Chinese officials announced a set of measures this September 2024, the calibre of which could be compared to the ones introduced after the GFC in 2008 and the China Real Estate Crisis of 2015. Some commentators¹ even compared China’s stimulus package to the former Italian Prime Minister Mario Draghi’s ‘whatever it takes’ statement, which marked the bottom of the European sovereign crisis. These superlatives emerged not long after strategists across the street were declaring China to be uninvestable². It was as if suddenly, investors were touched by a ‘speck of China magic’.

Not really. Apart from journalists and strategists, risk takers, who were overwhelmingly bearish and with some being short Chinese equities, got the proverbial ‘touch on the shoulder’ from their risk managers or margin brokers asking them to close their positions. The market reacted immediately. Trading volume on the Hang Seng Index was the highest since the GFC. People had to do what they had to do and ask questions later. The actual ‘story’ came only as an afterthought.

 
Source: Bloomberg & Trium Capital

If investors had been investing in Chinese equities based on ‘fundamentals’, they would have been out of business a long time ago. They say the stock market is not the economy. Well, one can say for sure that the Chinese stock market has had nothing to do with the economy. Take the MSCI China Index in USD compared to China’s GDP in USD: since 1992, the stock market is down -24%, while GDP is up +4,277% (not a typo in either). Analyse this!

 
Source: Bloomberg & Trium Capital

Or take individual Chinese tech stocks and compare them to some US tech equivalents. We understand we are looking at apples vs oranges, but how much of a discount should Alibaba trade to Amazon or Baidu to Google? What if Chinese tech firms appear better than most US tech on fundamental measures such as Free Cash Flow to Market Value or buybacks to Market Value?

The ultimate question for an underweight foreign investor in Chinese equities is how do I buy now, after this massive rally and ahead of an unfriendly (towards China) US election? If you have been short, you have already been stopped out, but if you are simply underweight, you have a bit of time to see how the market settles. After the short squeeze during the first week, there are fewer ‘natural’ buyers. Once the market stops rallying, some of the lucky investors that have been overweight will eventually lose patience and decide to take profit. And the market will lose its momentum and head down again. The details of the stimulus package become almost a non-story because they can be interpreted as they come, i.e. the common knowledge is determined by whoever has more clout in the market – the buyers or the sellers – and among foreign investors, it is undoubtedly ‘the sellers’.

Chinese authorities and the recent stimulus

The huge unknown, though, is the locals. The narrative domestically is controlled centrally, and the upper hand there is of ‘the buyers’, i.e. the Chinese authorities want to see stocks rallying, lifting domestic sentiment, household balance sheets, consumption, and ultimately the economy. Chinese retail has not been too enthusiastic about Chinese stocks recently, but that was before the economic package was introduced in September. 

We have been bullish on China throughout 2024, but we certainly did not expect the kind of bazooka statements from Chinese officials. When, in early September, the Shanghai Composite index was approaching that February 2024 low, before the authorities first intervened in the stock market, we were both getting nervous and apprehensive that if they were to do something again, now was the time (the one thing we have learnt about Chinese officials is that they hate to be proven wrong). But really, the barrage of measures which followed (and we are still awaiting details on some) was quite extraordinary. 

On the monetary policy side, the PBOC had never really cut rates, in modern times, by 20bps and announced forward guidance for more cuts. On the regulatory side, there were two measures specifically designed to boost stock prices, also a first. On the fiscal side, from what the media has reported so far, the stimulus could be as significant as 2008/2015. More importantly, these measures and the way they were delivered gave us a feeling that they were coming from the party’s highest echelons.

Chinese households might still be slow to react. They, too, have seen officials unsuccessfully trying to stem the decline in the real estate market in the last two years. The one thing China has going, which Japan or other Developed Markets (DM) countries that experienced real estate crashes didn’t have, is natural property buyers. With the urbanisation rate still much lower than DM averages and with local restrictions becoming looser, plenty of Chinese households are looking for homes in urban centres. And with local mortgage rates and downpayment ratios now close to all-time lows, these buyers might start being more active.

The Middle Kingdom’s future

What about the China story in the long run? The main difference between Emerging Markets (EM) and DM is not in the economic hard data (there are plenty of EM with better economic ‘fundamentals’ than many DM) but in the solid intangibles of the institutional framework – the idea being that if EM improves on that front, it can get elevated to a DM status. 

