China’s difficulties in recent years haven’t transmitted uniformly to other emerging markets.
China’s stimulus and prospects for emerging market stocks
The People’s Bank of China’s (PBoC’s) substantial monetary easing and the Chinese government’s fiscal support have lifted Chinese stock market valuations from the extreme lows they reached earlier this year.
This signal of intent from policymakers is encouraging. However, we will need to see further interventions – both via stimulus and regulatory – to be confident that Chinese corporate earnings are on a sustainable upswing, particularly in the face of likely further trade hostility. Investors should manage their emerging market (EM) allocations actively to take advantage of shifting trade patterns and nuance in domestic policy.
Addressing the Chinese real estate crisis
The property market has been a high-profile thorn in the side of the Chinese economy. Residential property prices have on average lost 12% from their high in the second quarter of 2021. In contrast to Europe and the US, China currently suffers from a short-term excess of residential property supply, as demand estimates made during the boom years have proven too optimistic. Indeed, the pandemic coincided with a sharp drop in China’s birth rate from 10.4 births per 1,000 inhabitants in 2019 to 6.4 births in 2023, as well as a significant decline in marriages. This has contributed to China’s property sector woes. It now takes on average almost 28 months to shift a new property in the 80 largest cities.
For Chinese households, the weak real estate market is particularly painful as nearly two-thirds of their assets sit in property (Exhibit 21). Thus, falling real estate prices are acting as a major drag on households’ willingness to spend. Compounding this problem, many of these properties and their associated debt sit on local governments’ balance sheets, reducing local governments’ ability to fuel further activity. Without government support, there is a real risk that China enters a prolonged ‘balance sheet recession’, much as Japan experienced throughout the 1990s and 2000s.
Exhibit 21: Negative wealth effects have been a drag on consumer spending
China consumer income and wealth effect
Index level, rebased to 100 in January 2021
Source: CEIC, China Securities Index Company, Goldman Sachs Investment Research, LSEG Datastream, National Bureau of Statistics of China, NIFD, Wind, J.P. Morgan Asset Management. Secondary residential property price index measures prices paid on existing home sales. Data as of 12 November 2024.
In our view, the policy measures implemented by Chinese policymakers thus far have fallen short. The September 2024 announcements reduced financing costs, lowered the requirements for home purchases and provided financial support for households. While these policies are supportive for property demand and should slow price declines in the near term, we’d like to see Beijing tackle the root of the problem. This would include taking the excess housing and debt from the broader economic system onto the central government’s own balance sheet.
Although overall population growth in China turned negative in 2020, there is no structural excess housing supply just yet. A continuation of urbanisation has the potential to balance the housing market over the medium term, as the degree of urbanisation in China at 65% is still relatively low compared to other developed countries such as Korea (81%) and the US (83%). Reforming the 'Hukou system’, which determines how rural individuals in new districts access health and education, would help with this process.
The central government should also consolidate some local government debt onto its own balance sheet. However, Beijing is still reluctant to take this step given total debt in the economy has risen from 224% of GDP to an estimated 289% in the last 10 years, and there is also a moral hazard issue in releasing local governments from any accountability.
Stocks as a source of consumer wealth effects
Negative wealth effects for Chinese households caused by falling property prices have been compounded by a simultaneous decline in equity markets and falling interest rates on deposits, leading to lower confidence (Exhibit 21). This is a fundamental difference between China’s recent experience and the US’s, where a booming stock market and more robust housing markets have contributed to positive consumer sentiment.
Recent interventions suggest that Beijing is focusing on measures to support the stock market and in turn boost consumer sentiment. The implementation of a swap facility at the PBoC, which enables investment firms, insurance companies and funds to finance share acquisitions, and a re-lending facility, which enables listed companies to finance share repurchases at a rate of 2.25%, is another clear indication that decision makers are pursuing a strategy of reflation for asset markets.
Investors should not underestimate the potential impact of such a positive liquidity effect in 2025. With 25% of Chinese household assets invested in deposits and cash, even a partial re-allocation into equities could give local markets a boost. The risk to this view is that foreign investors may instead use the recent bounce in prices to reduce their allocation to China.
While measures from the PBoC and the Chinese government have helped turn the tide on Chinese valuations, for the rally to continue we will need to see the earnings picture improve. At face value, the re-election of President Trump makes a revival in earnings more challenging.
Exhibit 22: Boosting stock valuations is a Beijing priority
MSCI China forward P/E ratio
x, multiple
Source: IBES, LSEG Datastream, MSCI, J.P. Morgan Asset Management. Forward P/E ratio is price to 12-month forward earnings, calculated using IBES earnings estimates. Past performance is not a reliable indicator of current and future results. Data as of 12 November 2024.
