Author: Asia Investment Strategy team
In the days leading up to the 75th anniversary of the founding of the People’s Republic of China, policymakers announced a string of easing measures. The timing and magnitude of these policies caught many investors off guard, and both the Hong Kong and China onshore equity markets have rallied strongly over the past week to log some of their best performances since 2008. Many clients are now asking: Is this time different? Where do markets go from here? What are the implications for investors?
CHINESE EQUITIES DELIVERED SOME OF THEIR BEST RETURNS IN YEARS ON POLICY SUPPORT
Total cumulative returns year-to-date, %
The line chart illustrates the year-to-date cumulative returns, expressed in percentage terms, for the Hang Seng and CSI 300 indexes from January 2024 to September 2024. Throughout this period, both indexes exhibited range-bound behavior until recent weeks. Notably, the Hang Seng index demonstrated a broader trading range compared to the CSI 300. The Hang Seng and CSI 300 initially declined by -12% and -6% in January 2024 but gradually rebounded, delivering returns of 15% and 8% by May 2024. However, the rebound was short lived as Hang Seng and CSI 300 declined since Jun 2024. As of 11 Sep 2024, total cumulative year to date returns for Hang Seng and CSI 300 were 0% and -7% respectively. From 11 Sep to 30 Sep 2024, Chinese equities delivered some of their best returns on policy support which beat expectations. Both Hang Seng and CSI 300 rose sharply, with total year-to-date cumulative returns of 24% and 17% as of 1 October 2024.
In this week’s Asia Strategy Focus, we discuss China’s latest policies, the macro and market outlook, and importantly, the opportunities and risks for investors.
What we think
The policy shift in China is a meaningful one. Policymakers are sending a clear signal to stop the de-leveraging spiral, which was a tail-risk many investors were worried about. Rate cuts in developed markets also provide a more favorable backdrop. In our view, the policy change warrants a substantial shift in the outlook, as it meaningfully reduces the downside risk to the economy and markets. That said, it is not yet translating into stronger growth. To overcome its various growth challenges, the economy likely still needs more policy direction and support in the coming months.
Investment implications
We are increasing our Chinese equity price outlooks and shifting the strategic view from negative to neutral. We see muted depreciation pressures for the currency as well. Government support for markets is explicit and we think present a near-term tactical opportunity. However, there are still question marks over policy details, and whether these measures are enough to spark a sustained reflationary impulse. Investor positioning is an important part of our recommendations – those with a large overweight can use this opportunity to trim allocations, while those with little or no China exposure can play the near-term tactical rally.
What policies were announced?
The newly announced policies encompassed monetary, fiscal and regulatory support aimed at supporting growth. What is interesting about this round of policy support is that they have been on multiple fronts, larger in magnitude, and generally unexpected by markets from a timing perspective. This represents a departure from stimulus efforts of the past two years, which were generally piecemeal and fizzled out over time. As a result, the announced measures handily beat low market expectations and sparked a rally in Chinese assets.
CHINA ANNOUNCED A SLEW OF POLICIES IN RESPONSE TO WEAK MACRO DATA AND PROPERTY PRESSURES
Announced policy measures
Furthermore, an off-cycle Politburo meeting also focused on the economy and signaled for more expansionary policies to come – perhaps an even bigger surprise for markets.
Why did the policy stance change?
These newly coordinated announcements of rate cuts, direct support for equities, and increased fiscal support indicate a greater sense of urgency to pull the economy out of deflation and restore confidence among consumers and private sector businesses.
A major difference this time is that the PBOC is focusing on ending the self-reinforcing deleveraging cycle that has dragged on the economy. The deleveraging cycle occurs when borrowers repay their loans and banks have to contract their balance sheets, which in turn pressures out other borrowers from normal business loans, dimming the economic outlook and further perpetuating the deleveraging cycle. Credit supply is available, but loan demand has been weak, a reflection of the pessimistic outlook held by households and businesses.
