On a monthly basis Sasfin’s strategist identifies themes that we consider in our investment decision making process. China’s slowing economic growth amidst an energy crunch was a key theme that we considered this month.
Steel mills have faced power cuts. Computer chip shortages have slowed car production. Troubled property companies have purchased less construction material. Floods have disrupted business in north-central China. This confluence of factors has taken a toll on China’s economy, the main engine for global growth. China’s real GDP growth slowed to 4.9% YoY in Q3:2021 from 18.2% in Q1:2021. While base effects in 2020 played a role, the main culprit was a sharp slowdown industrial activity, diluting gains in exports and retail sales.
Industrial output suffered from electricity shortages have spread across eastern China in Q3:2021 and early Q4:2021, prompting regulators to cut power to energy-intensive operations like chemical factories and steel mills to avoid leaving households in the dark.
China was the first major country to recover from the global pandemic. As the world has progressively reopened and the pandemic restrictions reduced, demand for Chinese goods has surged and with it the demand for electrical power. Compounding matters is that the Chinese authorities are targeting the country to be carbon neutral by 2060 and regulations instituted have caused a slowdown in coal production. As electricity demand has risen, the supply/demand imbalance has driven up the price of coal. The government strictly controls electricity prices, so where coal-fired power plants are unwilling to operate at a loss, they are drastically reducing their output.
A further factor impacting growth is the fact that the Chinese government has begun an economic reshaping by unleashing a raft of measures to narrow China’s huge and growing wealth gap and regulate businesses in an initiative known as "common prosperity”. These latest measures have started with billionaire owners of China's biggest companies and will extend to customers and workers having more say in how firms operate and distribute their earnings. In August 2021, the Chinese government published its 10-point plan, which runs to the end of 2025, outlining tighter regulation of "important fields" such as security, monopolies, science and technological innovation, culture, and education. The regulations have had a short-term negative effect on the technology and real estate sectors.
Since the Covid-19 pandemic erupted in Wuhan in January 2020, China has fared much better than the rest of the world thereby gaining a major strategic advantage, while also benefiting the yuan and helping fuel foreign inflows into China’s bond market.
By contrast, in 2021 China has become a major source of international concern. It is now the second-most important “tail risk” in markets after inflation, according to the findings of the latest Bank of America fund manager survey published on 19 October 2021. These concerns have not translated into declines in asset prices. The MSCI World Index, a gauge of stocks in advanced economies, is currently trading close to a record high, the average spread on JPMorgan’s Corporate Emerging Market Bond Index (CEMBI) has risen less than 20 basis points in the past three months, while the VIX Index, Wall Street’s “fear gauge”, is only slightly above its historical low.
The failure to reckon with a much sharper than expected slowdown in China could result in a serious mispricing of risk at a time when global growth is slowing sharply, and central banks are preparing to tighten monetary policy.