We expect 60% tariffs on imports entering the US from China to be a near-term policy priority for the incoming US administration. However, it’s worth remembering that since President Trump’s implementation of duties in 2018, China’s share of imports into the US has fallen from 21% to 12%. Yet, over the same period, China’s global export share has risen from 13% to 14% as Chinese companies re-organised their supply chains to incorporate countries such as Mexico and Vietnam. President Trump could impose wider tariffs, and/or encourage other regions to place similar restrictions on Chinese imports, but such a strategy would risk damaging both consumer and corporate sentiment in the US.
We would also expect foreign hostility to be met with more Chinese domestic fiscal stimulus, for both households and corporates.
Additionally, we shouldn’t underestimate the potential for regulatory and market interventions to become a tailwind in China, rather than the significant headwind that they have been since the Common Prosperity policy was established in 2021. The consequences of this policy for company valuations and earnings were significant, and the risk of further drastic regulation continues to be priced in, judging by the depressed valuations currently seen in the Chinese equity market. This regulatory risk appears particularly evident in growth sectors. At the beginning of 2021, major Chinese tech and online companies traded on similar valuations to their US rivals. Today, China’s growth champions trade at a significant discount (Exhibit 23).
Exhibit 23: Unpredictable regulation has depressed valuations of Chinese growth stocks
MSCI Growth forward P/E ratio: China vs. US
x, multiple
Source: IBES, LSEG Datastream, MSCI, J.P. Morgan Asset Management. Forward P/E ratio is price to 12-month forward earnings, as published by MSCI. Past performance is not a reliable indicator of current and future results. Data as of 12 November 2024.
Harsh regulation also squeezed the profitability of Chinese companies. Earnings per share growth has not been able to keep up with economic growth over the last 10 years (Exhibit 24), while return on equity fell from 15% to 11%. To see a sustained improvement in Chinese stock performance, fewer and more predictable regulations would be helpful.
Exhibit 24: Rapid economic growth has not translated into corporate earnings
China real GDP vs. earnings per share (EPS)
Indexed to 100 in 2010
Source: Bloomberg, China Securities Index Company, MSCI, National Bureau of Statistics of China, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Data as of 12 November 2024.
What about broader EM?
China’s difficulties in recent years haven’t transmitted uniformly to other emerging markets. Friend-shoring and the reshuffling of global trade have benefitted countries such as Mexico and Vietnam, while pro-growth domestic policies have fuelled investment into India.
Looking to 2025, stocks in broader EM may get a boost from China’s recent stimulus announcements, although we are mindful that measures to stabilise the financial system and the real estate market differ significantly from previous stimulus packages which had more of a focus on investment and infrastructure. Therefore, the positive impact on the global economy and on the commodity market will be somewhat limited. We thus do not expect a significant tailwind for the classic raw material exporters in Latin America, the Middle East and Southeast Asia.
A sharpening of the trade conflict between the new US government and China could further reinforce the friend-shoring trend. It seems practically more difficult for the US administration to craft a tariff policy that would counter the re-organisation of supply chains, and so economies like Mexico and Vietnam could be further supported. Northeast Asia is likely to continue to benefit from the ongoing global investment boom in technology.
The US dollar will also play a critical role in the relative performance of emerging markets in 2025. Tariffs and expansionary fiscal policy will likely have an inflationary effect on the US economy, meaning the Fed might be less inclined to continue steadily easing financial conditions. This would be dollar supportive and could prove a headwind for EM currencies, making it harder for EM central banks to support their domestic economies with further monetary easing.
Conclusion
Chinese policymakers want to support the Chinese economy. Their demonstration of intent is more important than the exact measures delivered to date. We suspect they are saving their ammunition until it is clear exactly what trade hostility they are facing. Nonetheless, it remains uncertain whether policymakers’ efforts will merely limit the downside to the Chinese economy and markets, or instead prove adequate to improve the medium-term trajectory of the economy and corporate earnings. The balance of risks, however, is now at least more two-sided, rather than skewed to the downside.
Current EM stock valuations look relatively cheap compared to developed market stocks. However, EM valuations look merely average compared to their own history (Exhibit 25). Investors need to be active in the EM space to take advantage of wide dispersion across the region, shifting global trade patterns, and the impact of idiosyncratic US foreign policy.
Exhibit 25: There is significant valuation dispersion across EM
EM price-to-book ratios by country
x, multiple
Source: IBES, LSEG Datastream, MSCI, J.P. Morgan Asset Management. All indices are MSCI. Past performance is not a reliable indicator of current and future results. Data as of 12 November 2024.