For example, in almost any other EM, the anti-corruption policies which China has recently introduced would have been called a ‘reform’ by Western analysts and taken as positive. In China, they were more characterised as a ‘crackdown’ and deemed a negative development. To be fair, the recent regulations in the tech sector have taken the wind out of the drive for entrepreneurship, but only to the extent that it is understood in the West, i.e., the incentive for monetary reward. It remains to be seen whether the collective nature of Chinese society can still generate a level of innovation away from monetary reward as the primary driving force.

In 1982, the SEC in the US introduced Rule 10B-18, which effectively made it very straightforward (and perfectly legal) for US companies to buy back their shares - before that, share buybacks were in the ‘grey zone’, and few CEOs dared to do them for fear of prosecution. That was the beginning of the shareholder primacy movement, which laid the foundations for the greatest bull market in US history. China could be on the cusp of something similar now. 

In March this year, CSRC got the ball rolling³, and now we have a more detailed paper⁴ (in Chinese - thank you, Google Translate!) on how they plan to implement that. As it may be, they called it Regulatory Guidelines of Listed Companies No.10 – Market Value Management. Here is the main point:

Listed companies should firmly establish the awareness of rewarding shareholders and take measures to protect investment by:

1. Mergers and acquisitions;
2. Equity incentives and employee stock ownership plans;
3. Cash dividends;
4. Investor relations management;
5. Information disclosure;
6. Share repurchase;
7. Other lawful and compliant methods.

Chinese regulators may have managed to introduce, in one go, all the major shareholder primacy points that the US eventually went through from the early 1980s till the late 1990s. If there is anything an investor wants to take away from all the recent developments in China, it is not necessarily the fiscal stimulus or the interest rate cuts. They are important, of course, but they are cyclical. What one needs to bear in mind is the institutional developments that should make the country very attractive while actually believing in them.

What about Chinese growth going forward? Who cares? China has been growing at 11% on average for the last three decades or so, which has done little to Chinese equities, hasn’t it? Joking aside, structurally, China is unlikely to ever adopt the consumer-centric economic development model, which is prevalent in the West, not because there is some kind of idealistic view against consumption but for security reasons, i.e., Chinese leaders do not want to be dependent on external factors for economic development. This sense of being in balance is partially cultural - from an economic point of view, Chinese authorities want to have 50/50 consumption and ‘production’ driving the economy. But it also stems from how they want society to be organised, i.e. authorities want to have ultimate control.

One can also see this in how they have been managing the stock market recently. After an extraordinary rally, the regulator, NDRC, issued a ‘stock market window guidance’ for commercial banks, basically prohibiting credit funds from entering the stock market so as to not create a stock market bubble! Ultimately, this was the main reason stocks collapsed after the Chinese holiday (and not necessarily because they did not give details on the fiscal stimulus – NDRC is the regulator; it is not its job to discuss fiscal policy). To an extent, this could also be the downside of China’s development model: the striving for ultimate control of economic and political outcomes in a world that is, by default, becoming more uncertain as society’s complexity increases.

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¹https://edition.cnn.com/2024/10/06/business/china-economy-stimulus-fiscal-spending-hnk-intl/index.html
²https://www.bloomberg.com/news/articles/2023-03-01/explainer-why-it-s-hard-for-china-to-shake-the-uninvestable-tag?embedded-checkout=true
³https://www.reuters.com/world/china/china-securities-regulator-tighten-regulations-listed-firms-brokers-2024-03-15/#:~:text=In%20addition%2C%20the%20CSRC%20urged%20listed%20companies%20to,purchases%20in%20the%20event%20of%20share%20price%20slumps
⁴https://www.csrc.gov.cn/csrc/c101981/c7508331/7508331/files/%E9%99%84%E4%BB%B61%EF%BC%9A%E4%B8%8A%E5%B8%82%E5%85%AC%E5%8F%B8%E7%9B%91%E7%AE%A1%E6%8C%87%E5%BC%95%E7%AC%AC10%E5%8F%B7%E2%80%94%E2%80%94%E5%B8%82%E5%80%BC%E7%AE%A1%E7%90%86%EF%BC%88%E5%BE%81%E6%B1%82%E6%84%8F%E8%A7%81%E7%A8%BF%EF%BC%89.pdf