What’s on the horizon for China?

Following a rapid rally before the Golden Week holiday, China's equity markets have cooled. Both the CSI 300 Index and the Hang Seng Index have retracted by more than 10% since October 8th. Despite this, both indices remain up nearly 20% since mid-September. After the consequential Politburo meeting on September 26^th, policymakers remain in the spotlight, with the latest press conference from the Ministry of Finance hinting at further fiscal expansion in 2025. As more developments unfold and the U.S. election approaches, investors have much to consider.

In this week’s Asia Strategy Focus we explore some of the recent developments by responding to five key questions.

What we think

The recent policy shift in China is a pivotal move aimed at addressing the risk of a debt-deflation spiral. Unlike the April/May measures focused on housing inventory, policymakers are adopting a comprehensive strategy that includes monetary, fiscal and industry-specific measures. However, sustainable economic stabilization requires further clarity on growth strategies, especially in the housing market. Meanwhile, business confidence remains subdued, and the export landscape will likely be clouded by the uncertainties of the upcoming U.S. elections.

Investment implications

Despite the lack of detailed stimulus measures, the commitment to economic stabilization is a positive signal. Market volatility remains likely, and as China remains a tactical trading market, investors should remain selective and focus on alpha opportunities. For qualified investors, structured products may be worth considering. A 8-10% market pullback could offer attractive medium-term investment prospects. We continue to prefer onshore over offshore China for investors looking to add medium-term exposure.

1. What’s changing on the Chinese policy front? 

In our view, the Politburo meeting in late September marks the beginning of a policy shift. After three years of deleveraging, the economy has slid into deflation and faces the rising risks of a debt-deflation spiral. We believe policymakers recognize the need for change and are now undertaking a comprehensive, multi-pronged effort to reverse this trajectory. In recent weeks, numerous programs have been either announced or implemented. Beyond lowering interest rates, injecting liquidity, and recapitalizing major banks, fiscal policy will likely also step up to provide more targeted support for the economy. The table below summarizes some of the key measures. 

Debt swaps will likely alleviate near-term liquidity pressures, allowing local governments to refocus on economic development. The Ministry of Finance has discussed significantly raising the debt limit and hinted at substantial room for the central government to increase debt and deficits. This would be a meaningful step to allow more investment and spending to take place.

A key question among investors is what differentiates the current situation from April/May, when the government also introduced measures to lower housing inventories. But we believe this is a major step up in fiscal policy. More broadly, a multi-pronged approach – including monetary, financial, fiscal, and industry-specific measures – indicates a more significant shift from a macro perspective, and additional policy measures appear to be in the pipeline as well. Nonetheless, there are many competing demands – and we think the key areas to watch are consumption-related support and potential further measures aimed at stabilizing the housing market.

2. What does this policy shift mean for the economy?

We think this multi-pronged policy approach could meaningfully reduce the risk of a vicious debt-deflation spiral. Local governments play a crucial role given their connection to local businesses and the labor market. Although specific numbers are not yet available, most support measures for local governments seem to have been authorized and are awaiting final confirmation and interpretation. For investors considering the macro outlook, the commitment from monetary and fiscal authorities to bridge the funding gap for local governments in a somewhat open-ended manner could help mitigate the downside risks to financing. Since many investors (including ourselves) have already accounted for a persistent drag from local governments, or the risk of a standstill in local economies, easing this risk suggests there is modest potential for GDP growth upgrades over the next one to two years.

However, for a more comprehensive reflation we need greater clarity on the policy approaches that will address growth challenges. For instance, while housing market activity saw a slight revival in October, a meaningful stabilization will likely require further inventory clearance, the easing of the liquidity crunch, and a recovery in household sentiment. Business confidence remains subdued, and the export outlook could be further shaped by the upcoming U.S. elections. Lastly, progress on market-based reforms that can unlock productivity gains are essential to improving China’s long-term outlook. Without durable structural reforms, potential growth could continue to undershoot.

3. What are some of the catalysts to watch for in the coming weeks?

Several key catalysts are anticipated in the coming weeks and months. The Standing Committee of the National People’s Congress is expected to convene in late October, potentially providing official confirmation of previously discussed fiscal plans. The U.S. elections in early November may significantly influence market dynamics and risk assessments. Furthermore, a Politburo meeting focused on the economy is scheduled for late November, preceding the Central Economic Work Conference in December. Depending on economic and market developments, we may gain further insights into the forward-looking strategies recently outlined by officials. Given that the scale of many policies remains unconfirmed, there is scope for expansion should policymakers deem additional economic support necessary. It is noteworthy that policymakers are adopting a more proactive stance, which may increase the likelihood of unscheduled meetings.

4. What is the outlook for the equity market?

Despite the lack of detailed stimulus measures, the stronger commitment to economic stabilization is a positive signal. The path to sustained recovery has become clearer following recent official press conferences. As equity market expectations adjust, a gradual bull market appears more likely. A rapid bull market, similar to recent weeks, or 2015, may not benefit the general public and could pose risks to financial stability. We anticipate elevated volatility due to low conviction levels – and while FOMO (fear of missing out) and under-positioning are both less of a factor, thus limiting near-term gains, dips are likely to attract buyers due to the persistently light positioning. China remains a tactical trading market, so it's important to stay selective and seek alpha opportunities. Investors can also consider monetizing these opportunities through structured products. A pullback of 8-10% could present better medium-term investment opportunities.

In terms of fundamentals, a more optimistic growth outlook for 2025 has ended the cycle of earnings downgrades. We foresee potential for earnings upgrades in 2025/26, likely occurring in March/April 2025 during earnings season, as visibility improves. J.P. Morgan Investment Bank estimates that a RMB 2 trillion fiscal stimulus package could increase 2025 MSCI China/CSI300 earnings per share (EPS) growth by 4-5 percentage points, from 10.7%/13.4% to 15.9%/17.3%.¹ A RMB 4 trillion package could further boost EPS growth to ~21% for both indices.

5. What is our current investment outlook?

Recently, consumption stocks have experienced a sell-off due to the lack of direct consumption-related stimulus, which may present an opportunity for those considering buying the dip. We believe consumption could play a significant role in the recovery. Many high-quality consumption stocks are trading below 20x forward price-to-earnings (P/E), suggesting attractive valuations. Meanwhile, several large-cap stocks have risen over 30% over the month, so investors could consider trimming positions in concentrated stocks for diversification. Given the high market volatility, trading within the range in offshore China (MSCI China 60-70/HSI 18,000-23,000) or exploring structured products for qualified investors could be attractive strategies. We continue to prefer onshore over offshore China for investors looking to add medium-term exposure.

These insights are for informational purposes only, and suitability will vary based on each investor's unique risk tolerance and financial objectives

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Index definitions:

CSI 300 Index: A capitalization-weighted stock market index designed to replicate the performance of the top 300 stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange.

The MSCI China Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31, 1992. This index is priced in HKD. Please refer to M3CN Index for USD.

Hang Seng Index is a free float-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong.