Outlook for China Related Stock Markets
The Chinese markets keep threatening a recovery , with rallies in October 22 and July 23 both fading out as weaker economic data and very poor investor sentiment overwhelmed ‘bottom fishers’. The chart above tells the picture over the last month but over the last 5 years it would look even more dire as Chinese equities have underperformed the world index by more than 50%.
The cause of the recent sell off has been poorer economic data than expected.. All the main activity indicators undershot consensus expectations in July, with most either stagnant or barely expanding in m/m terms. And with financial troubles at developers such as Country Garden likely to weigh on the housing market in the near-term, there is a real risk of the economy slipping into a recession unless policy support is ramped up soon – the recent rate cut of 0.15% wasn’t big enough to shift the dial.
Policy makers correctly identified household confidence as the crucial factor affecting the recovery. They had initially anticipated an improvement in confidence, which would have propelled consumption and provided stability to the property market. However, survey-based indicators of confidence deteriorated during the second quarter even after reducing mortgage rates to historic lows. It seems that the tumultuous conclusion of the zero-covid policy has left households grappling with a form of post-traumatic stress disorder. As a result, precautionary savings remain high, and consumers are primarily inclined to spend on affordable entertainment.
So what can be done and how willing are the authorities to tackle slowing economic growth? Two broad levers are available, monetary and fiscal policy and I think the PBOC and Government will pull both. They have cut rates, but I suspect more will come. They have a worry that cutting rates will devalue the Renminbi more than they want, but if they can show they are serious about defending the currency I think this will give them room to cut rates further. At a fiscal level, I would expect them to fall back on their tried and tested policy of spending on infrastructure and stimulating the property market. Expect widespread infrastructure projects to be introduced, probably with an environmental bias. Another measure that could be introduced is reducing the minimum deposit needed to buy a house from 20% to 15% or even 10%. I think the point I am trying to convey is that they have a lot of tools at their disposal to get the economy firing and it is now reaching the point when I would expect them to act. It will take a while for the population to overcome Covid PTSD, but it will happen, just much slower than in the West where the Covid experience wasn’t as traumatic as that for many Chinese citizens who were typically couped up in a crowded apartment for more than a year!
It would also seem that unlike last year when common prosperity and technology regulation were at the forefront of the minds of the leadership, that they now wish to see a resurgent stock market. China never wants to lose face and the state of their equity markets is becoming a growing embarrassment for a country that wants to present itself as the world’s greatest powerhouse. This is probably the source of my greatest optimism. Just in the last week Chinese authorities have intensified their efforts to support the country’s financial markets, reflecting growing concerns about the rapid declines in both stock prices and the value of the yuan. Last week, mainland exchanges requested that certain investment funds refrain from net selling equities. Officials have also urged state-owned banks to increase intervention to stabilize the yuan’s value. Additionally, companies listed on the tech-heavy Star Board have been encouraged to initiate share buybacks. The securities regulator announced its intention to reduce handling fees for stock transactions and explore the possibility of extending trading hours for equities and bonds. These actions follow the People’s Bank of China’s surprise interest rate cut, the most significant since 2020.
However, these measures have not yet had a significant impact on the markets. Last week Hong Kong-listed Chinese stocks recorded a third consecutive week of losses, and foreign investors have been net sellers of Chinese stocks, concluding a streak of outflows that set a record. This will not sit well with the powers that reside in Beijing and I would expect China to step up its efforts to revive consumption in the broad economy, as well as equity specific support, which potentially includes a cut in the stamp duty on stock trading, lifting of foreign investment caps and relaxation of equity trading rules.
Stepping back and looking at the big picture. The Chinese economy is still likely to achieve growth of near 5%, considerably ahead of the developed world. It does not have an inflation problem, if anything deflation is a greater fear. Now one of the advantages of China being a ‘benign dictatorship’ is that it can respond in ways that free market economies cannot, and the authorities have begun to act, and I will never rule out the ability of their state to engineer a positive outcome. Don’t fight the Fed or the wishes of the Chinese authorities are probably still two useful investor axioms.
