China’s highly anticipated economic rebound was expected to help offset weakness in the global economy. But the recovery has faced its own shortfalls. Haining Zha, Portfolio Manager at TD Asset Management, looks at China’s challenges and the state of global trade.
- Thanks for having me.
- So let's talk about this kind of rhetoric. This can be positive for trade relations. How should we read it?
- Right. It is no good to anyone, including the global economy and markets. But if you look at the exact wording using the announcement, actually, de-risk is a touch better than decoupling because they are still trying to put some guardrails around it and try to mitigate economic impact. So from that perspective, is actually a little bit positive compared to what we have seen so far.
- OK, so language becomes key here. It does seem that coming out of the G7, when we sort of seen this idea that there's a trend towards security ahead of economic growth. And I guess the most prominent way we've seen that is through this idea of onshoring or reshoring. What does that mean for China?
- Right. It is a long term concern, but in the short term, the impact might be less than what people is expected. For example, the offshoring, onshoring process is more complicated than what people usually think. Just take Apple, for example, it is trying to move more production to India, but it turned out the yield from their Indian factory is only 50%, which is not good for long term profitability.
And there is another Taiwan tech company, Wistron, which is also in Apple supply chain, they actually decided to pull completely out of India, citing concern on the tough operating environment and labor management issues. So you know, onshoring, or near shoring, or other type of adjustment in a supply chain, it is always a long and winding road. And some of those roads might even run into dead end. So the near-term impact might be smaller than what people expected.
- OK, that's interesting, want to keep an eye on, as well. Let's talk about China's economy. Of course, heading into this year, I think there are some pretty big hopes about the COVID restrictions coming down, there being a big bump there. It's been a bit uneven. What's happening?
- Right, so if you recall at the start of the year, after China has gone through extended period of lockdown and operating below trend growth, people have very high hopes that it's going to be a v-shaped recovery, just like we see we have seen in the US. But I think compared to the US, there are three main differences.
Number one, the US government has transferred a large sum of money to the household sector, which Chinese government didn't do. Second, the US monetary policy at one time was super easy, but the Chinese monetary policy has been broadly stable. And number three, the US real estate market has been booming because right now, it is still has a structural supply-side deficit, whereas in China, the real estate sector has run into some really strong headwind because the real estate developers there are trying to deleverage.
So because of all of these reasons, the recovery in consumption and economy, as a whole, has been tepid, or as you call it, a little bit uneven. So that unevenness is reflected on many fronts. For example, if you look at a service compared to goods, service are stronger.
And within service, the travel and restaurant related are stronger than the general business service or household service. And within goods, the high end product is stronger than the mid to low end. So there are a lot of unevenness within the economic recovery.
- How does that play out for corporate earnings, then? Some names benefiting and some others perhaps not, if we are talking about an uneven recovery?
- Right you can actually see that in the corporate earnings release. For example, let's take some of the bellwether companies. Take Alibaba, for example, the top line revenue is only growing at 2% year over year. And if you look at the core China e-commerce segment, the revenue actually is down 3% year over year. That is mainly online and offline retail.
So on that side, you can see the weakness within the economy. Another bellwether company, Tencent, their earnings report actually fare much better. The revenue is growing at 11% year over year and operating profit is growing 30% year over year. But that is because of idiosyncratic reason, not built on macro strength.
For example, their international gains revenue increased 25% year over year. And also, if you look at their online advertisement, it is increasing 17%, only because it is monetizing the mini program and the video accounts. So that's for idiosyncratic reasons. So if we look at some of the onshore a-share listed company, as a whole, in the first quarter, the overall revenue and the earning is growing at low single digit reflecting, again, the very weak recovery in the Chinese economy.
- It's interesting with the dropping of the COVID restrictions, the reopening of the economy, not only did people think it would be good for China's economy, thought it was going to be this big boon heading into this year for the global economy. You say the logic there is actually a bit backward. Explain that to me.
- Right, people are hoping that the Chinese reopening can kind of drive the global economic growth. I would agree with that if in the developed economy, you carry a positive growth momentum in the meantime, the China's economy is also gradually recover. Then that would be the case because these two dynamics can be mutually reinforcing.
But increasingly, we are looking at a scenario where the developed economy, their growth engine is actually going to lose steam because of tightening monetary policy. So under this scenario, expecting the Chinese economy to completely pick up where it's left off and to fill that gap--
- And the Chinese need someone to sell to at the same time, right?
- Right. It's not going to work. So if I can make analogy, the Chinese economy is like a patient coming out of ICU after the lockdown. So expecting the patient to carry the weight and move forward, to me, that sounds too optimistic.
- I have about a minute left with you, but I want to ask you about the employment situation. Obviously, for many economies, the healthy economy is reflected in the labor market. What does it look like?
- Right. Actually, one of the indicators that attract people's attention is the youth unemployment rate. The unemployment rate in China is not a good indicator of the overall economic direction for structural reasons because, in China, it is still going through urbanization process.
So when the labor market is good, those laborers moving from rural area, they will stay in the city and start working. But when the labor market condition is not good, they actually will reverse that flow, reducing the overall urban population to keep the unemployment rate stay unchanged. That's why if you look at the time series, it's basically fluctuating in a very tight range.
However, the youth unemployment rate is a much more sensitive indicator. And earlier this year, in the past few months, we have been noticing it's on the way up. And at this point, the last trend is above 20%. So typically, in a good labor, under good labor market condition, in a good year, that measure would roughly stay stable and only jump starting from June to August. But the steady increasing pattern is telling us that economy is still weak. And we need further labor market recovery.
- Always very interesting insights, Haining. Always a pleasure to have you on. Thanks for joining us.
- Thanks for having me.