Key takeaways

  • China’s economy is experiencing an uneven recovery after an extended weak period but continues to face fundamental challenges.

  • Consumer demand is lagging, and the property market is hurting.

  • Emerging market stocks made a solid recovery in the second quarter, despite these challenges.

China’s economic struggles since the outbreak of the COVID-19 pandemic in early 2020 changed the trajectory of what had been one of the world’s fastest growing economies. The country took drastic measures to tamp down the spread of COVID, including virtual shutdowns of whole cities, which took an economic toll. While China’s economy has mostly returned to normalcy, the recovery has been uneven.

In contrast to the U.S. economy, consumer spending in China languishes, as its government has not provided the kinds of stimulus that occurred in the U.S. following the COVID outbreak. “If you look at core demand from a consumer standpoint, it’s just not there,” says Eric Freedman, chief investment officer for U.S. Bank Wealth Management. “In addition, China’s property market is still upside down,” a consequence of significant overbuilding. Rising trade tensions with the U.S. present another challenge for China’s economy.

“Any investor who puts money to work in a broad, emerging market index likely owns a significant position in Chinese stocks.”

Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management

Despite current headwinds, China’s economy expanded at an annualized rate of 5.3% in 2024’s first quarter, slightly ahead of expectations.1 However, this represents a significant change for China’s economic trajectory compared to the first part of the 21st century. “China is gradually transitioning from its emerging market stage to a developed market stage, where growth will be slower than was the case in recent history,” says Haworth.

How do developments in China affect global markets today, and how should you assess investment opportunities based on China’s economic growth?

 

China’s economic challenges

Significant property sector challenges and export weakness are major contributors to China’s economic malaise. New home prices faced their steepest decline last year since early 2015.2 Property investment fell 10.1% on a year-over year basis from January to May 2024. Average new home prices have declined for 11 consecutive months.3 Exports, an important linchpin for China’s economic growth, fell 4.6% in 2023, the first annual decline in export activity since 2016.4 More encouraging data emerged in early 2024, with China’s exports growing 7.6% in the one year period ending in May 2024.5 Despite recent weakness, China remains the largest global exporter of manufactured goods.6 However, ongoing trade battles with the U.S. and other countries aren’t likely to help boost exports.

At the same time, slowing domestic demand remains a challenge. “One reason for concern about China’s property weakness is that consumers have limited savings, having spent it down during the pandemic, and much of their wealth tied up in housing, which has dropped in value. So they are not in a strong position,” says Haworth.

 

China’s economic reopening

China’s economic recovery was slow to emerge since it eliminated its zero COVID policy in late 2022. China’s growth of 5.2% in 2023 exceeded the previous year’s 3.0% but is still considered lagging by historical standards.7 The latest indicators, it appears China’s GDP may be on a slower growth trajectory than was the case for much of the last two decades. “Chinese consumers are still focused on rebuilding savings they spent down during COVID-related shutdowns. They are holding off on buying things like durable goods,” says Haworth.

Source: Historical GDP, World Bank national accounts data. 2024 and 2025 projections, International Monetary Fund. * Projected growth in 2024 and 2025.

Nevertheless, China’s status as the second largest economy in the world continues to position it as an important player on the global economic stage.8 With Chinese manufacturing back online, global supply chain issues have eased.

China’s economic transformation from an agrarian-based society to the more urbanized and industrialized China of today began in the late 1970s, and since then, rapid growth has been a staple of China’s economic story. Until the last decade, China’s economy often grew by more than 10% per year, resulting in an expansion of the country’s middle class.

“Two key factors at play are the fact that China now has a well-developed middle-class, and it also faces demographic issues,” according to Haworth. It has an aging population, causing some of its economic challenges. This includes fewer working-age people to support the needs of its elderly population, and ultimately, a potential decline in the country’s overall population, which could hamper future economic growth. For the first time in history, India in 2023 supplanted China as the world’s most populous nation.

 

Investment market impact

China’s stock market alone makes up one-quarter of the MSCI Emerging Markets Index. “Any investor who puts money to work in a broad, emerging market index likely owns a significant position in Chinese stocks,” says Haworth.

MSCI Emerging Markets Index Fact Sheet, June 30, 2024.

