By William H. Witherell
Russia’s war in Ukraine and Covid-related shutdowns in China have led to slower growth prospects and higher inflation for the global economy. What was expected to be a strong the recovery was transformed in the second quarter into a stagnant global economy. Worsening consumer and business sentiment, rising inflation and central banks moving to tighten monetary policy, with the US Federal Reserve the most aggressive, have increased the risk of a global recession. The Bank of England is already predicting a recession in the UK, and Germany’s GDP has likely dropped in the current quarter. However, a soft landing for the global economy may still be possible, depending on the strength of an early recovery of the Chinese economy along with other major Asian economies. Positive global growth is yet to return in the second half of this year, with real GDP growth for the year 2022 at 3% and at a similar rate next year. We wrote about the central role that China plays in the global economy. It has the second largest economy after the US and is the world’s leading exporter, with critical supply chain connections to most economies. Although much has been said about the “decoupling” of China, the reality is that the world economy remains strongly linked to the Chinese economy. When China imposed widespread lockdowns in April in pursuit of its zero Covid policy, its economy took a huge hit. Production in the industrial and service sectors turned negative in April; port activity was interrupted; and retail sales are down about 11%. In May, Covid restrictions were relaxed; supply interruptions have been reduced; and economic policy stimulus measures were increased, with promises of more to come. The Chinese economy responded more robustly than the market expected. Industrial production once again showed positive growth, with emphasis on the production of automobiles and electrical machines. Fixed asset investment rebounded, led by infrastructure investment. The decline in retail sales continued, but at a slower pace, beating market expectations. China’s Covid statistics have improved dramatically. The average number of seven-day daily cases has dropped to around 200, compared with around 30,000 in April. However, mass testing is being imposed in some areas; and there were some new and limited outages. The Chinese economy likely bottomed out in April. Economic momentum appears to be picking up in June as more of the economy gets back up and running, the Shanghai lockdown has been lifted and political stimulus measures are having a growing effect. Monetary and fiscal measures are being targeted to support small and medium enterprises, real estate, manufacturing and infrastructure finance. The “normalization” of oversight of tech companies, after a year of regulatory crackdown, and a direct pledge of support for the sector is good news for investors. Such measures to sustain domestic demand and improve export potential will be key to sustaining the recovery in the second half of the year and into 2023, when external demand may remain weak. The consequences of the Russia-Ukraine war will be a negative factor, causing a global shock of energy and food supplies. China’s economy is expected to reach an annual growth rate of around 4% this year. That would be just half the growth rate of last year, but still stronger than the growth of most other economies. Growth in 2023 could average more than 5%. Future Covid outbreaks will continue to be a risk to this outlook, although the government has modified its anti-Covid policies to be a little less disruptive. Economies in the Asia-Pacific region will benefit from a recovery in China. Particularly important will be the reduction of disruptions to Asian supply chains. China has already achieved substantial success in its efforts to reduce logistical obstacles and support foreign trade. Exports of Chinese goods in US dollars increased 16.9% year-on-year in May, up from just 3.9% in April. Supply lead times also improved in May. Stronger growth in China and fewer restrictions on activity should have a healthy effect on Chinese demand for exports from other Asia-Pacific economies. South Korea’s exports to China stabilized in May. The region will be affected by the Russia-Ukraine war primarily by the impact of the war on the region’s export markets, particularly those in Europe. However, growth rates in the region’s resilient economies are likely to remain among the strongest in the world, with this year’s growth rates for India, Indonesia, Malaysia, Singapore and the Philippines likely above 5%.
If our expectations of a sustained recovery of the Chinese economy are at the stage, China’s equities are likely to outperform. That has already been the case for the last three months to June 17, a dark time for global equity markets. During this period, the Shanghai market gained 2.0%, while the S&P 500 lost 17.7% and the STOXX Europe 300 lost 11.1%. At Cumberland Advisors, we currently have a positive but underweight position in Chinese equities in our international and global equity ETF portfolios. This position could change any day depending on developments.
Editor’s Note: The summary topics for this article were chosen by the editors of Seeking Alpha.