The myth of China's demand resurgence post zero-covid

Soft landing is when economic growth slows down to a sustainable level, avoiding negative outcomes like a recession. This can be achieved through a combination of policy measures & economic factors. In the current global economic climate, there are 3 factors believed to be critical in achieving it:

1. Europe's ability to survive the energy crisis which for now, it has managed to avoid the worst-case scenario, which is a positive sign for the global economy.

2. Strength of the US labor market. The US economy has been performing well in recent years, with low unemployment rates & a strong labor market. This resilience can help US weather any potential downturns.

3. China's reopening after pandemic restrictions are lifted. China is a major player in the global economy, & as it’s economy recovers, it will create new opportunities for businesses & investors globally which expected to lead to a period of sustained economic growth, however, the Chinese story hasn’t played out yet as expected.

Baltic Dry Index

A measure of shipping rates for bulk commodities like coal & iron ore, was at a low point of in December 2022, indicating weak global trade & potential for a global recession. However, there was a slight rebound as China began to reopen which was expected to boost economic demand. However, in January 2023, the Baltic Dry Index plummeted to 721, losing 1000 points in just one month even though Chinese demand rebound was expected to drive up shipping rates. Seasonal factors like China's earlier-than-usual Golden Week holiday & rainy weather in Brazil may have been cause for temporary shortfall, but the decline persisted even after these factors subsided. As of February 2023, the Baltic Dry Index had fallen to 530, which is worse than any day in March & April 2020, the worst of the pandemic lockdowns. This is concerning given that China has been reopening for almost 2 months & is supposed to be driving a tidal wave of demand for raw materials.

Japan Trade

Japan is a major trading partner with China. In January 2023, Japanese exports to China fell by 17% in value which is a significant decline v/s up 10.2% to USA & up 9.5% to Europe. These declining numbers are not a one-off event. In December 2022, exports to China were down 6.2% YOY. During the worst of April 2022 lockdown, Japanese shipments to China fell by just 5.9% in value. The recent Golden Week holiday was supposed to mark a full reopening but the decline in Japanese exports to China tells a grimmer story, given that Japan relies heavily on exports for economic growth. Asia as a whole saw a decline in Japanese exports of 4% in January 2023, with China being the major factor in this decline.

China's supposed reopening to lead the rest of the world is turning out to be fairy tale rather than reality. Mainstream media optimists believed that zero COVID was the problem. However, now situation is worse, with a global recession, weak global trade, & falling external demand on China along with its internal problems like the housing market, where home prices have fallen for the last 9 months with majority of Chinese household savings being tied up in real estate. As long as the market is contracting & creating uncertainty, internal demand will be constrained.

US Domestic Demand & Oil

According to the US Energy Information Administration, 59 million barrels of oil has entered domestic storage over the first 2 months of 2023, a number this high has only happened twice before. 1. April-May 2020, when the entire country was locked down due to the COVID-19 pandemic. 2. Early 2015, when overseas economies were experiencing a downturn, & many emerging markets ended up in depression during which China slowed down, fearing a hard landing (economy rapidly shifting from growth to slow-growth to flat as it approaches a recession, usually caused by government attempts to slow down inflation), which led to a decreased demand for oil, causing a surplus of supply.

Macro-economy is fuelled by access to large amounts of cheap energy, which drives growth. Rising energy prices, on the other hand, can cause inflation, especially detrimental to other sectors, such as transportation & manufacturing. Thus, by tracking oil prices & supply, real economic conditions can be better studied rather than relying solely on the stock market. Booming economy will have low inventory levels. However, the recent build-up in crude oil inventories suggests a demand than a supply problem. China's reopening was expected to lead to a surge in demand for oil, as the country is one of the largest consumers of energy globally. Rising oil inventory has happened before, even if not at this scale often & usually signals an upcoming recession. Though oil is not a perfect indicator, large trends in the oil market can be an ominous sign for what's to come, & investors should keep a close eye on this trend.

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