Investment Strategy

What’s on the horizon for China?

Oct 18, 2024

Authors: Julia Wang, Timothy Fung

 

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 26th, 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.

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.

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.

 

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. 

CHINA ANNOUNCED A SLEW OF POLICIES IN RESPONSE TO WEAK MACRO DATA AND PROPERTY PRESSURES

Announced policy measures

Source: Various government announcements, J.P. Morgan Private Bank. Data as of October 16, 2024.
At a recent press conference held by the Ministry of Finance, further information was provided regarding the likely areas of focus for next year. Although the meeting fell short of expectations in terms of specific fiscal stimulus figures, it was meaningful in two ways. First, it offered a four-point action plan; addressing local government debt swaps, state bank recapitalization, the housing market, and financial support for special income groups. In our view, the first two are significant steps towards enabling local governments to spend and invest, thereby supporting businesses and the labor market. Local government spending has significantly lagged in 2024 due to the unexpected backdrop of falling revenue, a locked debt limit, and constant pressures to restructure both on- and off-balance sheet debt.

LOCAL GOVERNMENT SPENDING HAS SIGNIFICANTLY LAGGED IN 2024

Local government spending, RMB trn

Source: Wind, J.P. Morgan Private Bank,. Data as of August 31, 2024.
The line chart shows China’s local government spending in RMB trillion for 2024 vs. the expected spending implied by original budget from February to December. Local government spending, implied by original budget is expected to increase from 5 RMB trillion in February to 35 RMB trillion in December. However, the actual spending by local governments has only increased from RMB 5 trillion to 19.6 RMB trillion as of August 2024. Compared to the expected spending of 22 RMB trillion in August 2024, the spending is trailing forecast by RMB 2 trillion.

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.

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.

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.

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.

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

OFFSHORE CHINA REMAINS A TRADING MARKET, BUT IN A HIGHER AND WIDER RANGE

MSCI China June 2025 Scenarios (utilizing JPM PB estimates)

Source: Bloomberg Finance L.P. Data as of October 16, 2024.
The chart shows the price of MSCI China from October 2023 to October 2024, as well as J.P. Morgan Private Bank’s June 2025 scenarios and estimates. For bull case, we expect a share price of 79-81, next 12-month P/E ratio of 12.7x and June 2026 earnings per share of 6.5 – 6.8. For base case, we expect a share price of 67-68, next 12-month P/E ratio of 11.5x and June 2026 earnings per share of 6.0 – 6.2. For bear case, we expect a share price of 53-55, next 12-month P/E ratio of 10.4x and June 2026 earnings per share of 5.1 – 5.5. MSCI China price level was largely range-bound from October 2023 to April 2024, trading close to our bear case scenario price level of 53-55. It rose sharply in April 2024, from 54 to 64 in May 2024. However, the rally quickly fizzled out and the price fell back to 54 in September 2024 before rebounding sharply to reach a peak of 76 in early October 2024 after China's central bank unleashed a blitz of policy support for the economy. After the sharp rally, it has retracted back to 66 as of 16 October 2024, near our base case of 67- 68.
1J.P. Morgan Investment Bank. China Equity Strategy: EPS sensitivity Part I: MoF & its upcoming stimulus. Data as of October 13, 2024.

All market and economic data as of October 17, 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.

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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.

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JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC ("JPMS"), a member of FINRA and SIPC. Insurance products are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states.

 

Please read the Legal Disclaimer for key important J.P. Morgan Private Bank information in conjunction with these pages.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

Bank deposit products, such as checking, savings and bank lending and related services are offered by JPMorgan Chase Bank, N.A. Member FDIC.

Not a commitment to lend. All extensions of credit are subject to credit approval.

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