China Used to Be the World’s Best Growth Story. Now It’s a Value Play.

The diminished expectations come after a year of disappointment. The sharp economic rebound predicted after Beijing lifted pandemic restrictions in late 2022 has underwhelmed. China’s multiyear crackdown on the private sector, targeting some of the country’s biggest success stories, like
Alibaba Group Holding
and
Tencent Holdings,
left behind scarred business owners skittish about investing or hiring.  

And the Chinese property market, which accounts for a fifth of economic activity and is the biggest store of household wealth, is entering its fourth year of a painful contraction that has left households in some cities with as much as 30% declines in their property prices. On top of that, millions of Chinese consumers are paying mortgages on prepaid homes yet to be completed, according to Autonomous Research senior analyst Charlene Chu.

 “A malaise has set in,” says Rick Waters, a former U.S. State Department veteran who now heads the China practice at risk consultancy Eurasia Group. “There is a fundamental reset of expectations of the future—and about whether people’s children will be better off.” 

Beijing’s reluctance to go big with fiscal stimulus, as it did in past downturns, has frustrated investors. But policymakers are hamstrung by growing debt levels and a shrinking and aging population, even as foreign companies look to reduce their reliance on China.

Rapid growth is no longer the only priority for Beijing. Policymakers are pivoting toward accepting “good enough” growth, while also prioritizing security and “common prosperity”—a push to deal with some of the inequalities that have emerged in recent decades.   

That marked change is just beginning to sink in, as multinationals realize that China won’t be the same monster buyer of everything from commodities to luxury goods that it was prepandemic, says Christine Phillpotts, a manager for Ariel Investments’ emerging markets value strategy.

Chinese consumer confidence sits at multidecade lows. Foreign direct investment into China turned negative last year for the first time in decades, and China’s stock market has lost $6 trillion in market value as investors sour on China’s outlook and worry about signs that President Xi Jinping is tightening his grip on the economy.

The pain is showing up in global companies’ quarterly results. In December,
Nike
cut its sales outlook for the year and introduced a $2 billion cost-cutting initiative, citing cautious consumers and increased economic challenges in China. That followed similar warnings from
Estée Lauder
and
Canada Goose Holdings
the month before.

To be sure, China’s economy isn’t imploding—and the world isn’t ditching China. That would be hard to do, considering China is the world’s largest auto exporter, mines 90% of critical minerals, and is the main trading partner for 120 countries. It’s also home to a still-expanding middle class and is a geopolitical force, having invested $60 billion to increase ties globally through its Belt and Road initiative.

China’s economy grew 5.2% last year, up from 3% the previous year. The country’s structural challenges mean that improvement could be fleeting. In the absence of Beijing changing its approach to stimulus, Capital Economics forecasts growth this year closer to 4.5%, roughly half of China’s longer-term trend in the preceding decades.

Part of China’s troubles stem from the very sources that fueled its rapid growth over the past decades. After the 2008-09 global financial crisis, China’s economy roared back as authorities unleashed massive spending for an infrastructure and property building boom. Local governments were the conduit for much of the spending, writing checks and financing the debt with robust income from land sales. 

China’s voracious appetite for commodities like iron ore and oil enriched producers. The strong economic growth created millions of middle-class Chinese, who began spending on an array of new services, from foreign travel to insurance and property management services.

This engine of growth has been in reverse in recent years as authorities popped the property bubble amid concerns about the pileup of debt, housing affordability, and wider income disparities.

The reversal has decimated property developers, leaving a trail of unfinished properties and 60 developers, representing a fifth of the group’s liabilities, in default. A Hong Kong court recently forced China Evergrande Group—one of the most indebted developers, with $300 billion in liabilities—into liquidation.

Beijing isn’t sitting on its hands. But the measures so far, such as vouchers to some home buyers in select cities, cutting mortgage rates, and easing financing for state-owned developers to finish the backlog of uncompleted projects, haven’t been enough to spur demand broadly. 

