About the author: Shehzad H. Qazi is the managing director of China Beige Book. He tweets at @shehzadhqazi.
Monday was a brutal day for Chinese equities. What became the biggest selloff in the Hang Seng Index since the Great Financial Crisis quickly metastasized into a broader route. The Nasdaq Golden Dragon China Index saw $73 billion in market capitalization wiped out, with five of the largest US-listed Chinese American depository receipts losing over $52 billion in market value.
Ironically, the meltdown came as the Chinese government claimed that the economy was rebounding. Gross domestic product rose 3.9% in the third quarter compared to a year earlier, according to official data. Those growth figures look curiously upbeat, however. Numbers from my firm, China Beige Book, which gathers real-time economic data from thousands of companies in China every month, show a less sanguine picture than the official numbers. Our data showed the economy continued to struggle, slowing significantly from year-ago levels, and failed to see much improvement over a poor second quarter when many major cities were under lockdown.
Yet for markets, the third-quarter data seemed mostly an afterthought. More important was the message of the recently concluded 20th Party Congress. That twice-a-decade meeting officially confirmed Chinese President Xi Jinping’s third five-year term as the country’s leader and saw the rollout of a new leadership team at the top of the Chinese Communist Party. It also effectively dashed hopes of major changes in China’s political direction and drove panic selling.
This popping of the China bull-case bubble was roughly two years in the making. Since early 2021, many investment-bank research teams have built the case that China was on the cusp of pivoting back to a more growth-friendly and business-friendly environment. When it didn’t happen earlier, the narrative eventually gravitated to the idea that this transformation would happen around the Congress Party. Wall Street’s bullish positions on China were predicated on three major expectations: that zero-Covid policy would end this year, regulatory crackdowns would ease, and surprisingly absent policy stimulus would finally get implemented. Each of these has proven disastrously wrong.
The most disappointing of these misses may have been the bet that Xi Jinping would announce an end to China’s draconian zero-Covid policy at the Party Congress. Under zero-Covid, Chinese officials have shut down huge swaths of the economy, including the entire city of Shanghai, for months at a time, in an effort to stop the spread of the virus through mobility control. The misbegotten bull case assumed that an economic rebound would be Xi’s primary goal after securing a third term, presumably because that’s what foreign observers think should be the goal.
What it fundamentally missed, however, is that yardstick by which Xi measures success is public health. In other words, the containment of the virus is his primary concern and not the pace of China’s economic recovery. The fact remains that without a national inoculation campaign using mRNA vaccines the end of lockdowns likely remains dependent on the virus itself.
Moreover, all hopes for a pro-market turn at the Congress Party were dashed, due not just to the absence of any focus on those issues but also by the composition of the new leadership, which was stacked with Xi loyalists and acolytes. This bodes poorly for a near-turn move towards greater policy easing, and indeed, the data suggest such a pivot remains unlikely. Even in the run-up to this crucial political event, China Beige Book’s proprietary Monetary Stimulus Gauge fell to all-time lows in the third quarter, as fewer firms accessed credit through banks or the bond market. Official loan growth data is similarly mired at multi-year lows.
Wall Street forecasts have been wrong repeatedly the past few years because their research shops remain fundamentally unwilling to recognize the obvious: the Chinese economy of today no longer operates under the same principles as they had grown accustomed to.
Until China can reliably protect against large-scale outbreaks, zero-Covid will not entirely disappear. When Chinese authorities begin to meaningfully relax the curbs, it will show up in the economic data, with business activity rebounding alongside consumer spending. The relaxation will also provide the opportunity for actual policy stimulus. But this will be a gradual process, and not a point in time event.
Finally, and most importantly, however, China’s old economic model has run out of road, and the economy is inexorably headed towards much slower growth. The new bull case for China will be much more subdued than markets have been prepared for.
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