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Tanner Brown

Analysts label China's economic recovery stable if unimpressive. Medicine and food-service sales key retail outperformance.

China is reporting mixed economic news following last week's political gathering that saw President Xi Jinping strengthen his grip on nearly all facets of the economy and society.

Consumer activity, the leading economic issue discussed at the annual meeting of the country's legislature, is humming along so far this year, according to new government data.

But factory output, long the driver of China's rapid economic growth, is merely inching along -- spraying cold water on increasingly bullish forecasts for the world's second-largest economy.

The latest numbers for other areas, such as real estate and unemployment, paint an equally muddy picture.

China's retail sales -- a proxy for consumption -- grew 3.5% in January and February as compared with the same period last year, according to data released Wednesday by the National Bureau of Statistics.

While only matching forecasts, that was nevertheless a sharp improvement from the big declines seen in the final months of 2022.

Driving the domestic activity were sales of medicine, which grew 19.3%, and the food-service and catering sector, which expanded 9.2%.

Consumption remains an area of particular importance for China's economy. The last 30 years of rapid economic growth have relied mainly on the industrial sector and exports, rather than domestic sales, creating an imbalanced economy that policy makers have struggled to remedy.

The rebound in retail sales are "a welcome respite from declines at the end of last year, although we are all hoping (and expecting) to see much faster increases in the next few months," said economist Michael Pettis.

So are businesspeople. "Our local crowd has been back for some time now," said Liu Jianlin, owner of a hot-pot restaurant in the western city of Chengdu. "But now we're seeing bigger gatherings, more group dinners, and traffic from other cities and provinces."

Yet the heart of the economy, industrial output, underwhelmed. Though the 2.4% growth so far this year is above the 1.3% at the close of last year, it fell short of economists' expectations.

Upstream sectors outperformed, such as the production of crude oil and steel, which both rose more than 3%. But more consumer-facing industries struggled, with automobile output falling a staggering 14% and sales of passenger vehicles tumbling 20%.

"The numbers aren't great, but I don't think anyone expected them to be great given how China was afflicted by the spread of COVID in the first two months," Pettis told MarketWatch. "They are definitely moving in the right direction."

Hong Hao, chief economist of Grow Investment Group, concurred, saying, "All these data suggest that the economy is healing better than expected."

The data come just days after China concluded its most important political summit of the year, which saw Xi begin his controversial third term in office by moving loyalists into key positions.

Top among them is his new No. 2, incoming premier Li Qiang, who told reporters on Monday that his focus was on "high-quality development" and improving citizens' quality of life by lowering prices and stabilizing employment.

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Yet the job market, along with the property sector, showed ongoing weakness in Wednesday's data.

The jobless rate nudged up to 5.6% from 5.5% -- worse than expected and slightly higher than the government's upper-range target.

Doldrums in the real-estate market also persisted, with property investment falling 5.7% so far this year, according to Wednesday's numbers.

The weakness in employment and property may bode poorly for a sustained rebound in consumer activity, analysts said, as they are key suspects behind why household wealth declined for the first time in at least two decades last year.

"This suggests that once the initial reopening rebound has happened, we shouldn't expect a further surge in consumer spending," Julian Evans-Pritchard, an analyst at Capital Economics, wrote in a recent note to investors.

Meanwhile, Chinese stocks may have come to the end of their five-month bull run.

The benchmark Shanghai Composite Index SHCOMP and Hong Kong's Hang Seng Index HSI are both down this month following double-digit growth after China ended its strict "zero-COVID" restrictions late last year.

From the archives (January 2023):Chinese have been snapping up flights abroad as Beijing puts zero-COVID restrictions in the rearview mirror and Chinese New Year nears

"The market has hit the wall after a strong rally from the bottom in late October 2022," Growth Investment's Hong told MarketWatch.

"The U.S. banking failure remains an emotional overhang and potential for risk contagion. We are waiting on the sideline, and watching whether the Hang Seng can hold the 19,000 level before getting back in."

Tanner Brown covers China for MarketWatch and Barron's.

-Tanner Brown

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March 18, 2023 21:00 ET (01:00 GMT)

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