POLICYMAKERS ARE SENDING A SIGNAL TO END THE RECENT STRETCH OF DELEVERAGING
Credit growth, percentage point change, %
The chart illustrates credit growth and the 12-month change in credit growth. Credit growth is depicted on the left axis and represented by a line, while the 12-month change in credit growth is shown on the right axis and represented by a bar chart. Credit growth declined from 16.2% in August 2013 to 9.1% in February 2017, then increased to 13.4% in February 2018. It declined to 10.3% in December 2018 then remained largely rangebound until February 2020, and rose to 13.7% in October 2020. Credit growth then fell from 13.6% in November 2020 to 8.1% as of August 2024. Credit growth, 12-month change started in negative territory from January 2014, reaching a trough of -27.1 in July 2015 and then rebounded back to positive territory in 2016. Credit growth, 12-month change rose from 1.85 in April 2016 to a peak of 46.8 in February 2018, then declined again back to a low of -20.5 in February 2019. It increased again from -20.5 in February 2019 to 29.5 in October 2020. Since then, it has been on a decline from 29.5 in October 2020 to -27.0 in October 2021. 12-month change of credit growth has largely remained in negative territory from April 2021 to July 2024.
Through this set of measures, policymakers are signaling that they are trying to stop the deleveraging cycle. The announced policies are geared towards stabilizing the financial channel in the economy, such as lowering borrowing costs, boosting liquidity to maintain asset values, stabilizing credit growth, and recapitalizing big banks – all aimed at boosting confidence to borrow and invest.
POLICYMAKERS ARE FOCUSED ON REDUCING THE DOWNSIDE RISK OF AN ENTRENCHED DEFLATIONARY TRAP
The chart shows China’s real and nominal GDP growth, as represented by the left axis and GDP deflator (nominal GDP growth – real GDP growth). If the nominal GDP growth rate is higher than the real GDP growth rate, the GDP deflator will increase, indicating inflation. Conversely, if the nominal GDP growth rate is lower than the real GDP growth rate, the GDP deflator will decrease, indicating deflation. GDP deflator started at 3.7% in March 2022 but has steadily declined since then to -0.4% in December 2022 when real GDP growth surpassed nominal GDP growth. There was a slight rebound in March 2023 when we saw deflator rebounding back to a positive 0.7% as nominal GDP growth came in higher than real GDP growth. However, that was short lived as GDP reverted to negative levels and has remained largely flat around -0.7% to -1.1% since June 2023. During the period from June 2023 to June 2024, real GDP growth has been outpacing nominal GDP growth. As of Jun 2024, GDP deflator is -0.7% as real GDP growth of 4.7% is higher than nominal GDP growth of 4.0%.
It appears policymakers have shifted from avoiding moral hazard to focusing on an ever-worsening de-leveraging spiral. The shift is a clear recognition of the downside risks the economy is facing – deflation, weak investment, falling housing sales, and perhaps crucially, signs that the labor market is deteriorating. Many investors have been asking when the slowdown will end. Businesses have been under significant pressure from slowing growth and China’s challenging long-term economic transition. Youth unemployment was becoming a bigger issue and wage growth has turned negative.
CHINA’S YOUTH UNEMPLOYMENT HAS BEEN A PERSISTENT PROBLEM
Urban unemployment rate, age 16-24, %
The chart shows China’s urban youth unemployment rate, age 16-24 from January 2024 to August 2024. China’s youth unemployment started at 14.6% in January 2024 and rose slightly to 15.3% in February 2024 and March 2024. It then fell from 15.3% in March 2024 to a low of 13.2% in June 2024. It then spiked from 13.2% in June 2024 to 18.8% in August 2024.
WAGE GROWTH, EVEN IN NEW ECONOMY SECTORS, HAVE BEEN UNDER PRESSURE
The chart shows China’s average entry level salary for new economy sectors, a represented by the left axis and year-over-year growth on the right axis. China’s new economy average entry level salary has been on a steady rise from RMB 7409 in August 2015 to RMB 14191 in July 2023. However, it has been declining since July 2023, reaching RMB 13464 in July 2024. Similarly, year-over-year (YoY) wage growth in new economy sectors, have also been under pressure. Wage growth was largely range bound during the period of 2016 to 2022 but has been on a steady decline since March 2022. YoY wage growth started at 15.7% in August 2016 and has declined to -6.1% in August 2024, although there were some volatility in between.