Investors with positions in overseas stocks may look for opportunities to put money to work in China, the world’s second-largest economy (behind the U.S.). China is still classified as an emerging market, but its equity values represent the largest among all emerging market countries.

 

Investing in international stocks

International stocks can contribute to a well-diversified portfolio. “There are reasons to include emerging market exposure in your asset mix,” says Haworth. “After all, despite trade tensions, we’re still a globalized economy.” Emerging market stocks struggled significantly in 2022 and lagged performance of developed global markets in 2022 and 2023. However, in 2024’s first half, emerging market stocks began to recover ground. The MSCI Emerging Markets Index gained 5.0% in the second quarter (outpacing the S&P 500 and the MSCI EAFE Index measuring developed market performance). From January through June, the MSCI Emerging Markets Index is up 7.49%.9

“A significant part of the emerging markets index is technology-oriented, and as was the case in the U.S., those stocks did particularly well, especially companies based in Taiwan and South Korea,” says Haworth. “The emerging markets index provides significant exposure to Chinese stocks since they make up about one-quarter of the MSCI Emerging Market Index. But it also provides exposure to other markets that help diversify investors away from potential risks arising from investing exclusively in Chinese markets.” Haworth notes that in recent times, a stronger dollar created headwinds for emerging market investors. When U.S. investors put money to work in overseas stocks, a stronger dollar detracts from net performance.

China’s equities market declined in three consecutive years between 2021 and 2023. “Earnings weakness and investor skepticism about future earnings have put pressure on Chinese stocks,” says Haworth. “For China’s stock market to stage a turnaround, investor confidence needs to stabilize.”

China’s stock market started 2024 in a positive direction, but currently stands relatively flat for the year. China’s economic trajectory may ultimately determine whether stocks can muster a sustained rally.

Represents price return on CSI 300 Index, which represents the 300 largest stocks on Shanghai’s stock exchange. No taxes or fees are assumed. *As of July 10, 2024.

Investment risks in China include concerns about accurate financial reporting. “We no longer get real data from China’s government about unemployment or income growth,” says Haworth. Other risks include ongoing tensions between the U.S. and China, and the Chinese government’s potential for direct intervention that can affect specific companies or industries.

Any changes to your investment strategy should be consistent with your goals, time horizon and risk appetite. Talk with your U.S. Bank wealth professional to review your current financial plan and determine whether there is an opportunity to incorporate emerging market stocks – with exposure to China – into your broader, well-diversified portfolio.

Note: The MSCI Emerging Markets Index captures large and mid-cap equity performance across twenty-four emerging market countries. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments.

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Disclosures

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  1. Soo, Zen, “China’s economy grew 5.3% in first quarter, beating expectations, though weak spots remain,” Associated Press, April 16, 2024.

  2. Gao, Liangping and Woo, Ryan, “China’s property market slide worsens despite government support,” Reuters.com, Jan. 16, 2024.

  3. Yao, Kevin, Zhang, Albee and Zhang, Ellen, “China’s factor output disappoints, property sector stuck in doldrums,” Reuters.com, June 17, 2024.

  4. Cheng, Evelyn, “China’s annual exports drop for the first time in seven years,” CNBC.com, Jan. 12, 2024.

  5. Cash, Joe, “China’s exports seen rising more quickly in June amid fresh tariff fears: Reuters poll,” Reuters.com, July 10, 2024.

  6. Coy, Peter, “The trade shift that the U.S. wants from China would also help its people,” New York Times, April 3, 2024.

  7. Cheng, Evelyn, “China’s misses fourth-quarter GDP estimates, resumes posting youth unemployment data,” CNBC.com, Jan. 16, 2024.

  8. World Bank, national accounts data, based on 2022 data.

  9. S&P Dow Jones Indices; MSCI Inc. Total return for MSCI Emerging Market Index for 2022 was -20.09%. Total returns for 2023 were 26.29% (S&P 500), 18.24% (MSCI EAFE), 9.83% (MSCI Emerging Markets Index). Total returns through June 30, 2024 were 15.29% (S&P 500), 5.34% (MSCI EAFE), and 7.49% (MSCI Emerging Markets Index).

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