Chinese stocks delivered its best week since 2008. Is it time to buy China?
Chinese stocks delivered its best week since 2008. Is it time to buy China?
The Chinese market has surged in reaction to economic stimulus measures. It's best not to stand in front of a moving bus but I would like to see more momentum before I turn long term bullish on China.
Standing in front of a moving bus is extremely dangerous that can have dire consequences. Buses are large and require significant distance to come to a complete stop. According to Newton’s second law of motion, the forward momentum of the vehicle is directly correlated with its mass.
China is a big country. Just the sheer weight and momentum of a bus mean that even a minor collision can result in severe injuries or fatalities. The driver of the vehicle has stepped on the accelerator and he does not care if there are pedestrians in front of him.
To ensure one’s personal safety, it is crucial to maintain a safe distance from moving buses and to be aware of your surroundings.
Last week of the third quarter
Beijing’s announcement to lift growth had sent short sellers to cover their short positions, and attracted some long-term buyers who have been sitting on the side lines. Chinese stocks have bounced off their lows and it is clear, that the bus is on the move.
While the stock market reaction was very positive, the bond market adopted a different perspective as 10-year Chinese government bonds began to sell off.
Among a slew of measures, the Chinese central bank said that it would reduce the reserve requirement ratio by 0.5 percentage points, which could introduce CNY 1 trillion of liquidity in the market - which is only a fairly small percentage of the stock market cap of CNY 70 trillion.
Regarding properties, the central bank said that it would lower mortgage rates, and reduce the downpayment for housing loans. Further, it would cover loans for unsold homes to be turned into affordable housing and allow local government special bonds for land reserves.
With respect to capital markets, a swap facility for securities, funds and insurance companies was launched, while a re-lending facility for stock buybacks was introduced. Funds obtained under the swap facility must be used for stock market investments.
Additionally, the National Financial Regulatory Administration will allow insurance companies to establish private equity vehicles to broaden their range of investments. Finally, the China Securities Regulatory Commission will draft measures to lower the barriers of entry for social security, insurance and wealth management funds to invest in capital markets.
Does this look like the three arrows of 2022?
Back in late 2022, China announced the three arrows framework to unlock more financing channels for China’s real estate sector. The framework lent a hand to distressed developers by facilitating their access to bank credit, bond as well as equity markets.
Following the policy move, sentiment in the China property high yield bond improved significantly. Onshore volume increased and housing prices in major cities stopped falling. As the year progressed till March 2023, economic momentum weakened and contracted sales continued to fall - the pace of decline had slowed but there was no meaningful upturn in the physical real estate market.
Developers still felt the pressure of debt repayments. The weakness of the market is reflected in the price of the Premia Partners China USD Property Bond ETF, which is down by more than 70% up till today.
Why stimulate the economy?
China’s economic stimulus was a step in the right direction as the economy needed a big push after it trailed behind its GDP target for the year. As of the second quarter, GDP only grew 4.7% year-on-year, below its forecast.
Other economic indicators over the third quarter such as production, consumption and investment fell below expectations. Before we close the books for the third quarter, the economy needed some window dressing so that it could reach the 5% target growth rate for 2024.
Are there headwinds for China in November and beyond?
The biggest determinant to China’s growth is US-China relationships.
Whether if it is a Democrat or Republican win in November, both Harris and Donald Trump are likely to be tough on China.
Current polls show a neck and neck race. But no matter who wins, the current direction of the US-China relation is not going to change overnight.
When the Trump administration was in power, nearly USD 80 billion of new taxes were implemented. The Biden administration thereafter, has kept most of the Trump administration tariffs in place… and with where the direction of where the Federal deficit is heading - chances are, there will be even more harsher tariffs on China in future.
If re-elected as President, Trump could implement a 10 percent tax on all foreign goods and tariffs of up to 60 percent on Chinese goods.
According to Goldman, the Trump tariff plan would slow US growth and lift US inflation. Even with the initial fiscal boost, the impact to the US economy would be modestly negative.
Thoughts on China
I have always not been very bullish on China, as I have long held the view that the country is in a multi-year bottoming process (read my blog that was posted in June).
Even with the recent market moves, I am still not entirely convinced that investors should buy China for the long term at this level, but if the bus continues to move, and the stock market continues to grind higher, I might have a change of opinion. While monetary policy and market announcements are in the right direction, it has not reached the point where thinking and foundations have changed.
Invest internationally
In my blog last week, I advocated my view on investing internationally as the US dollar is projected to weaken. The US dollar continues to trend down as participants expect a low growth environment with more companies coming forth to announce their layoff plans.
Last week, I also highlighted the case for investing in Japan, as the country is recovering from its multi-year slump. However, I cautioned that near term, the USDJPY would come under some selling pressure.
Over the week, new developments in Japan showed that the country has chosen 67-year former defense minister Shigeru Ishiba to be its new Prime Minister.
The market did not like the announcement initially as the USDJPY pair sold off and ended the day lower. The new Japanese Prime Minister has pledged to reshape the country’s alliance with the US and fulfil its proactive responsibility to build peace in the region. Depending on the reaction of neighboring countries and the market familiarity with the new leader, I do expect to see some volatility in Japanese stocks (but still maintain my long term bullish view on Japan).
Disclaimer
Seven Fat Cows is not a financial adviser. You should seek independent legal, financial, or other advice to check if the information from this website relates to your unique circumstances.