China stock rally likely to fizzle

The Hong Kong market’s nearly 20% jump in the week after Beijing unveiled major new stimulus measures looks based more on hopes than reality

  

By Rene Vanguestaine

It may have given long-suffering Chinese stocks in Hong Kong and the U.S. an adrenaline rush, something like giving a child sudden free rein in a candy store. But like the sugar rush that child will feel, the stock rally fueled by China’s mega-booster stimulus package two weeks ago is overdone, unsustainable and is almost certain to fade, unless there are additional fiscal measures that fully address the fundamental issues in the economy.

China’s weak economy isn’t going to improve overnight, and what’s really needed right now is time to see if some of the new measures will be effective. Let’s not forget that China has announced numerous similar measures that ultimately had little or no effect over the past two years, most aimed at boosting consumer demand and propping up the ailing property market.

At the same time, none of the measures will help to address other factors that are dragging on the Chinese economy, like geopolitics, the potential for new regulatory crackdowns at any time and local governments’ huge debt loads.

The stimulus package that got everyone so excited was announced on Sept. 24 and was seen as a highly anticipated “big bazooka” awaited by many for more than a year. Nearly all the measures were based in monetary policy, including cuts in the reserve requirement ratio for banks and lower interest rates.

The package also included several specific measures to support the property market, such as a cut in interest rates for existing mortgages and a reduction in the minimum downpayment requirement for home purchases. It also included several steps aimed specifically at supporting stock markets, including making 500 billion yuan ($71.2 billion) available to finance stock purchases by institutional investors and another 300 billion yuan to support company stock buyback programs.

Initial reaction to the package was mixed in the investment community, with some arguing that still more was needed. But the markets didn’t seem to care, as investors embarked on a buying frenzy that saw the benchmark Hang Seng Index rise 18% in the five trading days after the announcement. The Hang Seng China Enterprises Index rose by nearly 20% over that time, approaching a technical bull market in just a matter of days.

Beaten down

Granted, Chinese stocks have been beaten down for about three years now, following the ultimately aborted New York IPO by DiDi Global in 2021. As a result, they have been vastly undervalued compared with global peers. For example, leading Chinese e-commerce companies Alibaba (BABA.US; 9988.HK) and JD.com (JD.US; 9618.HK) now trade at relatively low P/E ratios of 29 and 16, respectively, even after the recent rally, both well behind the 44 for Amazon (AMZN.US).

The large new package obviously touches on several weak points in the economy. But Chinese consumers will need to feel much better about their financial wealth as well as employment and wage security to really boost the consumption that’s needed to get the economy back on track.

Part of that will require job creation, including improvement in youth unemployment that is already high and continues to rise. It will also require income increases to make people more confident in the future. That could be hard to do in the current environment where salaries are being cut and previous bonuses even clawed back as China teeters on the brink of deflation.

China will also need to convince its increasingly despondent entrepreneurs that it’s still possible and worth it to build a business in the country. That will mean finding ways to show that the regulatory crackdowns that cast a chill over China’s private sector during the last three years are finally finished, or at least scaled back, and that there will be concrete actions to support the private sector in a centrally controlled economy that increasingly favors the state sector.

Then there is the property crisis, which is a direct result of the huge overbuilding of China’s real estate market using large amounts of debt. This issue will take a long time and more than just lower downpayments to be meaningfully solved.

And there’s also the issue of huge local government debt – largely the result of big spending on Covid controls during the pandemic, unbridled infrastructure building over the last two decades, and the real estate crisis. Lowering interest rates and home downpayments will hardly do much to address the latter, which is weighing heavily on local investment.

In the meantime, geopolitical issues that are putting a drag on exports and foreign investment in China aren’t going away anytime soon. Things will only get worse in the run-up to the U.S. election next month, as both major parties agree on the China threat. Europe will also remain unhappy with China over its perception of unfair government support for Chinese exports, as well as Beijing’s support for Russia’s war against Ukraine.

In the end, verbal assurances, even from the very top, and another run at micro managing the stock market are not enough to fix China’s problems. That will make it hard for stocks to keep up their recent rally and could even see the markets shift into reverse if investors decide to pocket some of their recent gains after three years of suffering.

Rene Vanguestaine is a co-founder of Bamboo Works. You can contact him at rvanguestaine@thebambooworks.com

Recent Articles