China’s Struggling Economy Masks a Promising Investing Landscape

Investor sentiment toward China has soured after a tough year for the economy and stock market. But the painful economic transition is also creating real opportunity.

China is struggling to revive investor confidence after a particularly tough year for the world’s second-largest economy. But the negative headlines mask a more nuanced picture of an economy in transition, offering select opportunities in fixed-income and equity markets.    

Pessimism toward China was on full display in the stock market last year. The MSCI China A Index of onshore stocks fell by 11.5% in US-dollar terms in 2023, a sharp contrast to the MSCI World Index of global stocks, which surged by 23.8%. 

Chinese markets suffered because of government efforts to unwind the debt-laden property sector and the resumption of an anti-corruption campaign targeting various sectors. During this economic transition, policymakers were reluctant to provide substantial support for growth, which we view as an attempt to move away from China’s leverage-dependent growth model. As a result, corporate earnings were weak and investor sentiment soured. 

China’s real GDP grew by 5.2% in 2023, according to official data released in January. While that’s a marked improvement from the 3.0% growth rate in 2022, it’s still a far cry from the pre-pandemic era, when annual growth averaged 7.4% in the decade through 2019. In 2024, we believe a potential pivot by the US Federal Reserve toward lower rates could help improve sentiment toward Chinese assets, though additional policies to stabilize the property market and support growth will be essential to bolster confidence.

Looking Beyond the Property Pain

China’s property sales continued to tumble in 2023, marking a 54% contraction from the market peak in 2021. And industries related to the housing market account for about a third of GDP. That said, since we’re more than two years into the economy’s structural slowdown, the base effect of the sector on GDP growth will be milder in the quarters to come.

Consistent bad news from the property sector has overshadowed more resilient parts of the economy. In fact, since the economy has expanded at nearly 5% despite the housing sector’s woes, other industries are obviously growing at a much faster clip. Indeed, manufacturing and infrastructure have posted solid—if unspectacular—growth rates (Display). Industries fueled by domestic consumption, such as vehicle sales and retail sales, are also growing at a reasonable pace. 

Is Government Stimulus Coming?

For China’s economy to get back on track, stimulus is essential. The government and regulators have advanced various forms of stimulus to rebuild confidence and spur demand. Most importantly, the government announced plans in October to raise the fiscal deficit by 1 trillion renminbi, or 3.8% of GDP versus 3% of GDP, in the fourth quarter of 2023. 

This was a powerful message to skeptics who have questioned the government’s commitment to kick-starting the economy. Typically, the government has been reluctant to breach its traditional 3% deficit target. And because the government unveiled its intentions well ahead of the National People’s Congress (NPC) in March, we think it was signaling its commitment to step up support. That said, the devil will be in the details. Beyond the fiscal deficit, the NPC meeting could produce nonconventional stimulus measures; for example, to promote lending via state-owned policy banks, which could provide an important boost to economic activity.  

Fixed-Income Outlook: Support from a Relaxed Monetary Policy 

Monetary policy is expected to stay accommodative, which should support Chinese fixed-income assets. China’s monetary policy stance contrasts with much of the developed world, where central banks are keeping interest rates higher for longer than expected to tame inflation. In China, where annual consumer price inflation is running close to 0%, the central bank can afford to ease monetary policy. 

That’s good news for Chinese investment-grade corporate bonds, in our view. If the economy muddles through while interest rates remain relatively low, we expect yields on corporate bonds to stay low (Display) and credit spreads to tighten, as we’ve seen when similar conditions prevailed elsewhere. 

In these conditions, we see fixed-income opportunities in select onshore Chinese government bonds and high-grade credits as well as in offshore markets. Given much higher rates in the USD market, we expect Chinese companies to increasingly refinance in the domestic markets. This should ease supply concerns for offshore markets and allow yields to remain stable.

Equity Outlook: Seeking Value in an Earnings Recovery

Equity investors shouldn’t be deterred by the housing sector’s woes, in our view. As the housing crisis fades further in the rear-view mirror over the next year or two, we believe the quality of China’s economic growth will improve. Targeted economic reforms could help China derive more economic growth from innovation in consumption, services, technology and higher-value-add manufacturing.  

The long-term outlook for Chinese equities is promising, in our view. Chinese equity valuations are cheap compared with the last decade, and relative to the MSCI World Index of developed-market stocks (Display). 

It’s true that corporate earnings are currently depressed. But that also means there is real potential for an earnings rebound later in 2024, in our view. Earnings of Chinese onshore stocks are expected to grow by 16% this year, compared with 9% for global developed stocks, according to consensus estimates. A potential earnings recovery combined with today’s low valuations create attractive conditions for investors to initiate positions in Chinese equities. 

As we enter a new era of lower growth, we think a value-oriented approach can be rewarding for equity investors. That means targeting select companies with attractive valuations that are aligned with the government’s commercial and policy objectives; for example, in businesses focusing on technology security and domestic decarbonization. We also see opportunities in industrial cyclical firms, such as bus makers and forklift manufacturers with a strong international footprint. 

China is changing, and transition often creates uncertainty in financial markets. But dislocations can also create opportunity for investors who don’t succumb to negative short-term sentiment and take a longer view of China’s economic journey toward healthier and more sustainable growth.