The ramifications of this property revamp will reverberate for years. New housing starts have fallen back to levels last seen in 2009, with the value of total new starts down 60% from the peak in March 2021. That in itself creates a three-trillion-yuan ($417.3 billion) hole in annual fixed-asset investments, according to Chu. And the hit to local governments as land sales dried up constrains their spending—another CNY3 trillion to CNY4 trillion hit to investment spending, Chu says.

Authorities are trying to fill the gap, with the “Three Major Projects” initiative focused on building affordable housing and renovating urban villages. China has also been pumping money into the economy, extending new credit to the tune of almost a third of gross domestic product—much of it to state-owned enterprises. That’s helping the economy stay afloat and stave off a financial crisis, but isn’t sustainable and adds to concerns about asset quality in the future and ultimately limits China’s financial flexibility, Chu says.

Even more worrisome is the toll on the Chinese psyche and consumers’ willingness to spend as they face continued property woes, anemic income growth, and double-digit youth unemployment that leaves many others underemployed.

“Although this position isn’t even enough to support me to move out from my parents’ home, finding another job seems impossible,” says Rebecca Zeng, 26 years old, who lives in the suburbs of Chengdu and has been working for four years at a state-owned company that makes parts for trains.

Even those with overseas degrees that formerly paved a way to a lucrative job are struggling to find suitable work. Caroline Gou, a 26-year-old in Sichuan province, couldn’t find a job in her field after returning with a master’s degree from Manchester University, and used family connections to find an office job as a stopgap.

The challenges have scuttled her plans of purchasing property to secure her financial future. “It is impossible to afford a home almost anywhere in China without a company that gives really good benefits or lots of help from parents,” she adds.

Workers are scaling back their plans. “In 2019, it was about making as much money as possible and busting their tail at
Pinduoduo
or Alibaba. Now that those jobs don’t exist, it’s about eliminating costs and moving to a second-tier city,” says Zak Dychtwald, founder of research firm Young China. 

The business community is also skittish about spending, and has been rattled by the crackdown on the private sector under Xi. The start-up fervor that energized entrepreneurs just a couple of years ago has faded, says Sean Taylor, chief investment officer of Matthews Asia.

And businesses that were optimistic coming out of the pandemic are readjusting their expectations. “We had a short good time right after the pandemic, so we opened a new branch and hired another assistant in our shop,” says Luna Lee, an assistant at a bakery in Shanghai. Now it’s considering closing the other branch.

Comments from officials to reassure the private sector, which creates 90% of new jobs in the country, would go a long way toward improving confidence, says Taylor. “China still wants to be self-reliant and have a competitive edge in innovation and technology. It can’t achieve those targets without getting more private-sector involvement,” he says.

While economists want to see China offer more consumer-oriented stimulus to turn the tide on confidence, Chinese policymakers have favored supply-oriented measures—spending aggressively to build up strategic areas like renewables, batteries, and semiconductors. 

The new China is trying to pivot from being the factory of the world for cheaper goods to more-advanced products—think autos, turbines, telecom equipment—so it becomes more critical to the rest of the world while reducing its own reliance on others. That is doubly critical as China faces restrictions on its access to advanced technologies from the U.S. and allies.

That spending, though, is leading to overproduction. While the U.S. and Europe grapple with inflation, China flirts with deflation. Consumer prices logged the fastest pace of annual decline in 15 years in January, at minus 0.8%.

China’s monthly trade surplus has tripled since pre-Covid to $75 billion, and a greater share of that trade, with countries like Russia, is denominated in yuan—part of a broader trend to diversify away from the dollar.

The country’s overcapacity and overproduction pose risks not just to China but also to rivals in these sectors abroad. Take solar panels. Beijing mandated that state-owned enterprises get half of their energy capacity from renewables by 2025, contributing to strong solar panel growth. But prices for solar inputs and panels have tumbled. Eurasia Group estimates that 60% to 70% of solar firms could face bankruptcy or acquisitions in the next couple of years, potentially saddling Beijing with another debt-laden sector.

