China's Slowdown: How Concerned Should U.S. Investors Be?

A man looks at stock quotes in Beijing
Credit: Jason Lee / Reuters

China’s much-anticipated post-COVID boom proved fleeting, leaving policymakers and economists wondering what to make of the second-largest economy in the world. Strong first-quarter growth driven by pent-up demand stalled out in the second quarter. Lukewarm demand – domestically and globally – along with high unemployment and a souring real estate market led China to implement some surprising, albeit modest, rate cuts, defying the broader global trend of “higher for longer.” While much of the world remains focused on tamping down inflation, China must worry about deflation. The disappointment of China’s fading recovery has led to increasing investor concern about China’s broader impact globally.

The interest rate cuts indicate that China’s government is focused on supporting economic growth, a positive signal that potentially foreshadows further policy moves to shore up the economy. But even if China's policies successfully reignite growth, the weakening demand points to a mixed picture in the global economy, where higher interest rates have lowered economic activity in the fight against inflation.

For investors, China’s economic slowdown should highlight that the global risks that have existed post-COVID are not fully resolved. Some investors see these risks as a reason to buckle down and get defensive, while others believe we are at the end of a difficult inflationary cycle, with plenty of runway ahead for growth assets. While China’s slowing growth may have some impact on developed markets, the economic risks in the U.S. and Europe will have much more influence on global markets.

Global inflation: Still a greater risk than China deflation

In many parts of the world, including Europe and the U.S., inflation has come down off its peak, but it continues to run higher than the preferred 2% target of policymakers. From a historical perspective, another potential uptick or surge in inflation remains a higher possibility than policymakers seem willing to admit. In Europe, the likelihood of another interest rate hike ramped up as August’s preliminary inflation rate came in at a concerning 5.3%.

U.S. inflation seems, on the surface, to be on a better path toward resolution, but as inflation woes stretch into their third year, it is not clear at all when inflation will return to 2%, or if further interest rate hikes will be needed to finally accomplish the mission. Purchasing power is still being eroded at a damaging rate, while higher interest rates continue to weigh on growth. The U.S. economy may land softly, but it still has a long way to descend.

China’s short-term risks are priced in

While inflationary headwinds will have more of an impact on investors than any potential slowdown in exports to China, U.S. companies that export to China have cited the slowdown in adjusting their earnings guidance. Chinese equities, after a post-COVID lockdown rally, lagged other markets in the first half of 2023. Markets have priced in the deceleration in growth, reflecting the lower valuations for equities in China and those with China exposure. Additionally, U.S.-China relations have recently shown signs of warming after contentious period.

Because of its government’s economic growth support, China remains positioned to benefit from long-term structural trends. Household savings are high, which should lift future consumption. The travel sector in particular has steadily improved as middle-class households look to spend savings on experiences. Meanwhile, the government’s investments in technology and green energy reflect policies that prioritize high-quality, long-term growth.

China’s influence on emerging markets

While China’s slowdown will have a relatively benign and transient impact on the U.S. and other developed market economies, China’s woes have had a material impact on emerging markets. The slowdown created a drag on South Korea’s currency and equities in August. China is also a significant demand driver for commodities from emerging markets – the challenges in the real estate sector has led to a material decline in demand for building materials. As a result, Brazilian equities have fallen.

However, there are plenty of bright spots for investors in emerging markets. India has been unaffected by China’s slowdown, perhaps even benefiting from a rotation of foreign investment from China to India. Mexico has also enjoyed a change in investor preferences, as the pandemic-related supply chain interruptions and nearshoring trend has attracted investment in the country’s manufacturing sector. In Asia, weakness in demand for semiconductors is likely to abate soon, in part due to the rising use of artificial intelligence – which will drive growth in China, Taiwan, and South Korea.

As always, investors must fight the temptation to act on short-term fears and headlines. U.S. investors should understand domestic bias and the risk of allocating too much of their portfolio to domestic equities, especially when headlines about foreign slowdowns dominate economic news. While China’s current woes are real and won’t resolve overnight, the U.S.'s own economic challenges will also persist for some time. This is why having a long-term perspective remains paramount to rational investing.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Kavan Choksi

Kavan Choksi is a successful investor, business management consultant and wealth advisor. He works strategically with companies across fast-moving consumer goods, retail and luxury markets — he leverages his vast experience to help clients turn around and revitalize their businesses. With his expertise in economics and finance, Kavan has developed a passion for investing over the years and enjoys helping others do more with their money.

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