The Japan-ification of China: What You Need to Know

Whenever someone mentions China, the first image that appears in my mind is skyscrapers going up in a matter of months. Then traffic for days and an economy growing like wildfire.

It’s no surprise given that China has been one of the fastest-expanding economies in the world. From 1989 to 2023, the country’s average annual gross domestic product (GDP) growth was 8.95%. By comparison, the United States - outside of the pandemic - hasn’t seen greater than 5% growth in over 20 years.

But China is facing a much different picture today. And the impacts could be felt in your portfolio…

Under Pressure

Investors were optimistic for China’s economic rebound from the Covid-19 pandemic.

They expected a strong bounce back to not only spur global growth but return the country’s economy to high single-digit expansion.

However, as the recovery stalled, investors changed their chant. They began to root for an even weaker economy that’d force policymakers to inject stimulus.

In the past, China’s large-scale credit infusions boosted growth at home as well as abroad. Going back to 2008, in the wake of the global financial crisis, China was not only the first to exit, but in 2010 saw 10.4% GDP growth.

However, today the Asian powerhouse’s economic woes are proving much worse than initially feared. And in the face of a property market downturn, weak consumer spending, a slowdown in manufacturing, and rising unemployment, China’s central bank was forced to unexpectedly reduce a key interest rate to spur activity.

These challenges place immense strain on China’s economy. Putting the country in a precarious position. But judging by the initial reaction to the rate cut, even the arrival of a stimulus package might not be enough.

The question remains then, what happens to China from here. And what does it mean for your portfolio?

What Lies Beneath

Over the past several weeks we’ve seen several data points coming out of Chinese that are very worrisome:

This prompted the country’s central bank to swiftly slash a key interest rate by the most since 2020. It needs to spur economic activity in the face of a potential complete collapse that’d threaten China’s position as one of the world’s strongest economies.

Under the surface, any single piece of data is devastating on its own. But combined, China is confronting a major turning point.

Youth employment is an extremely important economic indicator. And soaring jobless numbers among this demographic are a warning sign of an economy in decline as employers pull back on hiring.

It also demonstrates the lingering impact from the technology sector crackdown. This was once a lucrative industry for many young professionals. But now, China could see youth flee the country for better prospects. This obviously would be a brain drain on the country. But the impacts are much larger as an aging population is left without proper care and social security. Not to mention, stagnant population growth, a problem China faces as fertility rates dropped to a record low of 1.09 in 2022.

Though, the real estate crisis is the most pressing. the country’s largest private real estate developer suspended trading in some of its corporate bonds, which are already mired at distressed levels.

Chinese developers took on billions in debt over the last 20 years to fuel expansion as well as population growth. But the economic slowdown triggered by the pandemic has catalyzed the sector’s financial problems.

Put into perspective, “China has 7 billion square meters of “sold but not completed” real estatethat’s equivalent to over 100 Manhattans. A liquidity crisis would send shockwaves through the entire economy. And it’d be swift if buyers can’t afford their property.

While I do believe China will turn its economy around, the stimulus won’t likely have a substantial impact in the next several months.

What to Do Now

I’d be careful of companies with significant exposure to China. Not only for the fact that its economy is faltering, but with U.S. semiconductor restrictions heating up, its tech sector is facing headwinds.

But don’t fret…

You can access Shah Gilani’s free special report on what stocks he believes you should be selling right now in the wake of the US-China chip war.

Chinese tech giants are struggling. Alibaba (BABA), the country’s largest e-commerce company, is down over 70% from its peak in 2020. And Tencent (TCEHY) is in a similar boat, down 60%. Companies like these depend on mainland consumer spending. And if China’s economy buckles, revenue and profitability will tumble.

Until next time,

Alex Kagin