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Despite recent government interventions, the Chinese equity market continues to face the headwinds of a distressed property sector, the fiscal constraints of local governments, and a lack of confidence in the private sector.
How can investors respond to this weakness, and seize on opportunities as they arise?
While the CSI 300 Index managed a relatively moderate year-to-date loss of 6.7 per cent, this belies the heavy intervention from government funds in some of its leading stocks, including state-owned banks and energy companies. It also masks the brutal selloff of most stocks in China’s equity market – specifically, those which have not been actively supported by the so-called National Team, a group of government-controlled investment funds tasked with stabilising the market.
Turbulence ahead
The lacklustre performance of the Chinese equity market is interwoven with numerous challenges confronting the nation’s economy, from anticipated defaults and bankruptcies among property developers, to the pervasive downward adjustments in home prices. Local governments also remain hamstrung by debt, limiting their infrastructure spending and public service provision.
As the economic recovery unfolds sluggishly and uncertainties persist, caution also pervades entrepreneurs and private sector management, hindering new investments. Regulatory tightening and uncertainty exacerbate this cautious approach, perpetuating a cycle of declining confidence.
The Chinese equity market’s predicament is further compounded by projections that the potential growth rate of the Chinese economy in the medium term is set to decline to 4 per cent, and towards 3 per cent in the longer term. Factors such as a diminishing working-age population, decreased fixed capital formation, and declining productivity contribute to this downward trajectory. The contribution of total factor productivity growth to real GDP growth in China has dwindled from over 4 per cent in the mid-2000s to around 2.5 per cent in recent estimates. Some economists anticipate this figure sliding to an average of 1.3 per cent over the next 10-15 years.
The external environment is also challenging, with the US and its European and Asian allies engaging in technology containment and supply-chain ‘de-risking’ practices. In response to heightened geopolitical risks, multinational businesses have accelerated the diversification of supply chains and production capacities away from China to ASEAN countries, India and Mexico, as well as re-shoring back to the US or Japan. More recently, Donald Trump has threatened China with the imposition of tariffs above 60 per cent if he’s elected US President in November.
Keynesian expectations dashed
Equity investors, well aware of the persistence of these economic challenges, have been anticipating more forceful monetary and fiscal stimulus measures to boost the Chinese economy and loosen financial conditions. However, the Chinese authorities have been rolling out stimuli that are relatively tepid and fall short of the desired stimulus ‘bazooka’. This timid policy response is unlikely to result from a lack of understanding by the Chinese leadership, but rather a conscious policy choice.
President Xi Jinping initiated a nationwide deleveraging initiative in 2017, starting with crackdowns on the shadow banking sector, followed by the property sector and excessive local government debts. There is no sign from the Chinese leadership of pivoting from these strategic goals.
Also in 2017, Xi coined the concept of ‘high-quality development’, emphasising China’s priorities in technological self-reliance and food security through agriculture modernisation. It signifies the transition of the Chinese leadership from pursuing high-speed economic growth to other goals deemed more important.
Previous development impetus, which relied on massive inputs of labour, resources and investment in capital assets is considered unsustainable, and the associated economic structure is deemed unbalanced. In short, there’s been a sidelining of short-term growth stimulation.
Against this backdrop, the Keynesian stimulus measures in investor minds have found little empathy in the Chinese top authorities’ policy deliberations – the stimulus ‘bazooka’ has not arrived, and is very unlikely to come. The determination not to bail out failed property developers and shadow banking entities signifies that the deleveraging initiative from 2017 persists.
The resistance to calls for Keynesian-style aggregate demand-boosting measures that can lift short-term growth (but not the long-term growth potentials of an economy) has a sound foundation in neoclassical economic growth models. Less comforting, however, is the lack of signs indicating that Chinese policies are moving towards increased private sector marketisation and galvanisation. The much-anticipated Third Plenary Session of the 20th Central Committee would be an effective venue for the Chinese leadership to formulate and communicate its economic development strategies over the next five years – but there is no indication as to when this will occur.
The intertwining theme of Xi’s directives is the logic, concepts, and narrative of the Marxist political economy – that is, eliminating any potential for development strategies that enhance the role of the market and the private sector. A return to the Marxist paradigm, and an environment in which ‘getting rich is no longer glorious’ and government officials are incentivised to watch their steps, means the economic challenge in the Chinese economy remains formidable.
Investment Implications
Navigating the tumultuous waters of the Chinese equity market poses numerous challenges. In this intricate scenario, it may be advantageous to remain nimble and flexible.
Short-term traders can find opportunities amid volatility – the stocks of central state-owned enterprises and large-cap stocks of the CSI 300 Index and MSCI China A50 Connect will tend to benefit from the buying of the National Team.
Meanwhile, longer-term investors may await clearer signals from the Third Plenary Session when it occurs. Furthermore, research and accumulation of positions in industries benefiting from China’s industrial tailwinds, such as technology and advanced manufacturing, remain strategic.
Despite cyclical swings, themes like productivity enhancement and technology self-reliance persist. Additionally, sectors like energy and green metals, supported by enduring themes such as energy security and green transformation, present opportunities amid China’s uncertain path to recovery.
Disclaimer: Saxo Capital Markets (Australia) Limited (Saxo) provides this information as general information only, without taking into account the circumstances, needs or objectives of any of its clients. Clients should consider the appropriateness of any recommendation or forecast or other information for their individual situation.
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