As China tries to export some of that overcapacity in batteries, renewables, chips, and autos, other countries are fighting back to keep cheap goods from flooding their markets and eroding the competitiveness of their own companies. The European Union, for example, launched a probe into whether state subsidies have given Chinese electric-vehicle makers an unfair advantage, setting the stage for a much wider global trade war that could impinge on global growth.

Global companies, meanwhile, are paring their investments in China, increasingly repatriating profits rather than reinvesting them there. They began looking for alternatives to China years ago, initially because of rapidly rising wages there. 

The trade war started under the Trump administration, and then the disruptions created by the pandemic and Russia’s war in Ukraine, emphasized the risk of concentrated supply chains. In addition, the Biden administration has put restrictions on China’s access to critical technology, and is pushing to return production of semiconductors to the U.S.

China’s own push to become more self-reliant, plus an ambiguous and amended counterespionage law—along with the detention of employees of U.S. due-diligence firm Mintz Group last year—have only added to the anxiety among foreign companies and investors.

In a recent survey from the American Chamber of Commerce in Shanghai, U.S. industrial companies noted increased competition from Chinese rivals as Beijing encourages local buying. About a quarter of businesses surveyed are relocating or considering relocating manufacturing or sourcing operations, an uptick from past years. The impetus is highest in industries that are at the center of the U.S.-China strategic rivalry—industrials, technology, and research-and-development-oriented companies, according to the survey.

The majority of companies are staying put, but consultants say new investment is going elsewhere.
Apple
is assembling more of its iPhones in India,
Alphabet’s
Google is making some of its Pixel phones in Vietnam, and
Honeywell International
and
Tesla
are expanding their presence in Mexico. Indeed, the U.S. imported more from Mexico than China last year, a first in two decades.

Meanwhile, investor sentiment toward China has soured. Some investors have decided that China is uninvestible, shunning it in the way some have fossil-fuel companies. The reasons vary from Xi’s more-aggressive geopolitical stance, allegations of human-rights abuses, increasing lack of transparency, and worries about increased scrutiny by Congress and others of China investments.

The angst has spread to Chinese investors. Money managers returning from meetings with clients in China note a newfound pessimism that’s almost worse than the soured sentiment among foreign investors. Even Chinese investors are looking to allocate money outside of China—a new development, Taylor says.

Yet many bearish investors see a bottom nearing as China becomes one of the cheapest markets in the world, trading at under nine times earnings. China has been making changes to stem further stock losses, including eliminating trade restrictions and encouraging state-owned firms to buy stocks.

“For markets to work, you don’t need things to get better, just less bad,” says Phillpotts of Ariel, who has been increasing weightings in China. She sees pockets of stabilization in the property market as households use Beijing’s incentives to upgrade their homes. “But the playbook is different now,” she adds.

No longer is the bet on revenue growth. Now, Phillpotts and other investors are looking for companies focused on cutting costs and improving margins or returning capital to shareholders through buybacks and dividends. 

For Phillpotts, that includes home-appliance maker
Midea Group
and auto maker
Great Wall Motor
—both of which are looking for growth abroad, including in many of the other emerging markets whose growth prospects are improving.

Matthews’ Taylor also favors companies returning cash to shareholders through dividends or buybacks, a trend that is showing up in earnings reports this year, with both
Yum China
and Alibaba bolstering their repurchases. The Matthews China Dividend fund is one way to access these types of companies.

Investors need to be more nimble when it comes to China. Not only are Chinese companies facing increasing competition, but Beijing also has less tolerance for a handful of giants dominating an industry—like Alibaba did before the crackdown.

“This isn’t the place for a buy-and-hold approach on the view you can hang on to a company over five years—like the Magnificent Seven—and ride its market-share gains,” says Taylor, who is finding opportunities among the entertainment and consumer-oriented companies targeting the middle class in smaller cities.

The once-hot growth market, he says, is now one for value investors. Add that to the list of ways China isn’t what it was.

—Tanner Brown contributed to this article.

Write to Reshma Kapadia at [email protected]