With these policy interventions, policy easing can buy time for businesses to restructure their balance sheets, reorganize and adapt to those structural changes, while minimizing labor market disruptions and the downside risks to consumption and growth.
BUSINESSES ARE UNDER PRESSURE FROM CYCLICAL AND STRUCTURAL CHANGES
Industrial profits, year-over-year %
The chart shows China’s year-over-year (YoY) industrial profits, in percentage terms from 2013 to 2024. YoY industrial profits started at 17.0% in February 2013 which fell to -10.4% in December 2014. It then increased to 25.9% in August 2017 but plunged to -24.0% in December 2017. YoY industrial profits stayed volatile from 2017 to 2019 and largely remained in the negative territory. YoY industrial profits saw a brief resurgence, reaching 13.7% in December 2019 but the trend reversed dramatically, plunging to a historic low of -42.0% in February 2020. Industrial profits experienced a drastic rise from 2020 to 2021, driven by a post-pandemic recovery and increased global demand. However, it fell again from 2021 to -26.5% in April 2023, then rose to 14.1% in April 2024. The trend has since reversed, with YoY industrial profits falling from 14.1% in April 2024 to -22.2% as of August 2024.
While the internal environment put more pressure on policymakers, the external environment also opened a window of opportunity. With the Fed cutting rates more aggressively than markets expected, the PBOC (and many other emerging markets) has more room to ease as well. This increases the likelihood for a more sustained period of global policy easing, lending more support for growth in China.
Is this package sufficient to drive growth higher?
This is a meaningful positive shift, but we are not yet changing our GDP growth outlook. In particular, we will watch to see how these policies will fit together with the changing structure of the economy. There are three things to watch:
1. What are the details of the fiscal stimulus? So far the pronouncements of increased fiscal support are lacking concrete details in terms of size or implementation. To change the trajectory of economic growth, more fiscal support is likely needed. There are still a lot of growth challenges, and how the fiscal policies play out in terms of magnitude and direction remain to be seen.
MORE FISCAL SUPPORT IS NEEDED TO LIFT GROWTH; POLICY DETAILS CAN HELP DETERMINE THE ROOM FOR AN ECONOMIC RECOVERY IN 2025
Fiscal revenue and spending, 6-month moving average % change
The chart shows 6-month moving average % change of fiscal revenue and spending from 1990 to 2024. China’s fiscal revenue and spending has been largely range-bound from 1990 to 2006, with 6-month moving average % change of fiscal revenue hovering between the range of 0 – 40% and fiscal spending between the range of 10 – 35%. Both fiscal revenue and spending took a plunge in 2008 due to the Global Financial Crisis. Fiscal revenue and spending 6-month moving average % change declined from 32% and 37% in June 2011 to 6.8% and 14.1% in June 2013 respectively. From June 2013 to July 2019, it remained range-bound but both fiscal revenue and spending fell again due to the Covid-19 pandemic, reaching -12% and -3.7% in August 2020. Fiscal revenue and spending % change were largely volatile from 2020 to 2024 but remained depressed compared to historical levels. Fiscal revenue % change fell from 8.8% in December 2023 to -2.63% in August 2024. Similarly, fiscal spending % change fell from 4.3% in December 2023 to 2.63% in August 2024.
2. China’s economic structure is changing. Compared with 2008 and 2015, debt levels are higher, overcapacity is worse, and rates are lower. Policymakers have been trying to change the growth drivers, away from housing markets, towards higher end manufacturing. This may limit the usefulness of traditional policy choices or levers.
3. Low confidence. Much of the post-Covid slowdown is marked by rapidly declining sentiment. Overall measured confidence among households and businesses are at historic lows. Apart from the housing downturn. Tighter regulations and a move away from a singular focus on growth to multiple competition priorities all contribute to lower confidence in the economy. It's unclear if this jolt will change that.
Where does the property market go from here?
