China stock rally highlights health of consumer rebound

China’s powerful stock rally has a remarkably important driver of momentum behind it: the nation’s 1.4 billion consumers.

After a lackluster start, households are finally getting on board the post-Covid-19 reopening trade – and doing so en masse.

In March alone, retail sales jumped 10.6% year on year. According to the National Bureau of Statistics, Chinese consumers bought goods and services to the tune of US$1.67 trillion in the first quarter overall. That’s more than the annual gross domestic product of Canada.

The even better news, arguably, is the broad range of sectors into which Chinese are pouring cash. One is the nation’s previously empty shopping malls, to which people are flocking in droves. Along with gorging on apparel, they are spending big in the wellness sphere – on exercise equipment, sports-club memberships and spa-related activities.

Leisure travel is experiencing a sudden boom, a real shot in arm for hospitality businesses around Asia’s biggest economy. Dining and entertainment are exploding, too, as Covid curbs disappear.

The movie-complex industry is a case in point. During a recent seven-day holiday, ticket sales were 15% over 2019 levels – more than $990 million worth.

Big-ticket-item purchases are moving in the right direction, though not as robustly as President Xi Jinping may have hoped. As economist Shehzad Qazi at consultancy China Beige Book notes, auto sales aren’t thriving as energetically as expected.

Apartment sales jumped 3.5% in January-February. Though hardly enough to make up for the 22% plunge in the corresponding two months in 2022, it’s a sign the Covid-reopening trade is gaining momentum.

Global investors taking notice

“Chinese equity markets are on the rise again after a volatile start to the year,” says economist Thomas Gatley at Gavekal Research. “The gains are supported by strong economic momentum in the form of accelerating credit, as well as improving household confidence and appetite for risk assets.”

The credit expansion to which Gatley refers is compliments of the People’s Bank of China. Last month, PBOC governor Yi Gang surprised markets with a 25-basis-point cut in the reserve requirement ratios for all banks. At the time, Yi’s team characterized the move as part of efforts to “make a good combination of macro policies, improve the level of services for the real economy, and keep liquidity reasonably sufficient in the banking system.”

To economist Carlos Casanova at Union Bancaire Privée, the signal to corporate China is that the central bank is keen to support growth, but loath to create new asset bubbles. “Although the pace of liquidity expansion slowed marginally, this remains very elevated and significantly above the government’s target of broadly in line with nominal GDP growth.” But not elevated enough, he adds, to fuel fresh overheating risks.

That support is being augmented by rebounding exports, which jumped nearly 15% year on year in March to help China achieve a 4.5% growth rate.

“Economic recovery is well on track,” says economist Zhang Zhiwei at Pinpoint Asset Management. “The bright spot is consumption, which is strengthening as household confidence improves and strong export growth in March.”

These dynamics are validating the rationale for this year’s 10% rally in Chinese shares.

Strategist David Wong at AllianceBernstein speaks for many when he says mainland “valuations still attractive” with additional “economic and earnings momentum still to come.” William Yuen, investment director at Invesco, argues that “definitely the reopening trade is not over” as data suggest “things are improving” on a month-on-month and year-on-year basis.

Of course, global headwinds could intervene. As strategist Matt King at Citigroup puts it, central banks around the world are withdrawing as much as $800 billion of stimulus to tame inflation risks. That could be a huge problem, considering that global equities have been buoyed by more than $1 trillion of central-bank liquidity.

That tsunami of money, King says, has “held down real yields, propped up equity multiples, and tightened credit spreads in the face of falling earnings expectations.”

On similar grounds, Nick Ferres, chief investment officer for hedge fund Vantage Point Asset Management, worries that the “market breadth supporting the rally has been extremely poor. Equity investors appear to want all the benefits of rate cuts without enduring the pain that would warrant them.”

With China, says Gatley at Gavekal, the MSCI China index soared 17% in January alone as foreign investors bought into the crowded reopening trade, before giving up all those gains in February as disillusionment set in and onshore investors proved reluctant to join the party.

Gatley says “the rally since mid-March, however, looks to be of a different stripe: gains in Chinese equities are now supported by strong economic momentum in the form of accelerating credit, as well as improving household confidence and appetite for risk assets.”

For now, Gatley adds, “Chinese households are not yet diving fully into the equity market, but they are definitely testing the waters and getting more comfortable. This combination of accelerating credit flows, improving macro household and consumer data, and much improved market sentiment indicators is a potent mix that should continue to drive Chinese equities higher.”

But data for March, he explains, showed that those positive expectations are “not unfounded.” The urban unemployment rate, for example, fell to 5.3% in March. “That’s evidence the huge disruptions to service-sector businesses from Covid lockdowns and restrictions are starting to heal and the job market is tightening again,” Gatley says.

The underlying economy is also giving investors greater confidence. “In short, with this GDP report, we believe there is no immediate need for the government to put massive stimulus into the economy,” says economist Iris Pang at ING Bank.

Challenges remain

More remains to be done, though, to ensure Beijing policymaking keeps up with investors’ bullishness. For Xi’s new premier, Li Qiang, that means stepping up efforts to make more economic space for the private sector to thrive, create new jobs and increase national productivity.

The recent move to break up Alibaba Group into six units – and founder Jack Ma’s return to China – is a vital step in that direction. And to reassure global investors that the regulatory crackdown on Big Tech is finished.

As analyst Kelvin Ho at Fitch Ratings notes, “value enhancement could come from individual businesses gaining greater focus, autonomy and accountability. Alibaba may also be able to unlock value via spin-offs or IPOs. This could boost Alibaba’s credit strength if capital is freed up from businesses that generate little cash and deployed in stronger cash-generating businesses, or used to pay down debt.”

It follows that Alibaba’s restructuring plan could become a model for other Internet giants in harm’s way, including Baidu, ByteDance, Didi, Tencent and others.

Li’s reform team also needs to make progress creating a bigger and more comprehensive network of social safety nets. That’s the clearest route toward getting Chinese households to spend more and save less.

Economist Nicholas Lardy at the Peterson Institute for International Economics notes that a “transition back towards a consumption-led growth model will require expanding household disposable income and further strengthening of the social safety net.”

To this end, he says, “ending zero-Covid lockdowns, which drove millions of workers out of the labor force, will boost incomes. Social programs still cover too few people with only modest benefits and should be expanded.”

Lardy adds that “China needs to spend more on its people if it wants its people to spend more. But none of these changes can be accomplished in the near term.”

The pressure is on Li’s team to put some big reform wins on the scoreboard, and the sooner the better. For now, though, the health of the economic recovery is signaling to investors that their exuberance on China isn’t irrational.