Putting China’s ‘Acceleration’ in Proper Context

If ever you needed proof that economic data are backward-looking, China delivered it in spades today. The country’s official economic data for January and February, which the National Bureau of Statistics (NBS) combines to remove skew from the Lunar New Year holiday week’s shifting timing, accelerated and beat expectations across the board. Yet there wasn’t much cheer: Investors remained much more preoccupied with COVID’s resurgence in the country, which has caused stiff new lockdowns in Shenzhen—a high-tech manufacturing hub—and seemingly renewed negative sentiment toward Chinese stocks. Now, we don’t think this is likely to be a huge headwind for the Chinese or global economy over a meaningful stretch of time, but we do think it helps put the latest data in context.

In a vacuum, the January/February numbers were encouraging. Retail sales growth accelerated from 1.7% y/y in December 2021 to 6.7%, while industrial production sped from 4.3% y/y to 7.5%.^[i] Fixed investment, measured on a year-to-date, year-over-year basis, sped from December 2021’s 2.3% increase from 2020 to 12.2% versus 2021’s first two months.^[ii] The latter is probably easiest to interpret: As growth slowed last year, Chinese officials ramped up fiscal stimulus efforts. That infrastructure spending shows up rather quickly in fixed investment, which is a nice early boost, but it remains to be seen how much fruit this will bear in the real economy. That depends on how the new spending recirculates, which takes time.

As for industrial production, the acceleration from autumn’s figures likely stems partly from the easing of China’s electricity shortage. Back in October, when European wind and natural gas were in short supply, it triggered a run on energy inputs globally, which cut into China’s supply. The resulting brownouts hampered local factories. But those problems have largely evened out, thanks in part to Chinese coal companies’ swift response, which enabled factories to return to their normal production schedules as 2022 kicked off. The easing semiconductor shortage also helped factories that assemble final products. Additionally, the Omicron-related regional lockdown in Xian ended in January, enabling people there to get back to work. It is also noteworthy that the sharp acceleration occurred despite the factory closures associated with the Beijing Olympics.

But we don’t mean “great” noteworthy—we mean “raise an eyebrow” noteworthy. For if there was a sharp year-over-year acceleration despite forced factory outages, that is a sign there are probably some base effect issues at work—weak-ish data from a year ago creating an easier year-over-year benchmark. The fine number crunchers at the NBS have been quite clear about this since the pandemic started and have de-emphasized the year-over-year growth rates as a result. In the developed world, we would use seasonally adjusted month-over-month data to avoid year-over-year base effects, but China’s seasonal adjustment methodology is still in its early days, and month-over-month data there aren’t headline statistics. So, the NBS has started highlighting two-year growth rates instead. Last year, they compared results to 2019 in order to strip out the huge swings associated with the early-2020 lockdown. Now, they are encouraging users to compare the current year-over-year growth rates with last year’s two-year growth rates—a novel but sensible approach, in our view. As their press release notes, the January/February growth rate is 1.4 percentage points faster than 2021’s average monthly two-year growth rate. So, an improvement—but not as much of an improvement as the sharp acceleration from December suggests.

Retail sales tell a similar story. One, there is a bit of an easy comparison as there were December 2021 lockdowns near Beijing. Two, there was probably a small boost from the Olympics. Three, easing regional lockdowns probably unleashed some pent-up demand. So yes, there probably was an organic recovery, but that alone probably doesn’t explain the sharp acceleration from December. The 2.8 percentage point acceleration from 2021’s average monthly two-year growth rate is probably a more meaningful comparison.^[iii] The annualized growth rate from January/February 2019 to 2022 is just 4.1%, which is rather pedestrian by China’s standards.^[iv] Don’t get us wrong, the latest data are a welcome sign of stabilization after a weak Q4 2021 for China’s big retail sector. But don’t overstate it, and understand that whether it has staying power or is a temporary boost from the rapid containment of the December/January COVID wave remains to be seen.

Either way, locking down Shenzhen will probably hit March data, but the extent of the damage is unknowable right now. The lockdowns in place right now are scheduled to end on March 18, and, economically, the best-case scenario is if they were to indeed last just one week. But given the rest of the world’s experience with Omicron and China’s zero-tolerance approach, a week may be rather optimistic. The Xian lockdown lasted over a month, consistent with the prior regional restrictions. We suspect the incentive to keep Shenzhen’s lockdown short is quite strong, given the city’s economic importance, but there are some competing goals here. Which will the government prioritize as Xi Jinping tries to nail down an unprecedented third term as president? Economic growth or the perception of COVID containment? Unclear.

Zoom out, however, and we doubt it makes a huge difference—for China or the world. Whether the latest shutdowns last a week, a month or a tad longer, it is unlikely to have much impact on total output and earnings over the next year, two or three. Chinese households and businesses have become increasingly adept at navigating these targeted shutdowns. Large manufacturers say they have shifted production within China to help cushion the blow.^[v] Additionally, the last two years show fast catch-up growth usually follows shutdowns, which should help iron out supply chain-related issues. In our view, nothing here seems hugely worse or longer-lasting than the logistical issues the entire world has dealt with over the last year or so.

When sentiment is stocks’ main mover, then yes, short-term developments can influence returns greatly. But over longer periods, stocks weigh fundamentals—usually over the next 3 – 30 months or so. In our view, the likelihood that COVID setbacks today meaningfully impact activity over that entire period seems low. When nerves are frayed, every piece of bad news can hit returns, but those who can stay disciplined, strip out emotion and focus on fundamentals usually have a leg up.