China’s economy has shown promising signs of stabilizing, which has eased concerns of a potential implosion. However, long-term economic challenges and geopolitical tensions continue to keep investors cautious, casting a shadow over the potential recovery of battered Chinese stocks.
A Positive Outlook
Citi Global Chief Economist, Nathan Sheets, has raised the bank’s forecast for China’s growth in 2023 to an impressive 5.3%, surpassing Beijing’s official target of 5%. This revision indicates a more optimistic outlook compared to the earlier projection of 4.7% at the beginning of the year. Sheets attributes this positive shift to the government’s proactive measures in implementing monetary and fiscal stimulus.
According to Sheets, the Chinese economy seems to have reached its lowest point in the current cycle, as private spending has shown signs of stabilization. Retail sales have experienced a notable rebound, and the firm’s index of Chinese economic activity reflects an upward trend. Despite these positive developments, certain weak spots persist. Manufacturing activity dipped into contraction territory in October, while construction activity slowed due to ongoing struggles in the property sector.
Addressing concerns about Chinese consumers’ spending behavior, Sheets highlights that although caution exists, it is not as severe as initially feared earlier this year. The combination of improved private investment and continued government stimulus is expected to further solidify the economy. Sheets confirms that officials remain committed to achieving growth rates between 4.5% and 5% for the upcoming year.
While Sheets acknowledges the recent positive developments, he maintains a cautious stance regarding China’s long-term economic outlook. The country faces significant risks, primarily driven by high levels of debt that limit the government’s capacity to provide fiscal stimulus. Additionally, uncertainties regarding alternative sources of economic growth after the struggling property market pose further challenges. Ongoing tensions with the United States and government pressure on China’s technology sector are additional factors contributing to the uncertainties.
In conclusion, China’s economy demonstrates signs of stability, offering hope for the near term. However, lingering long-term challenges and geopolitical tensions cast uncertainties over the future. Although the odds of achieving 5% growth in the near term have improved, the path ahead remains uncertain.
The Decline of Chinese Stocks: A Long-Term Concern
Investors have started to take notice of the downward trend in Chinese stocks. The iShares MSCI China exchange-traded fund (ticker: MCHI) has seen a nearly 10% decline this year, bringing it to about half of its peak level in 2021. Domestically-oriented shares are also struggling, with the iShares MSCI China A-shares ETF (CNYA) down 13% so far this year.
Despite the seemingly attractive lower price tags on Chinese stocks, such as the CSI 300 trading at just a fifth of the Nasdaq’s valuation, long-term investors may still not be lured in. Allocations to China have witnessed the largest decline among diversified Asia ex-Japan regional equity funds since the beginning of last year, according to EPFR Global.
Some strategists, including Nicolas Colas of DataTrek Research, suggest that it might be wise to favor U.S. stocks over foreign stocks more broadly. In a research note, Colas highlighted the poor track record of non-U.S. stocks compared to U.S. stocks since 2010.
Looking at trailing 250-day relative returns, the MSCI All Country World ex-U.S. index outperformed the S&P 500 as global markets rebounded from their lows during the March 2009 financial crisis. However, there have been only five instances where non-U.S. stocks beat the S&P 500 in a calendar year since then.
This suggests that the international stocks’ outperformance in the MSCI All-Country World index this year might come to an end soon. Colas believes that although Chinese stocks have outperformed the S&P 500 in the past year, it might be prudent to wait a month or two before selling them. The growth potential in the Chinese economy is more likely to accelerate compared to Europe or Japan.
Nevertheless, Chinese stocks have historically delivered exceptionally poor long-term returns. Therefore, it is advisable to gradually reduce exposure to these stocks over time, Colas concludes.