3 Reasons Investors Shouldn’t Overlook China’s Economic Rebound

It is nothing short of amazing, given the year we’ve had, that the S&P 500 is up nearly 8% year-to-date and the U.S. economic recovery remains on track. But as encouraging as that rebound seems, it may not be the most important driver of global capital markets going forward. Instead, I would point to the speed and durability of China’s economic turnaround. 

Evidence over the past seven months suggests that China has made the swiftest recovery from the COVID-19 pandemic of all major economies. China is the only country in the G20 to have already emerged from recession with 4.9% annualized year-over-year growth in the third quarter. For the full year, Morgan Stanley & Co. economists now forecast 2.3% GDP growth for China, while the global economy is forecast to contract 3.7%. China now accounts for 40% of global GDP growth—more than the US, Europe and Japan, combined.

Politics around the virus, trade issues, 5G infrastructure and cyber-terrorism may have obscured this narrative. But it hasn’t been completely lost on investors. China A-shares, which investors outside China can own, are up 24% year-to-date, nearly three times more than the S&P 500. Here are three reasons why we think China will continue to represent a long-term growth story:

• China’s economic balance continues to improve as domestic consumer and business demand makes up a greater percentage of spending. The country is less dependent on exports, which are now only 17% of GDP, down from 35% in 2007. U.S. imports of Chinese goods comprise only 3% of China’s total GDP, down from 12% in 2008. We see room for more growth as per capita disposable income and consumption spending return to their long-term growth trend, after a vaccine is available. Vacation-related spending is still off by close to 60% currently in China.

• China appears to have ample fiscal and monetary policy flexibility, unlike most central banks and sovereign governments around the world. It didn’t have to resort to bond buying, balance-sheet expansion or historically unprecedented levels of government spending this year. While the U.S., Europe and Japan pursued policies that saw combined fiscal and monetary stimulus move toward 30% of GDP, China’s policy expenditures have been about 6% of GDP so far.

• China’s interest rate and currency dynamics remain attractive, suggesting a healthy backdrop for attracting foreign capital flows and protecting investor capital gains. China 10-year bonds are yielding nearly 3.2%, the widest premium in 15 years to the U.S. 10-year Treasury, which yields less than 1%. For its part, the yuan, which China’s central bank generally keeps within a targeted range, is now at the strongest level since 2018, trading at 6.65 RMB to the dollar. Such metrics point to the ongoing internationalization of the renminbi. Morgan Stanley & Co. strategists estimate that 10% of global reserves could be held in China’s currency by 2030. 

To be sure, investors have reason to be skeptical. China’s similar stimulus-based surge from 2009 to 2012 proved unsustainable, built on an unstable foundation of real estate-linked debt. This time however, with its more measured fiscal policy and steadier economic trajectory, China may offer investors an attractive entry point to a multiyear secular growth story. Investors interested in this theme should consider taking advantage of volatility in currency and interest-rate markets to add China A-shares and emerging markets to their portfolios.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Oct 26, 2020, “China ‘Emerges’ Again.” Ask your Financial Advisor for a copy or find an advisor.  Listen to the audiocast based on this report.