Chinese stock markets surged in the last week of September in response to the authorities’ announcement of a slate of aggressive measures to stimulate the economy. Although the markets have since pared back about half of their gains after having quickly peaked in the first week of October, the MSCI China index still managed to have rallied 17% within a month.

This is China’s “whatever it takes” moment. As we wrote in our previous quarterly newsletter, we had expected that “PBoC may be more comfortable cutting rates if the Federal Reserve begins to ease” and “implementation of reflationary policies will most probably catch up in the reminder of the year” (see Quarterly Newsletter – Second Quarter 2024, published end July). In view of the larger-than-expected rate cut carried out by the US Fed on September 18, we were not entirely surprised by the timing of a series of policy announcements that kicked off on September 24. It also indicated that Chinese authorities had finally come to terms with growing deflationary pressures and appreciated the rising risk of an economic implosion. While many China observers are focusing on guesstimating the exact size of the stimulus package, we doubt even the authorities themselves have a clear idea of how much stimulus the economy really needs at the current juncture, and we therefore believe they have an open-ended commitment to boost growth until the economy improves. Indeed, the authorities have made it clear that the stimulus efforts are not limited to these measures announced so far.

The policy package features “three arrows”: monetary, fiscal, and structural. On monetary policy, PBoC cut interest rates and reserve requirements, and set up lending facilities to directly support the stock market. On fiscal policy, the authorities are conducting another round of local government “debt swap,” recapi¬talizing state-owned banks, and providing welfare benefits to people in need, such as low-income households and unemployed youth. On structural front, guided by the grand reform agenda laid out at the 3rd Plenary Session of the 20th CCP National Congress, some concrete policy initiatives announced so far include drafting law to promote and protect the private sector, raising statutory retirement age, and encouraging childbirth through a wide range of financial and non-financial incentive schemes. We think that among all the policy measures, the local government “debt swap” program will likely be the most important one, because “when it comes to getting the economy back on its feet, addressing the fiscal difficulties facing the local governments in China is similar to solving the financial (or sub-prime) crisis in the US.” We discussed this issues at some length in our previous newsletter (see Quarterly Newsletter – Second Quarter 2024, published end July).

The dramatic market reaction to the policy shift is largely justified, in our view. Many investors had for some time become quite frustrated with the lack of prompt and adequate policy responses despite deteriorating economic fundamentals and dismal capital market performance. And they had even started to doubt whether economic development were still of priority on the authorities’ policy agenda, thus rendering Chinese stock markets uninvestable. We therefore think the most important implications of the latest policy changes are to help dismiss these concerns in general and effectively eliminate the tail risk of an economic implosion and market meltdown in particular. In a similar vein, we are of the view that the on-going rerating of the markets is driven by a “return to normalcy” in terms of the economy and markets, as the markets have discounted for far too many negative narratives, be it factual or fictional. Looking ahead, we expect the current “whatever it takes” policy stance will be maintained until there are convincing signs of a sustainable recovery in the underlying economic and corporate fundamentals by probably mid next year.        

We had maintained a constructive outlook for the markets with a relatively high gross risk exposure in the run up to the major policy shift, and our contrarian view paid off. However, in view of such a strong broad-based rally within such a short period of time, we have since lowered the overall risk exposure of our funds tactically by taking profits on some defensive and deep-value names, the prices of which have had very decent run, indicating their re-rating may have run its course. Looking ahead and from a top-down perspective, we expect the economic and financial cycles will likely feature a combination of accommodative liquidity conditions and stabilizing growth momentum, which is a market environment conducive to quality and growth factors. As the markets seem to have entered a phase of consolidation, we plan to bring our funds’ risk exposure back to the previous high levels by adding positions in the innovative technology and healthcare sectors.