China flexes economic muscles, but equity markets barely notice

Brian Nick

The last week’s market highlights:

Quote of the week:

“Mankind was never so happily inspired as when it made a cathedral.” — Robert Louis Stevenson
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2Q 2019 Outlook :
  • U.S. economy: Late cycle but no recession
  • Global economy: Slower this year than last  
  • Policy watch: A dovish turn for global central banks  
  • Fixed income: Rates likelier to rise than fall
  • Equities: Get defensive, stay invested
  • Asset allocation: Still favorable to emerging-market assets

Global economy: China expands, markets exhale 

Over the past few months, headlines about China have been front and center: The U.S.-China trade standoff. China’s manufacturing recession. The U.S.-China trade standoff. Claims of Chinese currency manipulation. And, when there’s been nothing else to report on…the U.S.-China trade standoff. Eventually, China may recede a bit from the relentless news feed.
But that certainly wasn’t the case last week. Markets anxiously awaited a slew of Chinese economic reports, looking for reassurance about the health of the world’s second-largest economy and its implications for global growth. Overall, the data “flashed green,” providing a measure of support for global equity markets. Among the releases:
  • In the first quarter of 2019, China’s economy grew 6.4% compared to a year ago, slightly ahead of forecasts and matching the 6.4% growth rate recorded in the fourth quarter of 2018.
  • Industrial production surged 8.5% in March—its fastest pace since 2014 and well ahead of the 5.3% registered in both January and February.
  • Retail sales (8.7% year-over-year) topped forecasts in March. Online retail sales also grew impressively. 

Other recent bright spots: China’s housing market is showing signs of strength in the form of higher home prices, domestic bank lending is on the rise and exports are up substantially.
Taken together, these encouraging data points continued a recent spate of above-forecast economic reports that have flipped the Citi Economic Surprise Index for China from a low of -45 on March 8 to +74 as of April 18. (This index gauges the extent to which economic data releases have diverged from consensus forecasts. The more negative the number, the more that recent releases have come in below expectations and vice versa.)
What’s behind the turnaround? While China’s official economic data isn’t known for its transparency, it appears the government’s wide range of stimulus measures may be kicking in. These include tax cuts, cash injections into the banking system and bond issuance to finance new infrastructure. Beijing is thinking of further expanding its policy playbook by offering direct incentives for consumers to buy electronics and cars.
Another big economic boost may have come from China’s decision to relax its crackdown on shadow banking, the unregulated segment of the country’s financial sector. Shadow banking encompasses a variety of high-yielding, “off-balance-sheet” investment products marketed by banks, insurance companies and wealth management firms. Assets in these products jumped to around $10 trillion last year. In response, the government issued stiff regulations to curb the industry’s rise. But to meet the private sector’s financing needs, policy officials began to have second thoughts. Although they’re well aware of the need to scale back the country’s mountain of debt, they also know that these risky loans keep the economy well lubricated.
In summary, the short-term outlook for China has brightened, as it has for most of the world after a challenging close to 2018. China’s longer-term obstacles—chiefly debt and demographics—persist and may have been exacerbated by the stimulus efforts of the past several quarters. Even so, China’s government remains willing and able to effectively address a financial crisis should one arise unexpectedly. And as the economy retools on the fly to rely more on household consumption and less on government-sponsored investment, it should grow at a more moderate but more stable rate of 4%-6% over the next decade.

Equities/fixed income: Thank subdued inflation and the Fed for low bond yields and high stock prices

Steady, solid GDP growth and higher stock prices tend to go hand in hand, and this year has been no exception. The U.S. economy continues to demonstrate resilience, most recently evidenced by March’s stellar retail sales results and the uptick in leading economic indicators. Equities have responded with one of their best first quarters in years. April, meanwhile, has thus far lived up to its billing as a strong month for stocks.
Stocks have gotten a lift from low inflation and accommodative monetary policy. In January, core PCE, the Federal Reserve’s preferred inflation gauge, fell to 1.8%, below the Fed’s 2% target and its lowest level since last February. With inflation under control, the Fed has been able to remain patient in its rate-hike posture. Indeed, at its March meeting, the Fed scaled back previous forecasts for the number of projected interest-rate increases to zero in 2019 and only one in 2020. Lower borrowing costs encourage businesses to invest and become more productive, while also helping their bottom lines.
During risk-on periods such as the one we’ve seen this year, investors often gravitate away from safe-haven assets such as U.S. Treasuries. Reduced demand for such assets leads to lower prices and higher yields. Moreover, higher yields often accompany a healthy economy, as economic expansions can trigger inflationary pressures.
But with inflation not likely to accelerate any time soon, investors have been satisfied with lower yields, which helps explain why the bellwether 10-year Treasury yield has dipped from 2.69% at the start of the year to 2.56% as of April 18. Another key reason for lower Treasury yields: U.S. sovereign debt is the “best deal in town.” For instance, 10-year bond yields from Germany and Japan have topped out at 0.26% and 0.03%, respectively, in 2019. Each has also spent time in negative-yield territory this year.
It’s also worth noting that historically, falling U.S. Treasury yields have at times been associated with a struggling U.S. economy. However, credit spreads—the difference between yields on corporate bonds and similar-maturity Treasuries—have tightened significantly this year. That’s a sign that investors have been comfortable receiving less of a reward for venturing into higher-risk assets, not an indicator of an economy in trouble.  
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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