China stocks sink in the Taiwan Strait
China is back to its robust growth path after the COVID-19 pandemic threw away its 28-year streak of above-6 per cent annual growth. In 2022, the second-largest economy grew only by 3 per cent, but has picked up the pace to an average of 5.2 per cent from January-September this year.
The rebound trajectory remains uncertain with other uphill issues taking the spotlight. Unlike the coronavirus, this is no longer an “invisible” enemy – although the demarcation between subjects and enemies remains to be a question after all these years. Rising tensions between China and the US, where the conflicting alliances with Taiwan is an example.
Geopolitical developments have taken a turn for the worse quite literally after a Chinese navy ship took an “unsafe” maneuver in the Taiwan Strait in June, intercepting the path of an American destroyer while travelling between Taiwan, a self-governing democratic state being claimed by China and the Mainland. The US vessel had to slow down to avoid collision with the Chinese ship while in Taiwan’s waters. By October, the collision of a Chinese Coast Guard vessel with a Philippine ship on a resupply mission at the Second Thomas Shoal in the South China Sea threatened diplomatic relations further, given that Manila has an existing military defense treaty with the US.
Chinese stocks take the hit
Chinese stocks have since dipped even when a disaster at sea had been averted, and a meeting between Chinese President Xi Jinping and US President Joe Biden was unable to lift market sentiment for the remainder of 2023 – already reeling from Beijing’s domestic property crisis.
Share prices of Chinese firms listed in Hong Kong entered the bear market to start June, falling more than 20 per cent lower than their value at the start of the year before recovering by mid-July. In May 2023, CNN estimated Chinese stock valuations have dropped by USD 540 billion as optimism regarding China’s recovery sizzled out, on top of uncertainties triggered by sensitive geopolitical issues. Three Chinese stock indices are below end-2022 levels, with the Hong Kong Hang Seng index down the most at 19 per cent as of December 15. We partly relate this ongoing headwind with the very fundamental investor nervousness about China’s global political position.
We argue that too much nervousness currently is priced in the Chinese stock; in particular, those trading outside China. Many links between US and Chinese officials at different levels have been re-established since mid-2023. This is not recognised by investors. Though, what to watch out for is how the US officials evaluate the new attempts if the cooperation is working or not. If not, then it won’t help the stock market but if there are positive signals then it will lift Chinese stocks.
Graph 1 shows that Chinese stocks trading outside the Mainland have remained in the negative territory as market watchers grow uncomfortable with the souring relationship between the world’s two largest economies. The NASDAQ Golden China, Hang Seng, and Shanghai Composite indices have all fallen after peaking in early February and have not returned to that level since. This is compounded by the so-called China Plus One phenomenon wherein businesses sourcing their production in the Mainland are either looking to build secondary factories elsewhere in Asia or preparing to repatriate their investments and operations out of China due to intensifying tensions.
International investors are still pulling back, a trend that got fuelled when a growing part of investors feared a Chinese invasion of Taiwan. However, we argue this fear is overestimated and the negative impact on Chinese stocks is overblown. Taipei’s alliance with the US, and the latter’s assurance that it will come to the rescue against a potential attack by the Chinese, would make President Xi Jinping think twice before escalating conflict in the region. China is still reeling from the long-term negative effects of the COVID-19 crisis, and the last thing its government would want to do is to put its people and the country’s finances down in deeper debt to finance any sort of war against their neighbour.
China’s onshore growth
China’s impressive growth story has been one of its biggest selling points to global investors, although the trend has been disrupted by the pandemic. National output expanded by 4.9 per cent in the third quarter of 2023, easing from 6.3 per cent in April-June but still beating market expectations. Industrial output grew stronger at 4.5 per cent while retail sales expanded by 5.5 per cent.
However, the economy needs to pick up speed during this fourth quarter to meet the Chinese government’s target GDP growth of “around 5 per cent” for 2023. Private consumption needs to convincingly shift into a higher gear to support the Chinese economy’s recovery to its pre-pandemic growth pace. This has been challenging for the national government in the aftermath of increased unemployment and weak consumer confidence resulting from the pandemic. Consumer appetite has remained weak, which has driven near-zero inflation since April as households remain reluctant to spend.
Manufacturing might not be enough to provide a much-needed boost to the Chinese economy for now. Signs point to a contraction in factory output with China’s Purchasing Managers’ Index (PMI) having declined for most of the year as seen in Graph 2. A PMI score below 50 indicates production is likely to decline and the contribution of manufacturing to overall GDP will contract during that period. Goods exports have shrunk since May, casting doubt on China’s ability to revive the economy’s pre-pandemic luster anytime soon.
Since 2016, the industrial sector has contributed less than 40 per cent of the overall annual GDP in line with China’s pivot towards less investment-oriented growth to one that is more reliant on domestic household spending.
November’s non-manufacturing PMI signalled mixed outcomes, with above-50 index scores for business activity (50.2) and business expectations (59.8). Meanwhile, PMI numbers are weak in terms of new orders (47.2), sales price (48.3), and employment (46.9).
With China’s manufacturing sector underperforming, the economy may be some ways away from hitting close to 5 per cent growth in 2023. However, the buoyant services sector may provide the necessary boost to the country’s GDP. Both the World Bank and the International Monetary Fund are convinced China still has what it takes to spur faster economic activity, with the latest growth forecasts at 5.1 per cent and 5.2 per cent, respectively, for the full year on the back of larger consumer spending that will offset modest investment gains. Realistically, we believe even a 4.7 per cent growth would be a positive surprise to international investors that could encourage more flows to China.
