The Urethane Blog

China Conundrum

No Surprises in China’s Slowdown

Q3 GDP growth was largely in line with long-running trends.

By Fisher Investments Editorial Staff, 10/18/2021 Share

Chinese GDP growth slowed to 4.9% y/y in Q3, with most pundits agreeing the problems at Evergrande and associated real estate woes, combined with September’s electricity shortage, took a big bite out of the economy. While we agree those issues did have some negative effects, most of today’s coverage overstated them and ignored a simple but important point: Q3’s growth rate is right in line with the long-running trend. In our view, that makes these results a return to pre-pandemic normal, not a sign of sudden big problems in the world’s second-largest economy—a fine backdrop for stocks.

Also lost in most coverage: Chinese GDP is so far on track to meet the government’s full-year target of at least 6%, as it is up 9.8% year to date from 2020’s first three quarters.[i] Obviously there is some COVID skew there, but according to China’s National Bureau of Statistics’ (NBS) press release, the compound growth rate over the past two years is 5.2%.[ii] That is very much in line with pre-pandemic growth rates. So is Q3’s 4.9% growth, as Exhibit 1 shows—it largely extends the decade-long slowdown from the double-digit growth rates of old.

Exhibit 1: Slowing Growth Is the Norm in China

Source: FactSet, as of 10/18/2021.

Much of the sour sentiment today stemmed not from the headline GDP figure, but from September data—specifically industrial production and real estate. The former slowed to 3.1% y/y, the lowest rate since last year’s lockdowns, which pundits interpreted as a sign that the energy crunch is taking a big toll on factories.[iii] Yet slow growth isn’t contraction. Take this with a grain of salt or two, as the accuracy of seasonal adjustments is an open question, but industrial production was about flat month-over-month (up 0.05%, according to the NBS).[iv] Even if reality was a bit worse than that, it doesn’t point to electricity shortages sucker punching heavy industry. Rather, it points to the sector overall doing what it could in the face of a stiff headwind.

Reading into any one month as a sign of things to come is generally an error, but we think that is especially true of September’s industrial production. The electricity crunch is a one-off negative, not a permanent state. Over the past several days, the government has taken a number of steps to ease the electricity shortage, including easing price controls and beefing up coal production. That suggests the power shortage should ease sooner rather than later, giving factories a shot in the arm.

In our view, reading too much into September’s real estate data is similarly shortsighted. Yes, home sales fell -16.9% y/y in the month.[v] But is that any wonder, what with uncertainty over Evergrande and other property developers weighing on sentiment? And with regulators directing banks to restrict credit for developers and home buyers? Those restrictions are already easing, which should help sales stabilize looking forward. Plus, even with the late-summer swoon, home sales are up a whopping 17.8% year to date through September versus 2020’s first 9 months.[vi] Meanwhile, residential real estate investment fell a much milder -1.6% y/y in the month and is up 10.9% year to date.[vii] Here too, we wouldn’t read into one month, but the sharp divide between September’s sales and investment activity shows Evergrande’s woes aren’t representative of the property sector as a whole. The central bank’s recent measures easing liquidity for property developers should further support stability.  

At a philosophical level, we think the heightened focus on heavy industry and real estate shows that the West broadly has an inaccurate view of China’s economy. Several outlets have claimed real estate is responsible for 29% of Chinese GDP, which they calculate by folding in furniture sales, construction and anything tangentially related to the sale of a home. In our view, all the assumptions folded into that figure are debatable, making it more accurate to look at pure real estate only. That figure—real estate, renting and leasing activities—was just north of 10% of GDP pre-pandemic, which is bigger than the US but not the driving economic force.[viii] Even if you fold construction into that—which includes a lot of things unrelated to residential and commercial real estate—you wind up at 17%, not nearly 30%.

Similarly, while manufacturing is more important economically in China than in more developed countries, it was still only about 39% of pre-pandemic GDP.[ix] Services, which gets far less attention, now generates the majority of Chinese GDP—53.1% pre-pandemic and in 2020.[x] China now has an official Index of Services Production, which grew 5.2% y/y in September and even accelerated from August.[xi] The Tech-heavy component of that index is up 19.3% year to date.[xii] The legacy areas of China’s economy may have hit a speed bump, but those more oriented to China’s future are doing quite well. Incidentally, they are also more insulated against the temporary electricity issues, as factories are much, much more energy-intensive than offices.

China’s economy isn’t in perfect shape, but last we checked, no economy in the history of the world was ever perfect. All economies have pockets of strength and weakness at any given time. China’s weaker pockets are getting all the attention right now, but the stronger areas are more than offsetting them and helping the world’s second-largest economy continue adding to global GDP. That is a just-fine economic environment for stocks globally, in our view.