I believe the near- to medium-term outlook for China is improving. As the impact of last year’s regulatory shocks (though not enforcement of said regulations) begins to fade this year, we are seeing some loosening of Chinese policy and signs of an economic bottoming that should be followed by a gradual rebound as 2022 progresses.
I expect the recovery to remain unbalanced, however, with the manufacturing and goods sectors continuing to outpace domestic private services consumption and with investment spending driving much of the economic activity. Meanwhile, the persistence and the unpredictability of the COVID-19 pandemic still pose a risk to the economy, particularly given China’s tough “zero tolerance for COVID” stance.
Whatever transpires later this year, though, I firmly believe China’s economy and its asset prices are not “broken,” but rather are becoming largely uncorrelated — even negatively correlated, in some instances — with other emerging markets (EMs) and the rest of the world (Figure 1). Case in point: As of this writing, Chinese equities were trading at or near historic discounts to many of their developed market cousins.
This trend of declining correlations has potentially important implications for investors in Chinese equities and other assets. I’ll explore that investment aspect in a future blog post, but for now, let me briefly explain what I think is behind the trend itself.