China’s Domestic Market Uncertainty Threatens U.S.-Listed ETFs

The Chinese consumer market is the second largest in the world, behind only the U.S.

At over $6 trillion, household consumption in China is one-third of that of the U.S. and only 20% smaller than that of the entire European Union.

Yet, China’s economic growth is lagging behind the levels its own leadership was expecting for the first half of 2023. 

Domestic demand has not recovered convincingly after the country abruptly re-opened its borders and said goodbye to years of strict COVID-zero policies in late 2022. China’s GDP growth failed to meet economist estimates for the second quarter of this year.

However, the country’s domestic market is facing an undefined trajectory, which could make or break the performance of U.S.-listed ETFs focused on the Chinese market.

“China faces the new challenge of coping with multipolar world pressures from the US in particular,” wrote Morgan Stanley analysts.

Morgan Stanley issued a new report focused on emerging markets in Asia, after nine months of a bull market that began in October. The iShares MSCI Emerging Markets ETF (NYSE:EEM) is up over 19% since late October lows. For comparison, the S&P 500 is up 26% since its lowest point in mid-October, a few weeks earlier.

Specifically, U.S.-listed Chinese stocks present one of the best trajectories within emerging markets, with the iShares MSCI China ETF (NASDAQ:MCHI) up 36% since October lows. The fund, which follows the MSCI China Index, has seen better days this year: it is down 13% from its highest recent peak in late January.

For Morgan Stanley analysts, the investor debate around China is currently centered on whether the country’s demographic decline, a high domestic debt/GDP ratio and over-investment in property and infrastructure are starting to generate a balance sheet recession. 

The country is facing a massive real estate crisis. New home sales by China’s 100 biggest developers dropped by 33% in July from a year ago, according to a recent report by CNN Business. Many Chinese investors are turning to U.S. real estate as a way to hedge against their own country’s real estate slump.

“Recent statements from the Politburo have begun to acknowledge the need to reverse some of the measures that have pressured the property market, but there is no easy way out of the intertwined property and local government financing/debt burden that built up in the years when the growth model did not transition fast enough,” 

However, in spite of all the headwinds, Morgan Stanley analysts continue to see possibilities of fair weather for the Chinese economy.

“We do not rule out moving back to a more positive stance on China should policy implementation be more aggressive than hitherto and solutions to these structural problems start to fall into place,” wrote the analysts.

Produced in association with Benzinga