To understand how the world economy is doing, look at the engine: China
How is China's economy doing? The analysis by Sander Bus and Victor Verberk, co-heads of Robeco's credit team
Policy change in China will impact the rest of the world and the credit markets. We believe that the attitude of humility in making economic forecasts is yet to be maintained, given the degree of distortion and unpredictability created by the reopening.
Apart from the difficulties inherent in making forecasts on the current context, the question is also whether such forecasts are relevant. Do fundamentals still matter in a world of financial repression, where monetary and fiscal policymakers exert overwhelming influence?
Markets seem to have undermined the role of fundamentals for years; one scenario in which the relationship between fundamentals and markets could recur is one in which central banks loosen their grip on the economy. The main question for the markets is when this scenario will come true. With spreads still close to historic lows, it seems reasonable to us to maintain a cautious positioning in the credit markets. At the margin, we prefer financial institution stocks to other fixed income segments.
We believe the entire market is so focused on inflation expectations that it runs the risk of overlooking other potentially more important drivers. Over the past 15 years , China has been the main engine of world growth . As the country appears to be at a turning point, it seems more important than ever to monitor developments within it closely.
The strategy that aims to eliminate the infections from Covid in 2020 has been successful, but now it seems more like a double-edged sword. The virus will continue to recur, and every time this happens the harsh containment measures will affect mobility and consumption.
However, given that the services sector is more sensitive to lockdown measures than the manufacturing sector, a Chinese slowdown induced purely by Covid would not weigh on the economy too severely: China's service sector is largely oriented towards the domestic market and its products are not internationally marketable. However, excessively prolonged application of this policy will not benefit an economy that is already facing the impact of tightening real estate regulation.
It is clear that the real estate market is characterized by a certain effervescence and therefore, given the widespread moral hazard, more stringent rules would be necessary. At present, the uncertainty for the market relates to the possibility of excessive tightening of regulation and the future fallout of a restructuring of Evergrande.
The latest problem in China is the redefinition of economic policies, as the Chinese leadership wants to move from absolute growth to balancing growth with sustainability and social equality. This policy, called "common prosperity", will be implemented gradually. Some sectors will be severely restricted, but this will not mean the end of private markets in China, as they are too important to the economy.
However, the change will have significant repercussions on some sectors such as big tech, video games and education.
It remains to be seen what the implications of this new policy will be for China's role as a global manufacturing hub if it succeeds in the political goal of further raising lower wages and increasing the share of labor in national income. We note that this phenomenon can contribute to Sustainable Development Goals (SDGs) 1, 2, 8 and above all 10. As managers of sustainable investments, we welcome the official ambition to pursue carbon neutrality by 2060.
In any case, the fight against climate change has quickly become an important topic in the capital markets. According to the International Energy Agency, zeroing out net emissions will require investments of approximately $ 5 trillion per year. Some economists believe these large investments would provide a way out of secular stagnation, boosting growth and inflation.
Furthermore, at the micro level, we see that climate policies play an increasingly important role in business strategies. In addition to the potential slowdown in China, there are many other sources of uncertainty globally. First of all, we have not yet fully recovered from the Covid-19 pandemic. The immediate crisis caused by Covid seems to have passed, but the virus could still affect the recovery, perhaps through further interruptions in the production chains.
Inflation has recently caught the attention of the markets and the debate on the matter will not be resolved in the coming months. This could cause some volatility given the obvious two-way risks. A key metric to look out for is wage inflation, which could give an indication of the persistence of headline inflation and tense conditions in labor markets. This applies to both Europe and the United States. Any indications of more structural wage inflation would send the Fed and the ECB the important signal that the time has come to accelerate their monetary tightening plans.
Closely linked to the debate on inflation are the constraints of the production chains that afflict many sectors. The limitations initially affected semiconductors for the automotive industry, but now there are shortages of many other inputs, such as containers, services related to haulers, electricity and even raw materials for mattresses. Each of these has its own explanation, but the underlying problem is that supply falls short of demand. Most companies are able to pass these higher costs on to customers, as demand is generally robust.
Spread markets fluctuated in a very narrow range during the third quarter. The exception is the Chinese high yield segment, where yield spreads have widened considerably in the wake of Evergrande problems and signs of weakness in the Chinese economy. While it goes without saying that the introduction of an underweight to beta was a premature move, we are confident in this position.
In light of current spread levels, the cost of maintaining a modest underweight to beta is low. The search for yield has resulted in extremely compressed markets, where even the bonds of troubled companies have performed well.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/per-capire-come-va-economia-mondiale-si-guardi-cina/ on Sun, 17 Oct 2021 06:02:33 +0000.