China's Yo-Yo Economy
The Chinese are said to have invented the yo-yo over 2,500 years ago and this year, China's economy and stock market seem to be imitating one. The plunge in economic activity during the COVID lockdowns that took place from March through May of this year (the first provincial lockdowns since Wuhan and Hubei in January 2020) resulted in the GDP of the world's second-largest economy falling by -2.6% in the second quarter. But a rebound began in June, according to government and private sector data. China's stocks have also acted like a yo-yo this year with a bear market rebounding into a bull market.
COVID lockdowns are still possible in the months ahead. Although they may not be as severe as in March and April, they may still act as a drag on growth. Meanwhile, fiscal and monetary stimulus could accelerate growth in the second half of the year. The continued back-and-forth of lockdown and rebound means China's economy—and stock market—could remain volatile.
A drop in GDP is a rare event in China. China hasn't reported negative GDP growth in over 30 years, except for one quarter during the 2020 pandemic, as you can see in the chart below. We wrote about China's sharp economic downturn in early May (Recession in China?) noting that "The world's second-largest economy and consumer market has likely slipped into a recession, at least by China's standards."
China reports rare negative GDP quarter
Source: Charles Schwab, China National Bureau of Statistics, Macrobond data as of 7/15/2022.
So far, China appears unlikely to see two quarters of back-to-back declines in GDP. The economy began to recover in May and June, mainly due to a sequential easing in COVID restrictions and more policy support amid the reopening of some large cities such as Shanghai. The easing of restrictions particularly benefitted industrial production; the manufacturing Purchasing Managers' Index (PMI) survey of business leaders jumped back above the 50 level in June, the strongest reading in over a year, as shown in the chart below. Specifically, growth in automobile production surged to +26.8% year-over-year in June from -4.8% in May as auto supply chains continued to improve after Shanghai's reopening.
China's manufacturing PMI has rebounded
Source: Charles Schwab, S&P Global, Bloomberg data as of 7/15/2022. A PMI reading above 50 represents economic expansion and a PMI reading below 50 represents economic contraction, and a reading at 50 indicates no change.
Outside of manufacturing, other signs of rebounding growth in June emerged:
- Retail sales growth jumped to a stronger-than-expected +3.1% year-over-year pace in June from -6.7% in May. COVID-sensitive catering sales growth improved to -4.0% from -21.1%.
- Business fixed asset investment growth increased to +5.9% year-over-year in June from +4.7% in May, thanks to more policy support.
- Unemployment rates declined modestly in June, suggesting labor market pressure has eased slightly.
- June borrowing, a sign of confidence and future growth, came in above expectations. The rapid credit growth in June likely reflected a combination of strong fiscal policy support (record-high single-month government bond issuance), further easing in credit supply (the People's Bank of China urged banks to accelerate loan extensions) and easing COVID restrictions lifting activity.
The economic yo-yo could continue. The worst of China's COVID lockdowns may be in the rear view as the government seeks to reduce the negative economic and social impact going forward. COVID rules were clarified to give local governments less ability to abuse them and quarantines were cut in half. Even still, zero-COVID policies could continue to constrict activity in 2022 should new COVID waves develop, and the government is likely to move cautiously ahead of President Xi's next term. At the same time, fiscal and monetary stimulus in China is likely to continue feeding growth in the second half of the year heading into the Party Congress.
China's COVID waves
Source: Charles Schwab, Bloomberg data as of 7/15/2022.
What may be the only bull market in the world right now is taking place in China. The MSCI China Index has risen over 20% from its low on March 15, even as other stock markets, including the S&P 500 Index, have continued to decline.
China's bull market over past four months: March 15 to July 15
Source: Charles Schwab, Bloomberg data as of 7/15/2022. Indexes are unmanaged, do not incur management fees, costs and expenses (or "transaction fees or other related expenses"), and cannot be invested in directly. Past performance is no guarantee of future results.
While the lockdowns of March through May weighed only modestly on the performance of China's stocks, additional lockdowns amidst a more rapidly slowing global economy and tightening monetary policy in western nations may have a greater impact in the future. While any easing of trade relations between China and western nations may aid China's stock market, tougher trade and capital policies being discussed in Washington and any breakdown of discussions over audit transparency of Chinese companies traded in the U.S. could hurt.
What happens in China doesn't stay in China, due to China's large economy and influence on global trade. That said, the disruptions to supply chains during the second quarter were smaller in size relative to 2021, as inventory levels for many goods have caught up and demand shifted toward services. If China comes to embrace living with COVID rather than continuing lockdowns, it could give a boost to confidence in continued global growth. In the meantime, China's economy and stock market may remain volatile.