China Market Weakness: An Opportunity for Investors?

So far in 2021, the MSCI China Index has fallen 20%, as of July 19, from its mid-February high, while the MSCI World Index of global developed markets has gained 6.7%. 

The disappointing stock performance comes amid concerns about tightening credit conditions and slowing economic momentum in China. After surging 18.3% in the first quarter from last year’s pandemic-induced low, the country’s gross domestic product (GDP) growth slowed to a still-robust 7.9% in the second quarter.

Citing a need to spur lending to small businesses, China’s central bank cut the amount of cash that it requires banks to hold as reserves earlier this month—a stimulative move that we believe sets the stage for steadier growth ahead. It comes as central banks in other economies are moving in the opposite direction, toward withdrawing stimulus, following a period of rapid growth and rising inflation.

Looking ahead, we see several fundamental advantages for China that could be key to driving growth—and boosting China-listed stocks—relative to other regions. These include: 

• Resurgent credit growth: Morgan Stanley & Co.’s economics team anticipates that the central bank’s recent policy move will help credit growth in China rebound by roughly one full percentage point, toward 11%, by year-end. The increased liquidity should flow through to local bond issuance, helping to bolster infrastructure spending that could add significantly to second-half GDP.

• More manageable deficits and inflation: In contrast to the U.S. budget deficit of 13.4% and a recent year-over-year consumer-price-index gain of 5.4%, China’s budget deficit is 3.9% and its consumer inflation rate just 1.1%. That translates into greater flexibility for China’s policymakers to take measures that support the economy and fewer concerns about the kinds of looming government budget imbalances that other countries face.

• Tailwinds for exporters: With restocking pressures high for global supply chains and a capital-spending boom appearing imminent in the developed world, China’s exports, up 32.4% in June, could keep up their momentum. Notably, China’s exporters continue to gain market share in Europe and across emerging-market countries.
  

• Potential for robust consumer spending: June retail sales surprised to the upside, and household savings have been swelling, giving Chinese consumers ample spending power to unleash.  

To be sure, some industry sectors in China still face headwinds. Rising commodity and semiconductor prices have contributed to margin pressures at some companies, and the relative strength of the renminbi may pose challenges for exporters. In addition, investors have been struggling to understand the ramifications of China’s recent regulatory clampdown on Chinese technology and social media companies.

Given such factors, we believe underperformance among some sectors is understandable. At the same time, current valuations for many Chinese firms create compelling investment opportunities. We suggest that investors watch for China’s credit growth to rebound. Consider selectively adding to China A-shares—the stocks of companies based in mainland China that trade on the country’s two exchanges—within emerging-market portfolio allocations. Your Morgan Stanley Financial Advisor can tell you more about how you can gain access to the China A-share market.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from July 19, 2021, "Update on China." Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.