The recent bounce in the Chinese stock market has sparked optimism among investors, leading some to question whether the concerns surrounding the Chinese property market and deflation are something of the past. Whilst the Chinese government have been clear that they’re willing to do whatever it takes to put a floor under the crisis, one should act with caution with going all out of “long Chinese everything”.
It truly was a very significant bounce, only happening a few times for either index in the past, primarily during volatile times like the GFC. Overall, we’re skeptical of the rally, keeping in mind that over 80% of China A-Shares are “retail traders”.
We often like to point out that the financial markets in a particular region does not equate to its real economy, which is true for the USA and Australia, but that effect is ever so true in China. The magnitude of this bounce was probably due to:
Deeply negative positioning by investors (and hence depressed valuations)
Upside surprise of the monetary policies that were announced
Covering short positions (short squeeze)
Above we can see how disappointing the outcomes for Chinese equity investors have been over the past 10 years.
Though when we zoom further out, we can see that the Chinese stock market has only had deep struggles in the past 10 years. Succeeding these struggles, we saw a 30-year period underpinned by investment-lead growth, globalization and hence a cementing of China as the world’s second-largest economy.
Annualized Returns – Equity markets
USA
Australia
Europe
Japan
Hong Kong
34 YR (From 1990)
10.0%
8.6%
7.4%
2.2%
8.5%
20 yr
10.1%
8.6%
7.0%
6.8%
6.4%
10 yr
12.3%
8.0%
7.3%
10.4%
2.0%
5 yr
15.4%
8.4%
9.2%
15.6%
-1.0%
3 yr
8.2%
8.2%
7.5%
14.5%
-7.1%
1 yr
27.1%
16.2%
18.5%
20.7%
-3.6%
Source: Innova Asset Management, Bloomberg, Fred
Perhaps the most impressive statistic is pulling approximately 800 million Chinese people out of poverty from 1980 to 2015, where in 1980 around 88% of the population was living in extreme poverty (The World Bank). The major driving force behind China’s uprise was the market-orientated policies implemented by Deng Xiaoping into a communist society. The 3 main themes of this drastic shift were:
Privatization of SOEs
More power to the state governments (decentralization)
Open-Door Policy (foreign investment)
The mega urbanization and transformation of the country improved the average Chinese persons living standards and has led to China competing with the US on the technological innovation front, which has caused political tension over the past 5 years. A key question for China’s future is the sustainability of its economic model, which is dependent on subsidised lending for infrastructure, manufacturing, and real estate investment.
The Real Economy
To assess the sustainability of the current rally in the Chinese stock market, it is essential to evaluate whether the recent government stimulus can have a meaningful impact on the real economy. China is currently grappling with a “balance sheet recession,” where households and businesses are prioritising debt reduction over spending and investment.
The property crises caused a huge blow to Chinese consumer confidence, due to ~65% of their wealth being tied up in property. Just imagine in Australia, where that % is closer to 55% if property prices were falling between 20-30%, there would be widespread panic, and we’re dealing with 25 million people whilst China are dealing with 1.4 billion. In 2020, the Chinese government, under the leadership of Xi Jinping, made it clear that housing should be considered a place to live rather than a speculative asset. The introduction of the “Three Red Lines” policy reinforced this stance, making it unlikely that the government will rapidly reinflate the real estate market.
China’s initial stimulus in September was primarily focused on credit creation and private sector liquidity – essentially the supply side, where they’ve made it easier for consumers to borrow money. This became an easier decision, coinciding with the US cutting cycle, putting less pressure on the Yuan.
Whilst the monetary measures may have marginal effects, who wants to borrow more when confidence is at all-time lows (very high savings rate) and prices are falling? The money supply (M1) in China will be a key indicator to follow to understand whether the private sector have utilised the lower borrowing rates:
The stimulus certainly aided the consumer confidence and sentiment, but the structural issues embedded within the real economy have not been addressed and do ultimately require significant fiscal stimulus. This brings fragility to the equity market rally, where investors will be begging for a measurable stimulus announcement and a resurgence of domestic consumer demand which makes up 40-50% of GDP.
The Follow up stimulus
Investors were disappointed by the announcements made in the meeting on the 8th of October with the reopening following “Golden Week”. No signs of a “fiscal bazooka” as some were waiting for, and it seems more like China wants to create a floor under the economy and property sector, rather than ramp it up to the moon and create volatility as seen in the past. Price action quickly reflected this “disappointing” news for investors – and affirmed our belief that the real economy would not spring back to its feet as quickly as people may have thought. There was a $15bn USD (100bn Yuan) government spending announcement, though this is negligible compared to the predicted ~$9 trillion USD of impact the faltering property market may impact the Chinese private sector, which some of the most leveraged up globally:
Since then, we’ve had numerous announcements from central Chinese bodies urging the government to deploy more outsized fiscal packages, however still no sign of a broad-based, significant fiscal package.
Unless deflation in China turns a corner, or the government announce fiscal stimulus in the magnitude of trillions of USD, the real economy is likely to continue to struggle. Above shows they have leeway from a fiscal perspective, though are tentative to give direct consumer handouts to boost consumption.
