China's Economic Crisis is Getting Much Worse.

The second largest economy in the world has big issues. While US stocks are currently riding all-time highs, in China, the story couldn't be more opposite. Chinese stocks have raised more than $6 trillion since the 2021 peak, and the sell-off keeps getting uglier. China is the worst-performing major market so far this year, and it's getting so bad that Tokyo has now overtaken Shanghai as Asia's biggest equity market. It's not good news either for the country's local asset management industry, with the meltdown in Chinese shares causing the highest number of mutual fund closures in 5 years.

If we take a look at data comparing the CSI 300 index versus the MSCI World Index, really since Q2 of 2023, China's biggest companies have suffered an enormous sell-off. And if you want a truly insane statistic, the Hang Seng P/E ratio is now lower than the Nasdaq's price-to-book ratio. That is mind-blowing. But unfortunately, in China's case, when it rains, it pours. There are a few key reasons why it doesn't look like the country will be getting out of the woods anytime soon.

The first is huge deflationary pressures as a result of an extremely sluggish post-COVID recovery. Unlike the US, China has really struggled to revive its domestic demand for goods and services after tough lockdown measures. This situation has caused widespread deflation in the Chinese economy. Consumer prices have now marked their longest streak of decline since 2009, with the Consumer Price Index falling 0.3% in December from a year earlier. It was reported in Bloomberg last week that China's economy-wide prices are in their longest decline since 1999. That measure, calculated by Bloomberg using the difference between nominal and real GDP growth, contracted for the third straight quarter in Q4 of 2023.

The people simply aren't spending their money, and Chinese businesses are really feeling the pressure. Factory gate pricing, which is the pricing for goods and services quoted by the manufacturer before any taxes, shipping, or other fees are added, fell 2.7% in December after a 3% fall in November. These prices have now been on the decline for more than a year, thanks to lower commodity prices and weak demand locally and abroad. In fact, Chinese exports fell 4.6% over 2023, which marks the first annual drop since 2016—a worrying statistic considering just how much of a pillar exports are to the Chinese economy.

The value of Chinese exports is also in decline, making them cheaper for foreign consumers. In October, the index of export prices hit the lowest level in data going back to 2006, which was only slightly higher in November. Food prices in China have also fallen now for six straight months, and all in all, the ongoing deflation everywhere in the economy is leaving economists wondering if any meaningful stimulus from the government will ever arrive. Yes, you heard me right. While most countries around the world are currently keeping rates high to slow down a hot economy, China's situation is the opposite.

China's central bank has pledged to step up macroeconomic policy adjustments to support the economy and drive a rebound in prices, but the world is still waiting to see the CCP take meaningful action. The problem that China has is that demand in the economy is chronically weak. That's why prices are so weak as well. They keep talking about the fact that they want to strengthen domestic demand and "strengthen consumption," but time after time, they fail to take the measures that actually will do that.

Raymond Yung, chief economist for Greater China at AZ, said it best: "China needs to act boldly to break the deflationary cycle. It will fall into a negative spiral otherwise." And that's the tricky thing about deflation; like inflation, it can spiral if left unchecked. This is very much what happened in Japan during the 1990s. Price levels decline, which leads to lower production, reduced wages, decreased demand, and continued price declines. Therefore, economists are urging the Chinese government to step in and provide some support, and many are expecting this through interest rate cuts.

The Chinese government, on the other hand, might have another plan. After most analysts expected the People's Bank of China to lower the rate on its one-year policy loans, called the medium-term lending facility, to 2.4% (a 10 basis point reduction and what would have been the first rate cut since August 2023), the central bank decided to leave interest rates where they were. They chose to do nothing. This left analysts baffled, as there is no doubt that deflation is a big concern that needs to be addressed by the Chinese government as soon as possible. Some sort of stimulus will be necessary, and that point is further backed up when you look at their shocking recent economic data.

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China's economy still did grow in 2023, with GDP rising 5.2%, and that was an improvement on 2022's 3%. However, outside the pandemic years, that performance marks the lowest growth since the 1990 recession. On a quarter-by-quarter basis, GDP grew just 1%, slowing from a revised 1.5% gain in the previous quarter. If we read into the details, we can see cause for concern in some December indicators released alongside the GDP data. The obvious one pertains to their real estate sector.

The surprise was the shift in government policy from standing behind the debts of big property developers to allowing them to go under. Dozens of private developers have since collapsed, raising not only questions about the future of the property market in China but about the health of the entire economy. At this point, we all know about China's struggling property sector; I even made a video on it, which you can check out if you want a bit more of an explainer. But the crazy thing is, even since that video was published, the situation has gotten worse. China's second-largest property developer, Evergrande, declared bankruptcy in the US, and recently we got some additional information that's rather concerning.

