Breaking down the US and Chinese markets’ recoveries

Good morning. Moody’s lowered the US’s credit rating to Aa1 from the top AAA on Friday. This marks the first time in history the US government doesn’t have a triple-A credit rating from any of the big three major rating agencies. So far, 10-year Treasury yields have only risen 4 basis points. Will the calm last today? Email us: [email protected], [email protected] and [email protected]. 

US and Chinese market recoveries

US equity markets do not like Trump’s tariffs on China. Chinese equity markets, unsurprisingly, do not like them either. The Shenzhen Shanghai 300 index, the primary mainland stock index, and the Hang Seng index, made of the Hong Kong-listed shares of Chinese companies, had been trading flat since the Chinese market caught its second wind after DeepSeek. That came to an abrupt end after “liberation day”:

Both the Chinese market and the US market revived over April and May. While both leapt after the US and China downgraded from ludicrously high trade duties to just crazy high trade duties, the US had the stronger performance:

Just a few weeks ago, many commentators predicted that China would win in a trade war against the US: its government and citizens seemed willing to bear the pain of a long stand-off, and investors and markets were still coasting off high hopes for Chinese tech. That could still be true. But a closer look at the US and Chinese equity markets shows that investors may have walked back from that narrative. Before digging in, recall the standard caveats about the Chinese market: it gyrates in part on fundamentals, but also on government favouritism; its recent run-up has been partially from hopes of a stimulus that has yet to materialise; and foreign investors barely own it. 

Start by dividing the market into two periods: when tariffs were especially high (from April 1, right before liberation day, to May 8), and after they came down (May 9, when the market started to get excited about the US-China summit, to today). Sector performance in the first period is revealing (note that we just look at the CSI 300 and the S&P 500, as their sector groupings are similar):

China was clearly in a bear market. Only the classic defensives — utilities and consumer staples — and financials were up, and barely so. Real estate, which is not a main sector in the CSI 300 and is certainly not a defensive in China, was up, too, but that was more due to recent good news for the property market than economic optimism. All else was down, including info tech, which had powered China’s spring rally. 

Healthcare was down in both countries, due to the Chinese health system’s financial stress and concern about Medicaid cuts in the US. Outside of healthcare, however, only US industries particularly exposed to tariffs and shifting global trends were down: soft oil prices dragged down US energy stocks, and China’s metal restrictions hampered US materials companies. 

On its surface, this does not make a ton of sense. China and the US hit each other with tariffs of similar severity, and China appeared to have much more leeway to substitute US goods. But the US equity market benefited from two big advantages. First, tariffs were walked back on most other countries, and it became clear that Trump would walk them back further (Taco!). That boosted US investor sentiment, causing many to flock back to risky, pricey stocks like the magnificent 7 — some of which reported good earnings in April, too. 

Second, as we detailed the other week, the US economic data has been robust, while the Chinese economy has been flailing. The levers they have to respond to a crisis may be weakening further, too. At the current pace of spending — which has not included meaningful stimulus — the government is already projected to surpass its deficit goals; it seems less likely that effective stimulus will come at all this year. And the central government is suffering from “faltering tax revenues, blunted financial policies, and constraints over borrowing capacity because of bank capitalisation pressures”, says George Magnus at the Oxford China Centre.

The US’s outperformance after the tariff pause owes a lot to those dynamics, too. The S&P 500 finished the week around 5 per cent up, while the CSI 300 ended up by a little over 1 per cent:

Chinese healthcare stocks beat the S&P 500’s, as did financials, due to a rate cut and the start of “tactical monetary stimulus” by the People’s Bank of China. But hopes for economic relief from lower tariffs are not as high as they are in the US. And Chinese info tech stocks suffered after middling releases from Alibaba and Tencent.

To the extent that the US-China market divergence reflects China’s unique economic challenges, it feels justified. But US investors might be a little too exuberant. Chinese tariffs, even at 30 per cent, will sting, and US businesses may still need to contend with 10 per cent tariffs on the rest of the world. And China could still back away from a deal, or hold out for better terms from Trump. Though its government and economy need the relief, it continues to have political leverage.

(Reiter)

Consumer sentiment 

On Friday, the University of Michigan’s consumer sentiment index dropped yet again. It was the fifth straight monthly decline, and showed that US consumers are still concerned about the economy broadly, and inflation in particular; year-out inflation expectations jumped to their highest level in over three decades. The soft data is still bad.

But it did show that something could be changing. The latest monthly drop was more restrained than the falls earlier in the year. The main index only fell 2.7 per cent month-over-month, versus an 8.4 per cent decline in April and an 11.9 per cent decline in March.

It is not perfectly clear why. It could be that consumer sentiment has been buoyed by the Trump administration’s softening stance on tariffs. Or consumers may feel more optimistic about the economic outlook after a string of decent inflation readings and the equity market’s recovery. 

Also, it’s crucial to note that the May reading is preliminary, and the survey closed just a day after the US and China announced the 90-day tariff truce. That suggests that we could see a turnaround in the final May numbers — though Joanne Hsu at the University of Michigan, who publishes the survey, said that we should not expect too big a change. April’s preliminary sentiment reading came out just after Trump put a 90-day pause on “reciprocal” tariffs, but the final numbers still showed a big decline in sentiment, she said. 

One other possibility for why sentiment declines are slowing is that Democrats’ pessimism is bottoming out. Typically, sentiment drops among members of the party that is not in control of the White House in the first few months of any new presidency — and it is particularly low among Democrats right now. But the rate of change for May was not as severe as April. And, interestingly, sentiment fell faster among Republicans: average Republican sentiment was down 6 points from April, while Democratic sentiment only fell 0.5 points. If that trend continues and Trump starts to lose more support from his base, we imagine he will continue to lower the US’s trade barriers. Then consumers will really have something to celebrate.

(Kim)

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