Jennison Market Review & Outlook 2021
Jennison shares their views on the current economic environment and outlook for 1Q 2021.
China’s strong recovery from the Great Lockdown (to borrow the IMF’s phrase) is yet another turn in a year full of surprises. Moreover and in contrast to officials in other major economies, Chinese authorities have stressed the need to avoid large-scale stimulus. This has once again led some observers to marvel at China’s ability to outgrow its western peers in a presumably more sustainable fashion. We would argue that this view is quite mistaken as observed below.
China’s economic data have generally surprised to the upside since May, thus foreshadowing the upgrades currently underway for global and developed market economic projections. China’s economic recovery is also taking a much different shape based on the now-common letter and symbol taxonomy. China’s industrial production and exports have resembled “square root” and “swoosh” shapes, respectively, and have far outpaced those in the U.S. and euro area. On the other hand, China’s consumption—proxied by retail sales—severely lags the V-shaped recoveries in the U.S. and the EA (Figure 1).
Besides these glaring differences, these patterns also fly in the face of conventional wisdom. What about the fears of protectionism, the implementation of tariffs and technology restrictions, and the “rebalancing” of China’s growth model towards consumption?
China’s export strength reflects the overflow of developed-market demand stimulus. Stimulus measures outside of China focused on supporting incomes via generous transfers, thereby supporting demand while production remained locked down through much of the year. Therefore, China’s prioritization on production enabled it to meet the demand surge, and goods exports recovered to 2019 levels as a result.
Fulfilling demand stimulus in advanced countries allowed China to limit its monetary stimulus, which may already be reversing based on readings of money supply growth (Figure 2), central bank assets, and rising interest rates. In addition, while China’s fiscal deficit is very large, it has not expanded by much from 2019, thus preventing large-scale income support for consumers. As a result, the income shock to poorer households has not been offset by income adjustments, and this has become a key factor in the lagging consumption recovery.
This is not to say that China has eschewed stimulus completely. Indeed—and contrary to official pronouncements—the country has embarked on traditional investment-driven stimulus, which is again quite different to policies elsewhere, as public investment (mostly infrastructure and property) has staged a V-shaped recovery (Figure 2) while private-sector investment has been more depressed as has been the case in the rest of the world.
While China’s recovery is impressive, it is incomplete and likely unsustainable based on current trends. First, the recovery has re-invigorated patterns that had been thought to be remnants of the past, i.e., quickly rising trade surpluses and domestic leverage. Second, China faces tangible deflationary risks, and its balance of payments depicts some concerning trends.
Domestically, the surge in investment is once more highlighting the potential of excess capacity and renewed property bubbles. Moreover, the increase in investment has once again re-ignited debt growth, which has set a course to exceed 300% of GDP and has dashed de-leveraging hopes (Figure 3). Moreover, with monetary easing constrained and banks increasingly asked to assume non-profitable, quasi-fiscal tasks, strong demand for investment credit is once again fueling the shadow banking system. As a result, much of the perceived gains in economic rebalancing and financial de-risking/de-leveraging over the last eight years have been quickly lost.
The combination of tight monetary policy, investment-driven growth, and reliance on external demand are triggering disinflationary—if not outright deflationary—pressures (Figure 3). Low inflation has emerged as an additional threat to achieving high nominal economic growth, which heretofore has been a key factor underpinning Chinese debt sustainability.
Moreover, the trends over recent months threaten to unleash a new round of protectionism. China’s trade surpluses have surged, potentially raising the political stakes leading up to the U.S. elections. Moreover, China’s trade surplus with the euro area has exceeded its year-end 2019 level, which may also lead to some pushback given Europe’s dependency on exports (Figure 4).
Finally, the risks above may not have been lost on Chinese investors as the balance of payments experienced about $275 billion in capital outflows in Q2 and Q3 (Figure 4). The outflows are particularly surprising given the strong inflows from surging current account surpluses and the bond market ahead of index inclusions. The underlying nature of the outflows remains difficult to identify at this point. They could be benign, e.g., the PBoC rebuilding its forward book, or more concerning, e.g., corporations not repatriating export proceeds or households finding new ways to stash savings abroad. This is a topic for investors to closely follow.
Against this background, a few tentative conclusions can be drawn:
This material reflects the views of the author as of October 1, 2020 and is provided for informational or educational purposes only. Source of data (unless otherwise noted): PGIM Fixed Income.
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Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy. Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated, based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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1041077-00001-00 Ed: 10/2020
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