Download the Schwab app from iTunes®Get the AppClose

  • Find a branch
To expand the menu panel use the down arrow key. Use Tab to navigate through submenu items.

Slowdown in China

China’s economy is slowing, and the debate is raging over whether the country is headed for an abrupt hard landing or whether the slowdown will stabilize into a soft landing that may already be underway. However it plays out, one thing is clear: A return to the double-digit growth rates of years past seems unlikely.

China’s economy appears to be embarking upon an enduring downtrend in economic momentum—not just the drop in annual growth rates from 10% to 7.5% we’ve already witnessed, but what will likely be a further erosion to 7% in the coming years, and then on to 5% and below over the coming decade.

It’s worth noting that no economy can maintain double-digit growth rates forever—even an economy as big as China’s will slow as it matures. And the country’s recent growth spurt partly reflects the fact that China’s economy had a lot of ground to make up after years of ruinous economic policies in the mid-20th century.

The future outlines of the Chinese economy are still taking shape, and there will likely be challenges as China settles into its slower growth trajectory. However, there will also likely be opportunities, some of which may already be emerging. For example, Chinese stocks have already stumbled over the new slower growth rates and are now available at attractive valuations.

But before we get into possible upsides, let’s look at some of the challenges lurking behind China’s slowdown.

Demographics are destiny

China’s rise largely stemmed from a surplus of laborers willing to work for lower wages than the competition overseas. This allowed Chinese factories to turn out goods more cheaply than was possible elsewhere.

China isn’t the first country rise using this model. In the 1970s and 1980s, Japan relied on low-cost, export-driven economic growth to elevate itself to the second-largest economy in the world. However, Japan eventually had to change gears as the country’s birthrate declined and the number of workers fell.

China now faces a similar trajectory, as seen in the chart below. Its working-age population—defined as those between ages 15 and 64—is peaking and is set to decline in the years ahead.

China’s demographic problem has been exacerbated by the country’s “one-child” policy—a system introduced in the late 1970s that prohibits many couples from having more than one child. Although the policy has recently been relaxed slightly, according to the Chinese agency charged with population planning, the one-child policy has prevented more than 400 million births since 1979. To put that number in perspective, the entire U.S. labor force amounts to about 150 million workers. You can see how demographic trends in those two countries might play out in the chart below.

Looking ahead

Even as the number of workers shrinks, China’s economy has started to rely more on consumer spending and business productivity, as is usually the case in more developed economies. History shows that as consumer incomes rise, a greater share of an economy becomes driven by the spending of a growing middle class. Income per person in China has been rising at an annualized pace of about 10% for the past 15 years, allowing disposable consumer incomes to double every six years. Consumers are likely to be the force shaping China’s future growth pace and composition. In addition, China’s businesses are able to reap productivity benefits as they increasingly adopt automation and innovation pioneered in developed countries.

Market impacts

For investors, the consequences of this change may be felt in the markets for Chinese and frontier stocks, government bonds and commodities.

  • Chinese stocks. As the Chinese economic transition matures, an increasing focus on the efficiency—rather than the pace—of economic growth may lead to better profitability and performance among Chinese companies over the long term. That may be good for investors. In addition, China’s stock market has so far avoided the fate that befell Japan’s as it completed its transition to developed-country status. After years of surging economic growth, Japanese stocks were trading at bubble-like valuations at the end of the 1980s—but then tumbled into a long and painful bear market through the 1990s. The opposite conditions hold in China now. The price-to-earnings ratios of Chinese stocks listed on the Shanghai Composite and Hang Seng indexes are currently among the lowest in the world—and are less than a quarter of what Japanese valuations were in the ‘80s.1
  • Frontier stocks. China’s economic model may no longer fit China, but it is not outmoded. A new group of countries with a surplus of workers willing to work for wages lower than those in China will likely experience similar economic booms. These countries may include some of China’s smaller Asian neighbors, along with some African and South American nations. Together, these countries are often labeled “frontier markets.” It is important to remember that just because some new economy appears to be taking off, it doesn’t mean profits will follow. Even China’s world-changing performance generated a relatively paltry 3% annualized price gain for Chinese stocks over the past 17 years, as measured by the Hang Seng Index in U.S. dollars.2
  • Government bonds. China may continue to buy U.S. Treasuries and other government bonds as its economic growth slows, which may help keep yields on such securities low. China’s economy generates more money than it can use within its borders, and the country diverts some of this excess cash overseas. The Treasuries market is the only one big enough to accommodate all these funds. Slower growth in the years ahead will likely mean China has even less need for capital. Even at a 5% growth rate, China would generate the same amount of new economic output as it did in the middle of the last decade, when it grew 10%, simply because the economy has doubled in size. China’s ongoing demand for government bonds might be similar to that of Japan, whose investment in U.S. Treasuries increased when the country’s economic model changed in the early 1990s.
  • Commodities. China’s economic change will likely reduce demand for industrial commodities such as copper, aluminum and iron ore. China now consumes more than 40% of the world’s copper. Ratcheted-down expectations for China’s growth and internal construction may apply downward pressure on the prices of these commodities. Australia, a major metal exporter, has already experienced slowing demand from China, just as it felt the drag from Japan’s economic transition 20 years ago.

With the arrival of the Chinese New Year on February 19, the Year of the Goat is upon us. In 1979, another Year of the Goat, the one-child policy was announced and implemented. We think the combined effects of that policy and the economic restructuring now taking place will have long-term consequences.

¹Based on FactSet calculations using Shanghai Stock Exchange Composite Index, Hang Seng Index and MSCI Japan Index data as of 9/30/2014.
²Based on Hang Seng Index data from 9/30/1997–9/30/2014.

Financial Planning by the Decade
Make a Plan Before You Trade

Important Disclosures

Past performance is no guarantee of future results.

International investments are subject to additional risks such as currency fluctuation, geopolitical risk and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Commodity-related products, including futures, carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, illiquid and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions, regardless of the length of time shares are held. Investments in commodity-related products may subject the fund to significantly greater volatility than investments in traditional securities and involve substantial risks, including risk of loss of a significant portion of their principal values.

The Shanghai Stock Exchange Composite Index is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange.

The Hang Seng Index is a free-float capitalization-weighted index of a selection of companies from the Stock Exchange of Hong Kong.

The MSCI Japan Index is a free-float capitalization-weighted index designed to measure the performance of the large- and mid-cap segments of the Japanese market.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions.

Data herein from third-party providers is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

(0215-0042)

Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.