Turbulent first half likely to test China investors’ patience

The first alarming story came in February, when China’s foreign exchange reserves fell below $3trn (£2.4trn). The second scare is likely to be president Donald Trump designating China as a currency manipulator, while the third unnerving story could see him raising tariffs on a few categories of Chinese goods.

The fourth scary story will come in the spring, when new home sales are expected to decline year on year.

However, by the summer most investors will realise that China will still have more than enough reserves; that Mr Trump’s steps will have little concrete impact on the Chinese economy; and that even if new home sales fall 10 per cent, that would make 2017 the second-best year in the brief history of China’s commercial housing market, with sales of more than 11m homes.

In addition, sentiment should improve by the summer as it becomes clear that China’s transition from a high-speed, heavy industry-based economy to a moderately fast consumer and services-based economy is well under way. 

The challenges of completing this transition will result in gradually slower growth rates and increased volatility, but the risks of a hard landing are very low.

Let’s remember the base effect. The size of the incremental expansion of the Chinese economy last year, when growth was 6.7 per cent, was roughly the same as the addition to the economy five years earlier, when GDP growth was 9.5 per cent – at constant 2010 prices in local currency terms.

In other words, the opportunity for selling goods and services to the Chinese at the slower growth rate last year was just as big as the opportunity five years earlier at the much faster GDP growth rate.

For a little excitement we can turn to the weakest parts of the economy, the sectors connected to heavy industry and construction.

The growth rates of coal, cement and steel production have been anaemic over the past few years. But, over the past four years, average annual growth rates of more than 35 per cent for sales of online goods and sports utility vehicles – as well as more than 50 per cent growth in express package deliveries and Chinese tourist arrivals in Japan – demonstrate the strength of the largest part of the economy: services and consumption.

The Chinese consumer story remained very healthy in 2016, delivering 9.6 per cent real (inflation-adjusted) retail sales growth, a bit slower than the 10.6 per cent pace in 2015, but in contrast to 1.7 per cent growth in the US during the first 11 months of 2016.

Consumption contributed 64.6 per cent of China’s GDP growth, up from a 42 per cent share in 2006. Real income in urban China rose 5.6 per cent year-over-year, compared with 6.6 per cent in 2015.

Expectations for 2017 are also generally positive: rebalancing will continue, and although the growth rates of retail sales and income are likely to continue their gradual deceleration, China will remain the world’s best consumer story.

A new study by Oxford Economics forecasts that the number of Chinese middle-class consumers will exceed the entire population of the US by 2026. 

China is likely to once again account for about one-third of global economic growth, a higher share than from the US, Europe and Japan combined.

Investors, however, will have to be patient during a turbulent first half of the year.

Andy Rothman is investment strategist at Matthews Asia