While the PBOC announced more support for local government and state entities to buy unsold housing, and clear verbal support for house prices, there is still uncertainty whether the sector can stabilize after multi-year downturn. Despite measures already rolled out to support the sector, home sales have continued falling. This suggests many buyers do not see housing as a good enough bargain. Sales volumes have collapsed, but prices have declined by less. Government support for de-stocking might bring some confidence to the market, but it’s unclear if the sector has found an equilibrium.
THE ECONOMY REMAINS UNBALANCED WITH OVERALL WEAK DEMAND, WHILE HOME SALES HAS COLLAPSED
Indexed level, Sep 2019 = 100
The chart shows China’s home sales, retail sales, industrial production, and exports by value, indexed to 100 in September 2019, from 2015 to 2024. These metrics were growing steadily and in close alignment, indicating consistent and broad-based growth across all sectors from 2015 to 2019. This was followed by a dip in January 2020 due to the Covid-19 pandemic and a quick recovery in March 2020. From June 2020 onwards, a divergence is observed: exports significantly outperformed, retail sales and industrial production maintained a steady upward trend, while home sales declined sharply and eventually collapsed. Exports rose from 83.1 in April 2020 to 149.4 in July 2022 and remained largely range-bound, reaching 142.0 in July 2024. Industrial production rose from 95.2 in April 2020 to 126.9 in July 2024, growing at a steady pace similar to pre-pandemic trends. Retail sales observed a similar trend, increasing from 77.1 in April 2020 to 116.5 in July 2024. On the other hand, home sales have been on a sharp decline after rebounding from 2019 levels, falling from 113.8 in October 2020 to 51.0 in July 2024.
Do these policies change our investment view?
At a minimum, they greatly reduce the downside risk for markets and introduce an element of potential upside risk to our outlook. A key positive implication is that the PBOC is stepping up to minimize what many investors feared was the risk of a prolonged cycle of deleveraging. In addition, the equity market is a direct beneficiary of some of the announced policies.
Beyond this sharp rally, should investors consider building a larger strategic position, or is this just a tactical opportunity? For the former, we need to see companies generating stronger earnings going forward. We see onshore equities as a tactical opportunity right now, and we will wait-and-see before turning more positive on China from a strategic perspective.
How much more upside is left in equities?
This round of policy support leads us to upgrade our China equity view to neutral. We raise our offshore (MSCI China) end-2024/June-2025 outlook by 12% to 65-66/67-68, and onshore (CSI 300) end-2024/June-2025 outlook by 12% to 3,900-3,970/4,050-4,150. However, these figures imply little upside from current levels. The strong rally has likely front-loaded a lot of the positive news, and as a result the risk of market consolidation has increased, especially during the Golden Week holiday. A 10% or greater correction represents a trading opportunity with an implied “policy put” of the CSI 300 at around 3,100.
However, with a clear directive for potentially RMB800bn in credit facilities to be deployed into the onshore market, we see a near-term tactical opportunity and room to catch up to the offshore market (which has outperformed significantly this year). The scale of the stimulus is notable – equivalent to the amount of government-linked entities’ (or National Team’s) net ETF purchases year-to-date, according to a J.P. Morgan Investment Bank estimate. It is unclear if there are any direct liquidity benefits for offshore equities.
If substantial consumption-driven and property-related fiscal measures follow through in the next few weeks, this market rally may be able to extend and provide room for us to raise our index outlooks. Investor positioning in Chinese equities remains light, and if their confidence recovers further and they start to rebuild their positions, the buying interest could be significant, but this is not our base case.
However, for most of the last 15+ years, rallies in China have been almost entirely driven by multiple expansion with little sustained earnings growth – and as such those rallies have proved temporary. If the economy improves and companies begin to sustainably generate more earnings per share, we would turn more strategically positive in the long-term, but investors would be wise to exercise patience.
