China's economy rebounded impressively in Q2, with growth of 3.2%. The country is one of the earliest to report its second-quarter performance, and will also surely be one of the only ones to post growth of any sort.
But can that be sustained? The fine print of China's output deserves some scrutiny. There are some worrying signs.
First, it should be noted that China is used to outsized growth. The 6.8% collapse in the Chinese economy for Q1 was its first decline on record, certainly since the current tallies started in 1992, and in actuality since it started developing a market economy in 1979. The Q2 growth is growth, but the weakest growth on record.
Retail sales in Q2 shrank 1.8% in June, indicating that "regular people" are still very concerned about the direction China is headed. The sales were better than the 2.8% decline in May, but economists had been predicting that Chinese consumers would start spending - they had anticipated a 0.5% gain in retail spend for June.
Consumption is an increasingly important driver of the Chinese economy, as its shifts away from its position as "factory to the world," and develops an increasingly influential middle class. After any pent-up spending occurs, there may be lackluster activity from consumers for quite some time.
While Q2 has returned China to growth, "the recovery is likely to slow down noticeably," Commerzbank foreign-exchange and emerging-market analysts Hao Zhou and Charlie Lay write in a note to clients. They believe "the markedly deteriorating" situation in the labor market is holding back private consumption, and increasing the high level of indebtedness at companies.
The fact that Chinese shoppers are keeping their credit cards in their wallets is clear when you look at big-ticket items. New home sales fell 2.1%, year on year, in June, after a 9.7% fall in May.
Auto sales were impressive in Q2, up 10% year-on-year, but the sustainability of that rebound is uncertain, according to the credit analysts at Standard & Poor's. Employment in both manufacturing and non-manufacturing sectors remains poor. Without jobs to underpin it, "consumer confidence will likely stay weak, as will spending," the S&P team believes.
Commercial vehicles sales have recovered first, because China has directed a lot of its stimulus so far to help the industrial sector. So China Inc. is buying company cars, rather than Mr. and Mrs. Chan signing up for a new Shanghai-made Tesla (TSLA) .
Vehicle demand has been strongest in logistics and construction companies, many of which have ageing fleets with substandard emissions records, and which therefore need replacement. China, a government long led by engineers, loves a good infrastructure spend to stimulate the economy. The vehicle orders are coming from the companies benefiting from Covid-19 largesse.
Passenger vehicle sales have climbed from their trough in February, but the growth rate actually fell back a bit between May and June. So any "revenge spending," as it's dubbed here in Asia, may be short-lived.
S&P is skeptical the auto-sales recovery can be sustained in the rest of the year. Again, the poor jobs picture is putting strain on labor markets, income and in turn consumer spending. Car companies may be forced to embark on programs of aggressive promotions to spur sales and corner market share. That means profit margins for car companies are unlikely to recover to pre-pandemic levels until 2022 at the earliest.
S&P is concerned about the credit position of U.S.-listed BAIC Motor (BMCLF) and its parent Beijing Automotive Group, as well as U.S.-listed Geely Automobile Holdings (GELYF) and its parent, Zhejiang Geely Holding Group. Profit erosion and elevated debt have hurt their outlook, leading S&P to downgrade BAIC and its parent in June. Although Geely Auto is due to list on the new Star Market in Shanghai, intended to be China's Nasdaq, the timing of the offering is unclear, as is what it will do with any cash raised.
S&P had already issued in March-April a negative outlook on U.S.-listed Dongfeng Motor Group (DNFGF) and the state-owned manufacturer China FAW Group. All Chinese carmakers are on S&P's CreditWatch list, with negative implications. The ratings agency is watching to see what happens with the rebound in car sales, which is likely to be short-lived.
It is telling that investors more broadly found no reassurance in this week's economic numbers out of China. The Chinese benchmark CSI 300 index plunged 4.8% on Thursday, its biggest losses since the fall when the Shanghai and Shenzhen bourses resumed trade after Lunar New Year, when the coronavirus was taking hold in China. After three straight down days led to a 6.9% fall, the index reclaimed a sliver of its losses with a 0.6% gain on Friday, meaning the index is still up 10.9% so far this year.
There was some "sell the facts" selling, the Commerzbank pair note. But the weak spots revealed this week in the economy have not reassured investors, and should cause concern the rest of this year.