Free to Read: Can China Serve as a Safe Haven Amid Global Stock Turmoil?

To achieve that status, the potential of the domestic market must be fully unleashed

China's economic growth was driven mainly by exports in the first half, leaving it vulnerable to shocks to the global economy.

Amid signs of a cooling U.S. economy and disappointing corporate earnings, the U.S. stock market began an adjustment in July. Meanwhile, market expectations for Fed rate cuts have increased significantly, pushing down the U.S. 10-year Treasury yield.

Additionally, Japan has begun its rate hike cycle, bringing up the long-depressed yen, but its stock market has tumbled recently. Coupled with uncertainties surrounding the geopolitical situation in the Middle East, global financial markets may experience significant volatility in the coming months.

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In view of that, will Chinese assets become a safe haven, or will they be dragged down by the volatility in global capital markets? That largely depends on whether the U.S. stock market and economy experience a gradual and controlled cooling (soft landing), or a sharp downturn (hard landing).

High-tech stocks are already highly valued in the U.S. Assuming that U.S. interest rates begin a sustained decline, and corporate earnings fall short of expectations due to an economic slowdown, a considerable amount of capital is likely to exit the U.S. stock market.

Most of this withdrawn capital is expected to be reallocated to the bond market, while some may shift to other stock markets, including Japan and emerging markets. However, based on the recent performance of the Japanese stock market, it seems unlikely that it will be able to absorb much of the capital flowing out of the U.S.

The situation in China is different. Compared to the yen, the yuan’s exchange rate against the U.S. dollar has been relatively stable over the past few years, and the People’s Bank of China has stronger control over the yuan than most other central banks have over their own currencies. So, the market expects the yuan to appreciate slightly and steadily against the dollar in the context of a weaker greenback.

In addition, China currently has no significant inflation issues, allowing for a relatively loose monetary policy with a greater likelihood of interest rates moving downward rather than upward. If this policy expectation remains unchanged, it would be in favor of the Chinese stock market in the face of high external volatility.

Meanwhile, foreign funds have relatively limited influence on the Chinese stock market, especially on A-shares, which is also a beneficial factor when global stock markets experience turbulence.

Based on that analysis, the major determinant of Chinese stocks is the performance of the real economy, which is closely linked to the path the U.S. economy takes — a soft landing or a hard one.

China’s domestic demand in the first half of this year was only average, with underperformance in consumption, real estate and government infrastructure investment. Economic expansion was primarily driven by external demand.

While developing countries, like those in the Association of Southeast Asian Nations, were the major contributors to China’s export growth in the first six months, their economic growth is dependent on exports to developed nations, including the U.S.

Therefore, if the U.S. experiences a soft landing, the economic impact on those countries will be limited, which also means no significant negative impact on China’s exports. However, in the event of a hard landing, similar to the one during the 2008 financial crisis, a shock to the global economy will be inevitable, and China will not be exempted.

Domestic demand matters

The foundation for Chinese assets truly becoming a safe haven for global capital is China’s sizable, high-potential domestic market. In 2022, China accounted for about one-fifth of the global population, with manufacturing GDP and investment making up 30% of the global total, but consumption only represented around 13%. From the perspective of domestic demand, consumption has much greater potential than investment.

Expanding the share of consumption in China’s economy would help enhance its stability, but there’s no quick remedy. Although the central government has recently placed greater emphasis on propping up consumption, chances are low that consumption will become the main driver of economic growth in the coming months or even within the next year.

In the short term, the central government’s current supportive policies for real estate and local government investment may somehow help stabilize these sectors, but they are unlikely to lead to a significant rebound. Given domestic demand is not yet capable of serving as a key growth driver, the best option for China is to hope that the global economy does not experience significant turmoil.

To sum up, amid the global stock market volatility, China’s exchange rate, interest rate policy, and financial environment are favorable for Chinese stocks, including A-shares and Hong Kong stocks.

However, whether Chinese stocks can become global safe-haven assets depends on the performance of the country’s real economy. Currently, its heavy reliance on external demand poses a risk. If the U.S. economy experiences a soft landing, Chinese assets should become attractive; however, if the U.S. economy undergoes a notable downturn, it will be difficult for China to remain unaffected.