The second half of the summer has brought a slight decline in both equity and bond markets. Investors’ immediate attention is on third-quarter results from Canadian banks and takeaways from a major conference of global central bank leaders. We will unpack these developments and circle back with key insights in the weeks to come. Below, we focus on deepening concerns over China’s economic health.

China, as the world’s second largest economy and populace, has a significant impact on global growth. Earlier this year, there was optimism that China’s post-pandemic reopening would bolster global growth, especially when other economies were bracing for deceleration due to rising interest rates. The reality unfolded differently. The initial rebound in manufacturing, exports, industrial, and consumer activity began to fade after the first quarter of the year and since then has been uninspiring.

There are several longer-term issues facing China: demographics, geopolitical strains, policy uncertainty, and the retreat from globalization. In our view, however, these factors are not directly responsible for the present economic malaise. Instead, causation rests with cyclical factors such as weak consumer demand and an export market that is affected by the global demand shift from goods to services.

A primary concern in China is the deteriorating property sector. In 2020, the government clamped down on the sector to reign in over-leverage, over-building, and inflated home prices. Since then, the housing market has faced significant headwinds. Revenues from home sales and pre-sales, the largest source of funding for Chinese property developers, have been shrinking. This has translated into financing challenges for some of the sector’s largest players like Evergrande (which recently filed for bankruptcy protection) and Country Garden (which failed to make payments on some of its bonds earlier this month).

These stresses have created hesitancy among Chinese homebuyers, with some worried that pre-paid homes will fail to materialize and others anticipating that prices will continue to fall. This backdrop helps explain the more general reticence of Chinese consumers. The property sector makes up approximately two-thirds of their wealth and roughly a quarter of China’s annual economic output. The primary asset for many households and one of China’s most important economic engines are stagnating. Concurrently, signs of weakness beyond the housing market are dampening consumer confidence more broadly.

Revitalizing China's growth will hinge on skillful policy interventions and the evolution of trade dynamics. The Chinese government has rolled out a host of small and largely incremental measures, and we anticipate more policy relaxations in the upcoming months. Any future intervention may pale by comparison to the bolder action seen globally in recent years.

Despite prevailing pessimism, it is important to put things into context. Forecasts place China’s growth just below 5% this year – a rate that still outpaces most developed nations. China’s growth is poised to be the top contributor to global growth in the next decade. As China charts a new path towards sustainable growth, relying less heavily on infrastructure and housing, it will run into its fair share of both opportunities and challenges. It appears we are currently witnessing a period of challenge.

If you have any questions, please do not hesitate to contact us.

 

Drew M. Pallett LL.B. CFP

Senior Portfolio Manager and Investment Advisor 

RBC Dominion Securities         

Email: drew.pallett@rbc.com

Website: www.pallett.ca