The equity markets were wrong about China

Goldman Sachs strategists argued that the 46 percent rise in Chinese stocks in just a few weeks after Covid restrictions were removed was only the start.

They argued that “China appears well-positioned in terms of growth, policy, and inflation cycles within a global context for 2023.” Noting that shares could rise another 15 to 20 percent if China managed to put its disruptive lockdowns in the past, they noted. In the weeks following, the MSCI China Index rose by almost 10%.

The market had already reached its peak despite the optimistic predictions of many Wall Street banks.

Chinese stocks are down more than 20% from their high in late January, pushing the second largest economy of the world into a bear-market at a moment when global and regional peers outperformed negative predictions.

Did we expect China to be so bad? “No, we were all euphoric over reopening,” a Hong Kong-based investment bank trader said. It’s hard to talk about Chinese stocks right now.

Three factors were responsible for the high expectations of investors regarding Chinese stocks. The first was that tensions between the US and China would subside once regular diplomatic exchanges resumed.

Second, analysts expected Chinese consumer spending to roar back once households finally had the freedom to spend all of the money they’d been hoarding while in lockdown.

If that fails, Beijing will step in and provide a large-scale stimulus, as it has so many times done before.

The US government’s downing of the suspected Chinese spy ball in February shook global investors, who were already alert to the financial consequences of rising tensions between two world’s largest economies.

Instead of spending “revenge” in large waves, Chinese consumers — who have been scarred by years economic disruptions and financial instability due to harsh zero Covid policies — are reluctant to make big purchases that would boost economic growth.

According to a survey conducted by the People’s Bank of China and released on Thursday, more Chinese consumers will prefer to save their earnings during the first half of 2022. Nearly 60% of respondents indicated that they would prefer to save their earnings in the first six months of 2022, while only a quarter said that they preferred to spend them.

Dexter Hsu is a senior Macquarie analyst. He said that Chinese households are in a deleveraging mode. They save more and pay off their loans earlier. As [deposits] rates of interest continue to fall, households are looking for yields.

This has led strategists to rely on the last pillar, the tried-and-true policy of the Chinese authorities of spending huge amounts of money in an attempt to stimulate the Chinese economy. Steven Sun, head research and equity strategy of HSBC Qianhai securities said that there are high expectations for a stimulus package. “And suffice it to say, [authorities] have a great deal of policy space.”

In the past, policymakers focused primarily on infrastructure and real estate projects that were central to the previously explosive growth of the country.

Beijing, however, is wary about large-scale stimuli that could lead to developers’ debts ballooning again. China has reduced rates to stave off the downturn, but is still reluctant to provide the additional support needed to turn the economy around in the manner investors expected at the beginning of 2023.

The economic recovery was below expectations because people underestimated negative feedback loops from the property sector meltdown. They also underestimated lack of confidence caused by the deteriorating geopolitical climate and overestimated a rebound in post-pandemic revenge expenditure, said Lu Ting. Chief China economist at Nomura.

Some strategists believe that a stimulus of some sort is possible, and could be used to turn the market around.

HSBC Qianhai has recently lowered its year-end goal for the CSI 300 Index of Shanghai and Shenzhen listed stocks. Sun called the change “a tweak”, and said he still expects that the benchmark index, which is currently down about 1 percent year-to-date, will finish 2023 with a gain of more than 11 percent.

Sun said China will rapidly increase its stimulative measures in the second part of the year in order to compensate for the lack of consumer trust. He added, however, that policymakers are unlikely to focus as much on infrastructure or property as they did in previous efforts.

David Chao, Invesco’s global market strategist, Asia Pacific ex Japan, stated that investors will be tempted to buy Chinese stocks because the “current valuations” are too low.

He said that Beijing would likely take more stimulative measures in the months to come. These could be a “meaningful” boost to the economy and a “signal for the markets”. However, he noted that these “would come out in bits and parts”.

Goldman Sachs is also still hopeful about a stimulus-backed recovery. In a recent report, the firm explained that “political easing” is the “central premise of the positive market view”. It forecasted that China’s stock market onshore will increase by 7 percent from its current levels over the next year.

Some are less optimistic. Nomura analyst Lu and other sceptical experts argue that aggressive interest rate reductions or massive monetary stimuli cannot trigger the type of economic growth required to restore market confidence. They say that the bullish predictions for Chinese stocks are unrealistic.

Hong Hao is the chief economist of Grow Investment Group. But monetary easing cannot solve the long-term problems. The more we give to property, the harder is it to escape its trap.