China's December new home prices fell at the fastest pace in nearly 9 years, marking the sixth straight month of declines. As a result of all the stuff that we just discussed, the reality is people just aren't buying homes right now. The wallet is feeling very light, and property sales are on the decline. The NBS data showed that property sales by floor area fell 8.5% for the year, while new construction starts plunged a whopping 20.4%. That is a significant statistic, and it shows that both demand is low and debt-ridden developers have had to delay construction due to financing issues, both of which are again deflationary forces.

Yet the data seems, for now, to be falling on deaf ears. Speaking to the leaders at the World Economic Forum this week, Chinese Premier Li Qiang, in fact, trumpeted his nation's ability to hit their roughly 5% growth target for 2023 without flooding the economy with "massive stimulus." Interesting phrasing, as there's no doubt the CCP's relative inaction on the stimulus front is really frustrating citizens, economists, and investors alike.

Also included in this fresh economic data was the return of reporting of China's youth unemployment rate. In mid-last year, youth unemployment rose up to 21.3%, meaning one in five people aged 16 to 24 faced unemployment. But the weirdest thing about the situation was the number was getting so much attention and scrutiny abroad that the CCP simply decided to stop reporting it as the economy slowed. So too did hiring; China's youth unemployment rate rose for six consecutive months this year. Then, in August, the government abruptly announced that it would stop reporting that data, citing plans to revisit the methodology.

Analysts say the suspension fits a worrying pattern of haziness around the true state of China's economy. At the time, China was being compared to countries notorious for their youth unemployment, such as Spain and Italy. The reason that youth unemployment catches headlines so much is that these really are your economy's best workers. Each generation is generally better educated than the last, and these young people are in their prime and willing to work hard. So by having youth unemployment skyrocket, it really means you've got young, strong, educated people just sitting on the sidelines.

So why are younger workers not working? Well, it goes back to everything we've just been talking about. Because of the broader economic slowdown, businesses don't want to hire as many people. Why take on fresh new talent when your business is struggling and when you already got your existing workers that know what they're doing and have been doing it for a while? Another issue is the mismatch between the growing number of college graduates and the available jobs in the service sector, which is the primary employment sector for young Chinese.

The Chinese government's heavy emphasis on university enrollment has led to massive increases in graduates, with the number rising from 22 million in 1990 to 38 million in 2021. However, job growth in the service sector has not kept pace, especially as the sector faced downturns due to CCP policies and the pandemic's impact. Young Chinese graduates also want white-collar jobs in cities, but with the increasing unemployment rate and with the government's encouragement, many are returning to rural areas or smaller towns where there just isn't as much work available.

Then, there's also the problem of the CCP missing the mark on how it's been helping the issue. In response to the crisis, the Chinese government is focusing on increasing recruitment in the civil service and expanding post-graduate enrollment. They also invested around $1.8 trillion in infrastructure in 2023 to create jobs. But as was noted by the Council on Foreign Relations, "the property and construction sectors are virtually irrelevant to the prospects of the young and the educated." New stimulus-driven opportunities in fields such as carpentry and brick-laying hold no interest for graduates in areas such as literature and computer science.

With Chinese President Xi Jinping telling China's unemployed youth to "eat bitterness"—essentially eat a spoonful of cement and harden up—it's easy to understand why the youth are generally frustrated. If you have a lot of idle young people who are not employed, it adds pressure on social stability, which is what the government really is concerned about. They are choosing to stay at home full-time; they are counting on their parents to continue to support them financially. This is what many people are referring to as the "lying flat" phenomenon in China.

Students have much higher expectations for their job income, their job stability, and what they can derive by doing work. In the latest economic release, the CCP did report that youth unemployment was around 14.9%, excluding students, so less than its last rating at the midpoint of last year, but still with some ways to go. Overall, these are the key areas of concern for China's economy going into 2024: lots of deflationary pressures, a crumbling real estate sector, a youth unemployment crisis, and so far, a government that would prefer to tell its people to just tough it out than provide any sort of meaningful stimulus.

But with that said, how do you think Chinese stocks will fare in 2024? Do they have further to fall, or have they hit rock bottom? Also, if you're interested in learning how to pick stocks like Alibaba, Tencent, BYD—you know, the Warren Buffett way—check out "Introduction to Stock Analysis" in the description below. This is a 6-hour video course that covers reading financial statements, analyzing the competitive advantage of the business, and it also includes three full valuation methods. But apart from that, thanks very much for watching, guys, and I'll see you all in the next video.