Finally, the Chinese Stockmarket is exceptionally cheap on the world stage, both in absolute terms and relative. Global investors are significantly underweight Chinese equities and any sniff of a reversal in the Stockmarket could see a tidal wave of money hitting the markets and the rebound could be very significant. For what it is worth, for the funds I manage and personally, I think the recent sell off has created a good entry point and for those already having exposure to the region, I think now would be a bad moment to throw in the towel.
Much of this was caused by the zero covid policy implemented by the authorities that hindered growth and consumer spending throughout 2021/2. This policy has now been reversed and we are only now beginning to see a dramatic recovery in economic growth levels that in time will feed through in to improved company earnings and share prices. Chinese equities are also under-represented in global asset allocation, a position we expect to reverse, and we would expect increased buying of the market. We therefore have a high conviction that Chinese equities and related indices can make strong progress from current levels.
Why are we so positive? Recent data for the first quarter reinforces our belief that China’s economy is undergoing a gradual recovery led by consumers, which is expected to be sustained by supportive government policies and significant household savings. In fact, China is on track to drive more global economic growth than the combined contributions of the United States, Europe, and Japan.
Of course, there are risks associated with this recovery. One such risk is the possibility of the Chinese government implementing policies that hinder growth. However, this is now considered a low probability risk as President Xi Jinping’s focus is on supporting a consumer-led economic revival. The return of Jack Ma, the prominent entrepreneur and founder of Alibaba, after a year outside the country, indicates Xi’s recognition of the need to create a favourable regulatory environment for the private companies that are crucial to China’s economy. This is particularly positive for the technology sector which makes up most of the constituents of the HSCEI index.
The second key risk lies in the potential crisis in U.S.-China relations. While the political relationship is expected to remain strained, the likelihood of a crisis is considered medium level because both Xi and Joe Biden are pragmatic leaders who understand that further deterioration in relations would harm their respective economies and political prospects. Treasury Secretary Janet Yellen’s April 20 speech also suggests that the Biden administration is adopting a more constructive approach to Beijing, seeking a healthy economic relationship that fosters growth and innovation in both countries.
Consumer confidence in China has rebounded significantly. The economy has made a clear turnaround and is heading towards a gradual recovery driven by domestic demand. Chinese households and entrepreneurs have shown increasing confidence, with notable improvements in retail sales, home sales, manufacturing, and investment during the first quarter compared to the previous quarter. The recovery is further evidenced by the strong resurgence in sales at restaurants and bars, indicating that many Chinese citizens are ready to resume socializing and spending after the impact of the COVID-19 pandemic.
In the first quarter of the year, China’s GDP grew by 4.5% year-over-year, marking the fastest pace in four quarters. Additionally, the quarter-on-quarter expansion of 2.2% is the most rapid since the first quarter of 2021. Importantly, domestic demand played a significant role, contributing 67% to GDP growth, which is the highest consumption share in the past four quarters. Initially, it was expected that this turnaround would begin in the second quarter, but it is evident that the gradual recovery is already well underway. This earlier-than-expected recovery can be attributed to two COVID-related factors. Firstly, there was no second wave of cases following the extensive domestic travel during the Lunar New Year holiday in late January. Secondly, local governments have refrained from implementing lockdowns, alleviating concerns for consumers and businesses.
With Beijing expected to be the only major government engaged in fiscal and monetary policy easing while much of the world tightens their policies, China may once again become the driving force behind global economic growth. Additionally, the relatively low consumer price index, which only rose by 1.3% year-over-year in the first quarter, is projected to remain manageable throughout the year, reducing the risk of jeopardizing monetary policy easing.
So in conclusion, China offers higher growth, lower inflation worries, a government keen to stimulate the economy and attractive valuations, reinforcing our belief that equity indices have the potential to be significantly higher on a 12 month basis.