China’s equity markets are down by more than half since early 2021 amid the state’s failure to boost domestic consumption and other policy mistakes. We think the ongoing difficulties could boost high quality US bonds.
China’s equity markets are down 20% from their high of this year and 54% since Feb 2021. Global and domestic investors are wondering what caused China’s major change of fortune and what can be done to reverse it.
Over the past 3 years, China’s current administration has been willing to derail national champions in the name of “common prosperity”. From e-commerce to online education to car-hailing, China has impacted corporate decision-making, sacrificing rapid growth in revenues and profits for greater state control. As technology emerged as a national security issue for the West, Western governments sought to isolate their markets from China’s tech products. Finally, China’s alignment with Russia over the Ukraine war caused foreign direct investment to plummet.
At the center of China’s malaise is a growing real estate crisis. China’s highly indebted property developers seem certain to drive a wave of corporate defaults. More than 700 unfinished projects await completion nationally.
China has not taken sufficient actions to boost domestic consumption and make targeted investments in growth industries. While we don’t believe this will impact 2023’s overall economic growth rates significantly (as much as many assume), it risks a spiral of debt and deflation if its policies do not spark a recovery through 2024.
Any procrastination in stimulating China’s economy risks self-reinforcing negative economic effects. This may result in a “paradox of thrift”. As households seek to protect themselves by securing their balance-sheet resources, the economy may collectively face insufficient demand causing government and bank debt burdens to rise disproportionately.
Many have argued that the disinflationary impulse of Chinese exports on US consumer prices during the past two decades had already run its course. If China does not turn around, it would be another strong factor weighing against the popular view that the US is facing a higher long-term trend rate of inflation.