In brief

• Chinese equities, both onshore and offshore, have enjoyed an impressive valuation re-rating driven rally on the back of a more coordinated approach by Beijing to address economic and market weakness.
• A sustained rally may require investors to view China as a strategic rather than a tactical investment. Any further upside will likely require details on policy implementation and an eventual improvement in economic data.
• Beijing’s latest policy measures, alongside the monetary easing led by the Federal Reserve, should be supportive of global risk assets. In addition to Chinese equities, some investors could also consider regions or sectors that could benefit from stronger Chinese growth, such as commodities or consumer discretionary.

Chinese equities had a spectacular week. Since September 24, the CSI 300 rose 25%, the Hang Seng China Enterprise Index (H share) rose 17.5% and MSCI China is up 21.3%. This was brought about by a joint announcement by The People’s Bank of China (PBoC), the securities regulator (China Securities Regulatory Commission) and the financial regulator (National Financial Regulatory Administration) on September 24 on a series of economic stimulus measures, as well as the earlier than expected Politburo meeting on September 26 that prioritized growth, housing, jobs and social welfare. We have had two periods of market rally since 2022. The first one was in 4Q 2022 as China came out of the pandemic lock down. The second was in 2Q 2024, again on recovery expectations. Both episodes ended with the market going back to worrying about China’s economic outlook.

As we noted in last week’s podcast, Beijing has taken similar policy steps in the past two years. However, these occurred in isolation with limited economic effect. One thing which is different this time is that the latest effort is coordinated by the various ministries and regulators, which demonstrates a sense of urgency to boost momentum, whether in the housing market, domestic consumption, or the stock market. 

After the initial excitement, calm and patience is required

The policies announced are multi-faceted.

• Monetary policy: Required reserve, lending rates and mortgage rates were reduced to boost liquidity and lower funding costs. Six large banks have also been injected with additional capital.
• Property market: The down payment required for second homes was reduced from 25% to 15%. The PBoC has created a CNY 300billion relending facility to support regional state-owned companies to purchase unsold homes. Originally, this provided 60% of the principal of bank loans, and this credit support ratio has been raised to 100%.
• Stock market: The central bank is setting up CNY 500billion swap facilities with securities brokers and insurance companies to fund stock purchases. It is also looking to set up a specialized refinancing facility for listed companies to buy back shares.
• Fiscal policy: The government could be looking to allow for a higher level of fiscal deficit to reduce taxes, increase spending and allow for more fiscal transfer from the central government to local governments, given the latter has seen a drop in revenue from slower land sales.  Another way to boost government spending would be to raise the debt issuance quota, as local government bond issuance had already reached over 90% of the 2024 quota by the end of September. 

Good intentions will need to be followed by actions. Following the National Day holiday, as investors return to the market on October 8, they may be looking for more details on how these policy announcements will be implemented. For example, a consumption coupon may result in a short-term boost to spending, but a rise in income tax thresholds could bring a more sustained pick-up in consumption. The importance of fiscal policy is that the benefit to the economy would be more immediate than monetary policy, which has to work through the financial system. 

In the past two years, rate cuts and liquidity injections have yet to boost credit growth or economic activity due to cautious sentiment by households and the corporate sector. Could the surge in stock prices and the positive wealth effect unlock household savings that could translate into more consumption, or even a more constructive sentiment towards the housing market?

The National Day tourism and consumption numbers could provide an early glimpse of this sentiment change, which could point towards some short-term improvement in discretionary spending. For the housing market, high level of inventory and financial constraints with the developers implies it would still take several quarters before the sector could stabilize.

Overall, additional policy steps would be needed to boost economic activity and confidence. The policies announced so far can help to smoothen out the de-leveraging process, but the balance sheet repairing would still need to take place. There are also structural shifts in the economy that would require a different set of industrial policy response. This in turn would create jobs to match the new labor market structure. 

Then there is the international angle

Beijing’s coordinated policies to support the economy is a positive step for the Chinese economy and its markets.  As we wait for better economic data, it is important to remember that some external factors such as geopolitical uncertainty remain.

With the U.S. elections only a month away, many investors would argue that the U.S. view of China as an economic and geopolitical rival is a bipartisan consensus. However, details matter when it comes to policy implementation. Between former president Trump’s pledge of 60% tariff on all Chinese exports, and perhaps a more targeted approach from Vice-President Harris, the impact on the Chinese and global economy could vary considerably.

Moreover, how international investors manage the potential geopolitical risks may influence the duration of the current market rally. For now, foreign investors may choose to wait for economic data to bottom out and for this new policy direct to solidify. Buy-in from international long-term real money investors, when it comes, could add to the sustainability of the current rally in the Chinese stock market.

Investment implications

The market rally in the past week showed what depressed valuations, light investor positioning and the right policy catalysts can do to a market. MSCI China’s forward price to earnings ratio has risen from 9.1x on September 24 to 10.5x, which is broadly in line with the 15-year average. Hence, Chinese equities are no longer very cheap on a forward earnings basis (Exhibit 1).

Exhibit 1: MSCI China valuations
Forward P/E ratios

Source: FactSet, MSCI, J.P. Morgan Asset Management. Data are based on availability as of September 27, 2024.

In the early stage of market recovery, further valuation re-rating that sustains the current market rally is on the cards. However, this would need to be followed by an improving earnings outlook to underpin a longer-term market rally. The latest policy measures may help to support corporate earnings over the next 12-18 months, if the economy responds in a positive way (Exhibit 2).

Exhibit 2: MSCI China earnings growth estimates
Earnings per share, year-over-year change, consensus estimates

Source: FactSet, MSCI, J.P. Morgan Asset Management. Data are based on availability as of September 27, 2024.

Between the onshore A share market and the offshore Hong Kong H share market, the relative discount of the latter still makes it look attractive. Moreover, the technology and communication service sectors could benefit from a cyclical recovery. Many of these tech giants have improved on their operational leverage over the past three years with better profitability. Economic improvement could help investors to better appreciate these companies’ efforts to handle the regulatory changes in 2021/22, more stringent cost controls, engaging in share buybacks and increase dividend payouts.

Beyond Chinese equities, investors may opt for other proxies that could benefit from an economic upturn in China. European consumer goods and commodities are two potential areas of focus. While some investors may prefer ‘China-like’ exposure through these ideas, this usually does not deliver the same benefits as direct investing and can be complicated by other exogenous factors. For example, a stronger China usually translates to higher commodity prices, notably oil. However, Saudi Arabia and the Organization of the Petroleum Exporting Countries may choose to step up production to regain market share, offsetting the possible increase in oil demand from China.

Asian economic performance could also gain additional support from China’s demand for the region’s exports, in goods as well as tourism. This could facilitate a broader recovery in Asian equities, beyond the semiconductors and tech hardware exporters.

Between China opting for more aggressive economic support and global central banks embarking on monetary policy easing, this current global economic policy landscape is supportive for risk assets. Even if the recent sharp rally in Chinese stocks may face some short-term pullback pressure, Beijing’s overall policy stance should reinforce our call for a well diversified asset allocation in Asian and global equities. 

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