China’s economy has been slowing since 2007 and is expected to slow further. But we believe that it’s now possible to identify the beginning of trends that, in time, could ease China’s decline and help its growth to stabilize.

One of the interesting aspects of the correction in China’s A Shares market in June and July was that it refocused concerns on the country’s economic health, even though the rally (driven mainly by retail buying, margin loans and optimism about government reforms) and subsequent slump bore little relationship to economic fundamentals.

This lack of a connection was underlined by the economic data for August, which showed little change from the three months prior, when the A Shares market had been surging. On this evidence alone, we think that investor concern about China is out of proportion to the actual state of the economy.

The data showed a continuation in the sluggish growth environment. Amid the gloom, however, there was a welcome ray of light. It came from the property market, one of the sectors that has been of most concern to investors and policymakers.

Hopes Rise for Infrastructure

Housing investment and new project starts fell further in August; importantly, though, transactions stayed strong (up 15.6% year over year) and mortgage lending rose sharply (up 50% year over year, for the third consecutive month). Sales of household appliances and furniture improved, too.

These trends are particularly encouraging because they point to a true market-based correction brought about by rising demand and a relative scarcity of supply. They reflect a fall in housing inventory and the fact that property developers—still nervous after the equities crash and last month’s currency devaluation—are not rushing to build. In our view, however, the market is ignoring these signals and underestimating the potential for a spillover effect from the housing sector into the rest of the economy.

There is anecdotal as well as statistical evidence to suggest that momentum for an uptick in activity is starting to build. Earlier this year, the central government introduced a budgetary law that forced provincial and municipal governments to reduce their dependence on bank finance and raise capital in the domestic bond market. This gave rise to the municipal bond sector, which raised RMB1.7 trillion (US$267 billion) in its first three months of operation.

Once the central government announces its 13th Five-Year Plan next month, we expect this pool of liquidity to be channeled into infrastructure and other activities, which will provide a boost to the economy late this year and into 2016.

Warnings Are Misplaced

The switch by local governments from bank finance to bonds is a welcome development in its own right, as it reduces concentration risk in the banking system and contributes to overall financial stability. The growth of the shadow banking market, which until recently was another headache for regulators, has also become much less of a concern.

In light of this, the warnings in recent media and sell-side broker reports about the increasing downside risks to China’s economy—and the consequent negative implications for the global outlook—seem misplaced.

Instead, we expect that, by the middle of next year, China’s growth may well have steadied and formed enough of a base for a rebound. That, in turn, suggests that the current pricing of risk in China’s markets is far too conservative.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.