Reflation is what investors should look out for, as well as the pricing of assets heavily linked to the success of Chinese real economy activity such as the AUD and commodities such as copper and iron ore. The most recent producer price index came out at -2.8% vs -2.5% consensus, not a very encouraging sign.
Other headwinds
The equity market is not only discounting the structural real economy worries, but for some time has priced in geopolitical concerns regarding the US. To add to the heap of issues, Trump has been vocal about heavy tariffs for the automobile market and tensions in the semiconductor world.
On top of this, the EU members voted to implement a 45% tariff on Chinese electric vehicles by 2029, up from the current 10%, aiming to protect European manufacturers.
Despite these negatives, there are plenty of companies within China that are growing their earnings at double-digit pace year-on-year, but as we know there can be a ceiling for excess profits and power within the private sector in China.
Looking Forward
Perhaps the recent monetary and fiscal band aids may get China to their 5% growth target, however their underlying structural challenges including the property sector, deflation, poor demographics, risks from tariffs and declining confidence, cannot be resolved solely through short-term measures such as equity market liquidity injections, monetary easing, or a mere $15bn USD of government spending.
While valuations in the Chinese stock market have rebounded from their lows, reaching a reasonable price-to-forward-earnings ratio of 11, substantial evidence of reflation is needed to justify China as an idiosyncratic investment opportunity and of a broader economic recovery.
Relying solely on a potential government fiscal package for market gains is speculative and carries significant risks. There are other sectors within the global equity market that offer more reliable expected returns and compensated risk.
Timeline
1911 – Qing Dynasty ended, Nationalist Party led China through lots of civil war, warlords
1949 – Mao beats Nationalist party and creates People’s Republic of China
1966 – The Cultural Revolution begins, Mao aims to battle capitalism but leads to social unrest, chaos and economic disruption. Employ “Red Guards” (kids) to attack intellectuals, teachers and officials
1976 – Mao dies, Deng Xiaoping introduces market-orientated policies (privatize, decentralize, open to trade) & infrastructure/education developments
1990 – Significant progress is made; many are pulled out of poverty and urbanization via infrastructure
2001 – China joins WTO, integrating into global economy and becoming a global manufacturing powerhouse.
2008: Global financial crisis impacts China’s economy, but the government stimulus, strong middle-class consumption and bank stability lead to resilience against declining exports from crashing global demand.
2010s – China continues to experience robust economic growth, becoming the world’s second-largest economy.
2020s – China faces challenges such as slowing growth, trade tensions with the US, and the COVID-19 pandemic. The government continues to implement policies aimed at promoting economic development and innovation. The real estate market in China began to crash in 2022/2023, with Evergrande and other large developers going bankrupt as prices fall and 60% of household wealth is tied up in property.
2024 – China now attempts to compete with the US in technological advancements, shifting exports away from manufacturing to high-end tech. This has led to overall political tension. China is currently experiencing deflation.
Is China the Golden Dragon again?
The recent bounce in the Chinese stock market has sparked optimism among investors, leading some to question whether the concerns surrounding the Chinese property market and deflation are something of the past. Whilst the Chinese government have been clear that they’re willing to do whatever it takes to put a floor under the crisis, one should act with caution with going all out of “long Chinese everything”.
It truly was a very significant bounce, only happening a few times for either index in the past, primarily during volatile times like the GFC. Overall, we’re skeptical of the rally, keeping in mind that over 80% of China A-Shares are “retail traders”.
We often like to point out that the financial markets in a particular region does not equate to its real economy, which is true for the USA and Australia, but that effect is ever so true in China. The magnitude of this bounce was probably due to:
Above we can see how disappointing the outcomes for Chinese equity investors have been over the past 10 years.
Though when we zoom further out, we can see that the Chinese stock market has only had deep struggles in the past 10 years. Succeeding these struggles, we saw a 30-year period underpinned by investment-lead growth, globalization and hence a cementing of China as the world’s second-largest economy.
Perhaps the most impressive statistic is pulling approximately 800 million Chinese people out of poverty from 1980 to 2015, where in 1980 around 88% of the population was living in extreme poverty (The World Bank). The major driving force behind China’s uprise was the market-orientated policies implemented by Deng Xiaoping into a communist society. The 3 main themes of this drastic shift were:
The mega urbanization and transformation of the country improved the average Chinese persons living standards and has led to China competing with the US on the technological innovation front, which has caused political tension over the past 5 years. A key question for China’s future is the sustainability of its economic model, which is dependent on subsidised lending for infrastructure, manufacturing, and real estate investment.
The Real Economy
To assess the sustainability of the current rally in the Chinese stock market, it is essential to evaluate whether the recent government stimulus can have a meaningful impact on the real economy. China is currently grappling with a “balance sheet recession,” where households and businesses are prioritising debt reduction over spending and investment.
The property crises caused a huge blow to Chinese consumer confidence, due to ~65% of their wealth being tied up in property. Just imagine in Australia, where that % is closer to 55% if property prices were falling between 20-30%, there would be widespread panic, and we’re dealing with 25 million people whilst China are dealing with 1.4 billion. In 2020, the Chinese government, under the leadership of Xi Jinping, made it clear that housing should be considered a place to live rather than a speculative asset. The introduction of the “Three Red Lines” policy reinforced this stance, making it unlikely that the government will rapidly reinflate the real estate market.
