As growth recovers, it is expected that the unemployment rate will continue to trend lower.
What does this mean for investors?
All-in-all, the rebound in consumption suggests that the economic recovery is broadening, which is a key requirement for a sustainable growth recovery. Though labor market stability remains a key priority for policy makers, it is unlikely for them to prompt further broad-based fiscal or monetary policy easing. We also expect policies to upgrade infrastructure, encourage consumer spending, and further open up the economy. Together, this will continue to support China’s growth and the country’s higher interest rates versus the rest of the world. As always, there are still risks. A “tough on China” stance has become politically popular on both sides of the aisle in the United States, and a further escalation in the U.S.-China tensions or a slowdown in global demand amid globally rising COVID-19 cases and localized restrictions could still result in a further headwind for China’s recovery.
From an equity perspective, China remains one of the global equity markets that is positive with a preference for the Consumer Discretionary, Technology and Industrial sectors. All of the above goes to support that view. Some value sectors could also benefit from a more broad-based recovery in the coming quarters. The recovery in Chinese consumption could also be positive for global consumer names that have a significant presence in China. □
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- Kuo, L. (2020, October 19). China becomes first major economy to recover from Covid-19 pandemic. Retrieved October 22, 2020, from https://www.theguardian.com/business/2020/oct/19/china-becomes-first-major-economy-to-recover-from-covid-19-pandemic
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