China's slow bleed

China watchers have long set store by the outcome of the Third Plenum. This latest meeting was a disappointment, with the country’s leaders setting priorities other than growth.   

China appears to be at an inflection point. After years of roaring growth, the pandemic and its aftermath have introduced (relative) stagnation even as hopes for peaceful cooperation between China and the West appear to be faltering. Demographics, likewise, remain a cause for concern, given the country’s ageing workforce and negligible immigration.

Finally, the government’s proactive economic policy stance seems to have changed too. Here, the mantra is no longer growth at all costs. Instead, the Chinese Communist Party’s doctrine of “common prosperity” and competition with the West now take center stage.

This, at least, was the message when the Chinese Communist Party’s Central Committee met in July for its Third Plenum meeting. Historically, these gatherings have resulted in new growth-oriented policy announcements – and, this time around, investors had hoped to hear party leadership articulate a new way forward for the economy.

Yet little to nothing from the meeting changed the narrative. Rather than switching focus to jump-starting the economy, the party’s 22,000-character document which summarized the plenum spoke of increasing the state’s influence and channeling state resources into strategic sectors.

While this matters less for the US, it’s potentially a big deal for Europe given the importance of current trading relationships.

A slowing economy

The Chinese economy has slowed further in recent months. Exports remain a bright spot, having largely recovered from Covid, but the property market is in a funk, mired by years of overcapacity and misallocation. Within China, sentiment remains weak, and the slowdown in consumer spending is problematic.

The Bank of China may have lowered rates but not by enough to alter the course of an economy burdened with a moribund property market and subdued sentiment. The official response has been supply-related rather than to stimulate demand.

Even so, we don’t believe we are seeing the “Japanification” of China. After all, the Organisation for Economic Co-operation and Development still projects China’s GDP to grow at the third-fastest rate in the G20 this year (4.9%) and next (4.5%), behind only India and Indonesia.

Likewise, China’s push for common prosperity is bearing some fruit and Xi remains highly popular among the broader population. The government claims to have eradicated extreme poverty as of 2021, and medical coverage became universal in recent years. While not yet universal, pension coverage has been expanded greatly as well.

A path forward for investors

So, how should investors think about current opportunities in China? Even at its current 25% weighting in the emerging markets index (it was once as high as 45%), the country is too big to ignore. And any bold, outlier position on China will likely result in a sizeable departure from the index in a way that would not be the case with a smaller country.

For now, a slow-moving deflationary and subdued-sentiment cloud hangs over China – with value-oriented, dividend-paying State-Owned Enterprises (SOEs) the main beneficiaries. In fact, value has trounced growth in strides, with the MSCI China Value Index returning an annualized -9.01% versus -19.62% annualized for growth over the past three years. Even year-to-date, value is still up 6.67% while MSCI China Growth has declined 1.63%.  

Entrepreneurship has done much less well of late in Xi Jinping’s China. Xi has kept the free market under wraps and seems willing to bear the cost of near-term economic pain in return for longer-term cultural and technological gains. Time will tell whether China can rebalance its economy in a way that will promote growth and yet still focus on common prosperity and geopolitical competition.

In a country burdened by an aging society, a weak property market, and a government focused on geopolitical competition, we term the current state of affairs as a slow bleed of the economy.