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What does China’s new policy direction mean for investors?
China’s leaders have shown clear intent on where they see policy heading. Over the past month we’ve seen a series of announcements from the central bank, financial regulators, the finance and housing ministries as well as the Politburo (see chart, below).
Source: Pexels
But what do these announcements mean for markets? Schroders experts examine some of the key considerations for investors.
Source: Supplied.
Patrick Brenner, global head of multi-asset investments notes, “From a multi-asset perspective, we have a positive tactical view on Chinese equities to reflect the fact that the authorities are clearly focused on stimulus. So far, this has largely been on the monetary side and more is needed from the fiscal side.
“The Ministry of Finance has promised to recapitalise banks and buy unsold properties but did not attach detailed expenditure to this plan in its announcement of Monday, 14 October, 2024. It may be that a concrete figure is yet to be announced, and potentially we may have more detail at the end of the month when the National People’s Congress is due to meet.
“All in all, there are still doubts surrounding the equity picture in China from a fundamental perspective. But it is hard for investors to ignore the strong signals coming from Beijing in terms of stimulus.
“We think this is a trade best played via direct exposure to Chinese equities given the authorities’ support for the local stock market (this includes allowing domestic financials to buy up stocks).
"We don’t think now is the time to be over-elaborate and try to gain exposure to China via European equities (for whom China is a key export market) or commodities, for example. We would need to see a more fundamental improvement in China to consider those options.”
Structural reforms needed
Abbas Barkhordar, fund manager, Asian Equities add, “The de-rating in the Chinese equity market over the past few years has been largely in line with the deterioration in the return on equity. This deterioration has occurred for several reasons, including regulation, manufacturing overcapacity and geopolitics, as China has suffered from increasing restrictions on trade.
“The country’s growth model has become overly reliant on capital investment, which doesn’t have the impact it did in the past.
"For now, the broad picture hasn’t really changed. It’s the return on equity outlook which drives shareholder returns and that outlook hasn’t materially improved as a result of the announcements so far.
“We could become more positive on China were we to see structural reforms. The property sector absolutely needs sorting – it is a big overhang and clearly, given the country’s demographic trends, it is not going to be as big a growth driver in future.
"In terms of the consumer sector, the high level of precautionary savings and low consumer confidence need to be addressed. That’s likely to require more spending on welfare, pension and healthcare provision, the social safety net.
“Measures to remove overcapacity would be welcome - there are lots of great companies being completely overwhelmed by competitors on government lifelines.
"Conversely, the long-term issues facing the economy could be made worse by more property and manufacturing investment. This might boost growth in the short term, but result in a less productive economy, less competitive companies, while worsening the debt load and lowering the capacity to pay the debt off over time.”
Confidence key challenge
Louisa Lo, head of Greater China equities says, “Many of the issues facing the Chinese economy are inter-related and improving domestic confidence, both household and corporate sector, remains key.
"With equity markets rallying sharply, investors are betting that the authorities can somehow shift the domestic narrative in a more positive direction and ‘jump-start’ confidence.
“Expectations have increased for a large, multi-trillion RMB fiscal stimulus programme to be announced over the coming weeks. A common view is that having made these high-profile announcements, Chinese policymakers cannot afford to disappoint, and we have now reached a point where the authorities will do ‘whatever it takes’ to kickstart growth.
“Despite the sluggish economic growth, we have felt for some time that stock prices in Hong Kong and the China mainland were oversold. Valuations before this recent rally were close to all-time lows as investor attention had been drawn to better-performing markets such as India, Taiwan and all things AI related around the world.
“Although valuations today, after the bounce, are still a long way below the peaks of 2017/18 and 2020/21, the recent recovery has now returned multiples closer to ‘mid-cycle’ levels, with much of the ‘distress’ in China now priced out of the market.
“If more forceful fiscal stimulus in coming months can stabilise the property market and improve sentiment on the ground, then the earnings outlook - especially for the consumer discretionary sectors of the market - could improve going into 2025, which in turn should justify further upside. However, this leaves the market very sensitive to policy announcements in the coming weeks.”
Comments-Tom Wilson, head of emerging market equities, “There is clearly a need for structural reform in China and it’s important to remember we could see substantial volatility should a Trump victory in the US election lead to increased tariffs.
“On the structural side there’s significant capital misallocation of fixed asset investment – the drag from negative real-estate investment growth may fade through time, but infrastructure investment remains reasonably elevated, as does fixed-asset investment in the manufacturing sector.
"The manufacturing side of the economy has seen substantial investment as well as excess capacity which simply supresses returns and really you need to go through a period of cleansing.
“Overall, investment as a share of GDP remains very elevated and looks unsustainable, you still have an orientation to industrial policy which leads to excess capacity which leads to pressure on returns. If you’re exporting that excess capacity, it may lead to reactionary behaviour from your trading partners.
“We need to see more to drive consumption as a share of GDP and that relates to improving the social safety net and reducing the savings preference.”
Debt crisis looms
Abdallah Guezour, head of emerging market debt and commodities says, “We estimate the total credit outstanding in the Chinese economy is more than two times its money supply. This ratio is significantly above trend and keeps moving higher.
"When we look at the trends of this ratio in various past credit crises, including in some developed economies, we remain concerned about a solvency and liquidity crisis in China.
“Aside from structural reform to achieve high growth to sustain the debt levels, the textbook resolution mechanisms might include creating inflation, through debt monetisation, or debt restructurings, by allowing defaults.
“In terms of the debt monetisation option, we estimate that China would need a one-off 20-30% increase in the money supply for it to be a game changer, on a scale similar to the ‘helicopter money’ experienced in the US in response to the Covid pandemic.
“While measures of real, effective exchange-rate competitiveness and the degree of China’s reliance on short-term foreign capital have improved over the past two years, we’ve not seen a convincing amelioration in all the other early warning indicators we track in our country risk models.
“In terms of the policy announcements we have heard to date, they are not of the magnitude required to take the country out of the danger zone.
"As a result, until we see signs of the money supply increasing convincingly, implying the transmission mechanism of stimulus is working, rallies are unlikely to be sustained over the long term.”
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