The Uncertain Path of China’s Economic Recovery

China’s economic recovery hangs in the balance as its consumers grapple with the lingering effects of strict Covid restrictions, increased government control over the private sector, and a slump in the property market. However, recent quarterly reports from global consumer giants suggest that the economy is far from turning a corner.

Estée Lauder (EL), the renowned parent company of beauty brands like Clinique and M.A.C, has witnessed a decline in demand in China. In light of this, it has issued a warning that fiscal 2024 adjusted per-share earnings may potentially drop by as much as 33%, a stark contrast to earlier projections of growth. Furthermore, sales are now anticipated to decrease by up to 2%, compared to initial expectations of a 5% to 7% revenue increase. Tesla (TSLA), which manufactures electric vehicles in China, experienced an 11% decline in sales in September when compared to the previous year.

Yum China (YUMC) has also raised concerns about China’s path to recovery. The company missed third-quarter earnings and revenue expectations while highlighting a softening demand among fast-food customers in late September and October. Chief Financial Officer Andy Yeung described the post-pandemic recovery as “wavelike” and “nonlinear” during a call with analysts.

Laura Geritz, head of Rondure Global Advisors, has expressed skepticism about China’s recovery, stating, “I was calling China’s recovery a crab walk, but I think that is probably even optimistic.” She points out that there is a growing fear that these setbacks are not merely temporary waves but indicative of a more worrying trend.

Although certain areas of the economy have shown signs of stabilization, an actual recovery remains elusive. Even with the introduction of more stimulus measures by Beijing, the path ahead for China’s economic revival remains uncertain.

The Changing Consumer Landscape in China

As the Chinese economy faces challenges, consumers in the country are shifting towards a more value-oriented mindset. With double-digit youth unemployment and a struggling property market, this change in consumer behavior is not unexpected.

According to Ginny Chong, a senior portfolio manager at Mondrian Investment Partners, Chinese consumers are increasingly opting for value-for-money brands in categories like sportswear, food, and beverages. This sentiment is echoed by other fund managers who have observed a growing preference for Chinese brands that offer better value as disposable income becomes tighter.

In the cosmetic industry, for example, Estée Lauder’s local Chinese brand Proya is performing well, while Huawei poses a stronger competition to Apple in the smartphone market. Analysts are closely monitoring how Huawei’s new phone will impact demand for iPhones.

However, both consumers and companies are struggling in the current economic climate. The team at Geritz found executives across various sectors to be “meek and bleak” during their visits to Chinese companies, indicating a significant shift from the pre-COVID optimism.

Despite Beijing’s implementation of stimulus measures, investor concerns remain high as these measures have not yet instilled confidence or turned the tide for consumer sentiment.

As China’s version of Black Friday, Singles Day, approaches on November 11th, Citis China Internet analyst Alicia Yap expects a subdued performance. She notes an abundance of “ever cheapest” offers aimed at attracting consumers. This trend further emphasizes the growing emphasis on value among Chinese consumers.

Overall, the evolving consumer landscape in China is leading to a reevaluation of brand preferences, especially as economic pressures mount. Chinese brands are gaining market share, posing challenges to international competitors. As the economy continues to navigate uncertain times, both consumers and companies will need to adapt to remain competitive in this shifting landscape.

Chinese Policy Measures Fall Short, Raises Concerns for Investors

Renowned fund manager Schwab expresses skepticism over the effectiveness of current Chinese policy measures in addressing structural issues in the market. With less than 20% of his fund allocated to China, Schwab’s cautious stance is supported by his observation that these measures are proving to be ineffectual.

Another factor contributing to Schwab’s apprehension is the increasing involvement of the state in the private sector, which requires Chinese executives to prioritize Communist Party ideology in their strategy meetings. This shift towards common prosperity and the emphasis on reducing inequalities may negatively impact luxury spending, cosmetics, and experiential restaurants. Consequently, consumer-oriented companies may face significant challenges.

There is a possibility of Chinese stocks experiencing a sharp rebound if Beijing alters its approach to stimulus measures or if a U.S. recession prompts investors to seek recovery opportunities in other markets. However, Schwab views any potential bounce as short-lived and temporary, akin to last year’s rally when China relaxed Covid restrictions.

Investors should exercise caution as the iShares MSCI China exchange-traded fund (ETF) trades around $42.11, similar to levels observed before the previous rally. This serves as a warning sign for those anticipating a swift recovery in Chinese stocks.