On September 24, 2024, China’s central bank and financial regulators adopted a series of policy stimulus measures designed to stabilize its ailing property sector, arrest its economic slowdown and combat deflation. A day later, those moves were explicitly endorsed at the highest levels of China’s government in a meeting of the Politburo attended by President Xi Jinping.
China has acted. The Chinese equity markets have jumped on the news. What does that mean for Chinese, Asian and global markets over a longer term? How will they react? In what follows, we outline our thinking and offer broad longer-term investment conclusions.
We begin with a summary of the measures China has adopted.
China’s policy shift
In a joint press conference on September 24, 2024, China’s central bank governor, Pan Gongsheng, flanked by key financial regulators, announced that they will cut China’s main lending rate by 20 basis points (bps), mortgage rates by 50 bps and bank required reserves by 50 bps. Additionally, they will reduce the minimum down payment for second homes from 25% to 15%. In their press conferences, China’s policymakers also expressed support for China’s stock market, announcing up to 800 billion renminbi in funds for banks, insurers and brokers to purchase shares.
China’s equity market responded favorably to the stimulus measures, with the Shanghai Stock Exchange (SSE) Composite Index jumping 8.3% in the first 48 hours after the announcement.1
What’s at stake?
In our opinion, two primary conclusions arise from China’s recent policy actions.
First, the fact that the measures were announced at a major press conference that the central bank and regulators jointly held—and that a Politburo meeting with President Xi in attendance backed up—signals a major shift in Chinese economic policy. China’s patience with slowing economic growth—due to overinvestment and excessive debt in its property market—has run out. The latest industrial profit growth figures signaled pressure on profit margins and partially serve as the latest data reinforcing the need for additional policy response. China’s leadership is publicly united in efforts to stimulate economic growth and reduce the risks of deflation in the economy. That is a significant step.
Second, while China’s policymakers are determined to spur economic growth, additional measures will be needed going forward, in our view. The experience drawn from the historical record of other countries, developed and emerging, shows that debt overhangs and property bubbles cannot be solely addressed, nor overcome, by cutting interest rates and providing additional liquidity. China will ultimately have to introduce comprehensive monetary, fiscal, regulatory and legal measures to address the reallocation of resources and debt, and to stimulate demand. There is no easy or quick fix.
Taken together, those twin conclusions point to a third: These policy announcements are likely to be harbingers of additional steps from Beijing to turn around China’s economic and financial fortunes. By publicly staking their credibility to these measures, even with the knowledge that they may be insufficient, China’s policymakers are effectively committing to additional, if unspecified, policy actions. It was this type of commitment to “do whatever it takes” that produced market confidence in the United States after the global financial crisis.
Investment implications
The surge in China’s equity market after the announcement is based on investors’ hope that Chinese policy is making an important turn, one that while not sufficient has nevertheless improved China’s growth and earnings prospects relative to the previous status quo.
To emphasize, this is not yet a case of Beijing “having done whatever it takes.” But given the high-level personal credibility at stake, we believe it suggests a willingness to do much more in the months to come. China still needs to address growing the consumer market and building social safety reforms—like retirement and health care—to reduce the high savings rate. The work of the government is far from done.
In the nearly 15 years since January 1, 2010, the SSE Index is down 3.5%, while the S&P 500 Index is up 391%.2 The average price-to-earnings ratio on China’s mainland Shanghai index is 12.3 times compared with the S&P 500’s multiple of 27.5.3
Therefore, in our analysis, the Chinese equity market represents an intriguing value proposition. As value investors know, however, low multiples alone do not assure high returns. Cheap can remain cheap. In our view, what is instead required is a catalyst to shift investor attitudes from the justification of low multiples to the possibility of something better. We believe China’s high-profile commitment to buttress its economy is just that type of catalyst.
In general, foreign equity investors have been unenthused about Chinese equities. We believe now could be the time for investors to consider increasing their exposure to Chinese equities, with mutual funds or ETFs offering investors access to this market.
China’s impact on other regional and global markets is, however, apt to be more contained. China is taking steps to keep its economy from slowing further. That should reduce domestic investor pessimism about dour earnings prospects. It should also lower Chinese economic and financial risk premia. But China can still do more to accelerate growth or increase consumer spending. Thus, its demand for imports ranging from raw materials to capital goods may still be subdued. Accordingly, we believe the spillover from China’s policy shift should initially be modest for regional and global growth and earnings prospects, and hence for equity markets in Asia and elsewhere.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. These risks are magnified in emerging markets.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Hong Kong and Taiwan could be adversely affected by its political and economic relationship with China.
ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.
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1. Source: CNBC, September 26, 2024. The SSE Composite Index, also known as SSE Index, is a stock market index of all stocks that are traded at the Shanghai Stock Exchange. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
2. Source: CNBC, Bloomberg. September 26, 2024.
3. Source: “Global P/E Ratios by Country.” World PE Ratio. September 27, 2024. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