CHINESE EQUITIES HAVE HISTORICALLY STRUGGLED TO KEEP PACE WITH THE ECONOMY
Indexed to Q2 2010 = 100
The line chart shows MSCI China earnings, index level and China GDP (indexed to Q2 2020 = 100) from 2006 to 2024. China GDP grew from 51.3 in March 2006 to 325.1 in June 2024. However, this has not been translated to MSCI China earnings and price level. MSCI China earnings rose slightly from 62.1 in April 2006 to 132.9 in August 2024. From 2010 to 2024, MSCI China earnings was largely flat. Similarly, MSCI China price levels rose from 61.9 in April 2006 to 171.1 in October 2007 and declined back to 58.9 in October 2008. It then remained range-bounded from 2009 to 2017, before increasing to 193.7 in January 2021. Since then, MSCI China index price level has been on a decline, falling to 94.8 in August 2024.
What about the currency?
For the most part of this year we saw a bearish case for CNH, given 1) weak China sentiment and capital inflows, 2) wide negative carry, and 3) tariff risks and broader geopolitical concerns. The new policies have mitigated the risk of the first factor. In terms of carry, CNH rates may fall further if we see more meaningful monetary easing. The third pillar remains, and the U.S. election will likely be the next defining event for the geopolitical trajectory.
The factors above suggest the currency implications are more mixed instead of being outright bullish. Some bearish tail risks have been minimized, but a sizable policy easing suggests more supply of the currency. This is a bearish scenario unless the supply is outweighed by demand, so whether improved sentiment can lead to sustained capital inflows will likely be key to watch.
THE TRADE-WEIGHTED RMB STILL ABOVE 2018-20 LEVELS; PERSISTENTLY NEGATIVE CARRY AND TRADE PRESENT RISKS TO THE CURRENCY
CFETS RMB Index
The chart shows CFETs RMB Index which measures the value of Chinese yuan (RMB) relative to a basket of currencies. The index is managed by the China Foreign Exchange Trade System (CFETs), which is a subsidiary of the People’s Bank of China (PBoC). The purpose of the CFETs RMB is to provide a more comprehensive view of the yuan’s value against a broader range of currencies, rather than just the U.S. dollar. The CFETs RMB Index started at 95 in 2017 and increased to 97.85 in June 2018. From June 2018 to January 2020, which is the period of the U.S. China Trade War, the CFETs RMB Index declined from 97.85 to 93 in January 2020, it then increased steadily to a peak of 106.8 in March 2022. From March 2022 to July 2023, the CFETs RMB Index fell from 106.8 in March 2022 to 95.9 in July 2023. It then increased to 100.7 in April 2024 but has dipped to 98.36 as of September 2024, which is still above the 2018-20 levels. Persistent negative carry and U.S. China trade tensions could present risks to the currency in the near-term.
Another important factor is the PBOC's approach towards the FX market. We have started to see interventions to weaken the yuan and clear communications from officials expressing concerns over a one-way appreciation of the currency. This can put a floor on how low USD-CNH can go.
We lower our USD-CNH outlook to 7.10 (7.00 to 7.20) on a partial relief of negative tail risks. We are still cautious on CNH's longer-term outlook given extended negative carry and geopolitical uncertainties, especially against a basket of trading partners’ currencies.
Conclusions
These policy shifts are a meaningful change. The combination of monetary and fiscal policy easing reduces the downside risk, and depending on how fiscal support materializes, introduces some potential upside risk. We are increasing our Chinese equity price outlooks and shifting the strategic view from negative to neutral. We see muted depreciation pressures for the currency as well. Government support for markets is explicit and we think present a near-term tactical opportunity. However, there are still question marks over policy details and whether they are enough to spark a sustained reflationary impulse. Investor positioning is an important part of our recommendations – those with a large overweight can use this opportunity to trim allocations, while those with little or no China exposure can play the near-term tactical rally.
The policy initiatives indicate a substantial shift in how the government is approaching the economic situation in China. Will it succeed? Time will tell, but in the near-term the market is taking it positively and at a minimum it greatly reduces downside risk – both to China and the global economy.
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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.
The CFETS RMB Index mainly refers to CFETS (China Foreign Exchange Trade System) currency basket, including CNY versus FX currency pair listed on CFETS. The sample currency weight is calculated by international trade weight with adjustments of re-export trade factors.