China’s initial stimulus in September was primarily focused on credit creation and private sector liquidity – essentially the supply side, where they’ve made it easier for consumers to borrow money. This became an easier decision, coinciding with the US cutting cycle, putting less pressure on the Yuan.
Whilst the monetary measures may have marginal effects, who wants to borrow more when confidence is at all-time lows (very high savings rate) and prices are falling? The money supply (M1) in China will be a key indicator to follow to understand whether the private sector have utilised the lower borrowing rates:
The stimulus certainly aided the consumer confidence and sentiment, but the structural issues embedded within the real economy have not been addressed and do ultimately require significant fiscal stimulus. This brings fragility to the equity market rally, where investors will be begging for a measurable stimulus announcement and a resurgence of domestic consumer demand which makes up 40-50% of GDP.
The Follow up stimulus
Investors were disappointed by the announcements made in the meeting on the 8th of October with the reopening following “Golden Week”. No signs of a “fiscal bazooka” as some were waiting for, and it seems more like China wants to create a floor under the economy and property sector, rather than ramp it up to the moon and create volatility as seen in the past. Price action quickly reflected this “disappointing” news for investors – and affirmed our belief that the real economy would not spring back to its feet as quickly as people may have thought. There was a $15bn USD (100bn Yuan) government spending announcement, though this is negligible compared to the predicted ~$9 trillion USD of impact the faltering property market may impact the Chinese private sector, which some of the most leveraged up globally:
Since then, we’ve had numerous announcements from central Chinese bodies urging the government to deploy more outsized fiscal packages, however still no sign of a broad-based, significant fiscal package.
Unless deflation in China turns a corner, or the government announce fiscal stimulus in the magnitude of trillions of USD, the real economy is likely to continue to struggle. Above shows they have leeway from a fiscal perspective, though are tentative to give direct consumer handouts to boost consumption.
Reflation is what investors should look out for, as well as the pricing of assets heavily linked to the success of Chinese real economy activity such as the AUD and commodities such as copper and iron ore. The most recent producer price index came out at -2.8% vs -2.5% consensus, not a very encouraging sign.
Other headwinds
The equity market is not only discounting the structural real economy worries, but for some time has priced in geopolitical concerns regarding the US. To add to the heap of issues, Trump has been vocal about heavy tariffs for the automobile market and tensions in the semiconductor world.
On top of this, the EU members voted to implement a 45% tariff on Chinese electric vehicles by 2029, up from the current 10%, aiming to protect European manufacturers.
Despite these negatives, there are plenty of companies within China that are growing their earnings at double-digit pace year-on-year, but as we know there can be a ceiling for excess profits and power within the private sector in China.
Looking Forward
Perhaps the recent monetary and fiscal band aids may get China to their 5% growth target, however their underlying structural challenges including the property sector, deflation, poor demographics, risks from tariffs and declining confidence, cannot be resolved solely through short-term measures such as equity market liquidity injections, monetary easing, or a mere $15bn USD of government spending.
While valuations in the Chinese stock market have rebounded from their lows, reaching a reasonable price-to-forward-earnings ratio of 11, substantial evidence of reflation is needed to justify China as an idiosyncratic investment opportunity and of a broader economic recovery.
Relying solely on a potential government fiscal package for market gains is speculative and carries significant risks. There are other sectors within the global equity market that offer more reliable expected returns and compensated risk.
Timeline
1911 – Qing Dynasty ended, Nationalist Party led China through lots of civil war, warlords
1949 – Mao beats Nationalist party and creates People’s Republic of China
1966 – The Cultural Revolution begins, Mao aims to battle capitalism but leads to social unrest, chaos and economic disruption. Employ “Red Guards” (kids) to attack intellectuals, teachers and officials
1976 – Mao dies, Deng Xiaoping introduces market-orientated policies (privatize, decentralize, open to trade) & infrastructure/education developments
1990 – Significant progress is made; many are pulled out of poverty and urbanization via infrastructure
2001 – China joins WTO, integrating into global economy and becoming a global manufacturing powerhouse.
2008: Global financial crisis impacts China’s economy, but the government stimulus, strong middle-class consumption and bank stability lead to resilience against declining exports from crashing global demand.
2010s – China continues to experience robust economic growth, becoming the world’s second-largest economy.
2020s – China faces challenges such as slowing growth, trade tensions with the US, and the COVID-19 pandemic. The government continues to implement policies aimed at promoting economic development and innovation. The real estate market in China began to crash in 2022/2023, with Evergrande and other large developers going bankrupt as prices fall and 60% of household wealth is tied up in property.
2024 – China now attempts to compete with the US in technological advancements, shifting exports away from manufacturing to high-end tech. This has led to overall political tension. China is currently experiencing deflation.
Related Posts
How much more pain for the AUD vs USD?
Some Thoughts on A.I. and Historical Precedents
Quarterly market update | Q1 2025