Is this time different in China?

Author: Asia Investment Strategy team

In the days leading up to the 75^th 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?

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.

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.

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.

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.

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.

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. 

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.

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