Chinese equities have been soft and President Trump is threatening a trade war, leading to some jitters about the state of the economy. But new macro data for the second quarter reflect that economic fundamentals and corporate earnings in China remain strong.

In this issue of Sinology, I focus on the health of the largest part of the Chinese economy: domestic demand. I will also explain why even a trade war would have only a modest impact on China.

Equities Soft But Earnings Firm

The Shanghai Composite Index may be down 14% year-to-date through July 13, but profit growth for larger industrial firms (including many not listed on a stock exchange) remains very healthy.

Industrial profits rose 21.1% year-over-year (YoY) in May, the most recent data available, compared to 16.7% a year ago. For the first five months of the year, industrial profits rose 16.5%. That was 1.5 percentage points faster than during the first four months of this year but down from 22.7% during the first five months of 2017. This slower (but still quite strong) earnings growth rate was expected due to the tough base from last year. To put this in perspective, during the first five months of 2016, profits rose 6.4%, and during that period in 2015 profits declined slightly.

Industrial margins in the first five months of this year are at the highest levels in eight years for the same period, and margin expansion continued in May.

Industrial value-added rose 6% in June (vs. 7.6% a year ago) and 6.6% for 2Q (vs. 6.9% in 2Q17), signaling a healthy manufacturing sector.

Still the World's Best Consumer Story

The rebalancing of the Chinese economy continued, and in the first half of 2018, consumption accounted for 78.5% of GDP growth (up from 45.2% in 1H13).