Why the World’s Second-Largest Economy has Room to Run

You may have noticed that Chinese stocks have experienced a bumpy ride over the last couple of months. At the heart of the turbulence: concerns about whether the government can successfully engineer a soft landing for the world’s second-largest economy, with a market capitalization that accounts for around 20% of broad emerging markets.*  Ultimately, we think there are more positives than negatives here.

The Story

The HSBC flash PMI figure – a key economic indicator that measures private sector performance data across manufacturing, construction, retail and service sectors — released in late November disappointed the markets, and last week’s official PMI reading of 50.2 confirmed a still expanding, but softening economy. (The PMI, or Purchasing Managers Index, measures manufacturing activity and is a widely watched economic growth indicator; anything over 50 points to expansion, anything under 50 to contraction.) Property prices also declined this fall, albeit at a slower pace than they had been. Finally, the highly anticipated launch in mid-November of Shanghai-Hong Kong Stock Connect, linking the two stock markets, was underwhelming (although adoption is likely to grow over time).

Policymakers Act

In response, policymakers took bold steps to bolster China’s GDP, using a range of levers. Last month, the People’s Bank of China cut interest rates for the first time in two years and only the third time since 2001. Combined with a $113 billion commitment to infrastructure and a reduction in reserve ratio for banks lending to small business, these measures should help support both the economy and China-related assets.

After shedding over 3% in the wake of the mediocre data, the MSCI China Index rose sharply for the remainder of November to finish the month up 1.57%. This positive performance helped offset weakness in other emerging market countries, as Brazil sold-off following its election and Russia slumped amid declining oil prices. The MSCI Emerging Market IMI Index slid -1.12% in November.