China's Market Surge: Bull Market on the Horizon or Just a Bear Market Bounce?

Chinese stocks have experienced heightened volatility as President Xi and the Chinese Communist Party introduced a series of stimulus measures aimed at reviving the country's sluggish economy. This influx of news has driven significant capital into Chinese markets, with the iShares China Large-Cap ETF (FXI) surging over 30%, reflecting growing investor interest. However, this volatility, coupled with rising implied market risk, has left investors uncertain about the sustainability of the rally and whether now is the right time to invest in China.

Since Beijing's recent announcement of more efforts to support the economy, many investors have been on edge, balancing fears of missing out on potential gains against concerns of getting caught in a short-term market spike. Some are closely watching government briefings for signs of further stimulus or a lack thereof, which could heavily influence market sentiment. The current rally has raised questions about whether it marks the beginning of a new bull market in China or is merely a temporary response to stimulus news, with many unsure about the long-term effects of these measures.

Despite the surge, skepticism persists regarding the effectiveness of China's stimulus plan. Investors worry that the country's structural issues—such as malinvestment, an aging population, and unfavorable demographics—may limit the impact of the government's efforts. This has led to a debate about whether the market rally is genuine or just a bear market bounce, where prices rise temporarily before resuming a broader downtrend. In this article, we will assess the recently announced stimulus measures and explore whether Chinese assets, including ADRs and ETFs, present viable opportunities for investors seeking to capitalize on these developments.

The Pivot

Xi's centralized decision-making, often resulting in abrupt policy shifts, has contributed to the opacity and unpredictability of Beijing's economic strategy, potentially increasing the risks for investors in China rather than mitigating them. This unpredictability was evident when, in late June, Premier Li Qiang emphasized a cautious approach to stimulating China's post-COVID economy, likening it to a patient in recovery who should not be given strong medicine. He advocated for gradual, precise adjustments to restore the economy's foundations.

However, by mid-September, it became apparent that the economy had worsened. Real estate problems deepened, consumption continued to decline, and youth unemployment climbed, threatening social and political stability. Additionally, the CSI 300 Index faced an unprecedented fourth consecutive year of losses, while reports of a growing liquidity crisis surfaced, with local governments struggling to pay civil servants and contractors.

After resisting calls for aggressive economic intervention, Xi initiated a series of interest-rate cuts and other measures in late September aimed at stabilizing growth. However, Xi's focus goes beyond simply stimulating demand; his priority is to prevent a financial crisis by bailing out indebted municipalities and reviving the stock market. All of this is done while staying committed to his broader goal of advancing state-led industrial and technological development. Xi's immediate objective is to stabilize the economy and meet the 5% growth target without derailing his long-term strategic vision for China's future.

Steps Taken

On September 24, China's central bank announced rate cuts and various measures to boost growth and stabilize the stock market, surprising even some financial officials with the scope of the actions. A key move was the creation of a facility to help commercial banks lend to listed companies for share buybacks, a rare step aimed at reviving stock trading, which led to a surge in Chinese stocks. Wall Street firms like Goldman Sachs and BlackRock upgraded their outlook on Chinese equities, though they remained cautious about the country's long-term economic challenges.

This shift was more tactical than strategic, focusing on providing liquidity support for local governments and big banks, key pillars of the Chinese economy. The market's reaction was reminiscent of the Uncle Xi bull market of 2015, when a government push led to a stock market rally, though many investors are now wary that these gains could mirror the 2015 crash.

An October 8 briefing by China's top economic planning agency left investors disappointed with vague promises of pro-growth measures, continuing to focus on high-end manufacturing like electric cars despite concerns about overproduction and trade tensions. However, hopes were reignited following the Finance Ministry's briefing, which hinted at more substantial fiscal support in the near future.

China's latest stimulus measures surprised many with their scope and scale, as the government seeks to boost its struggling property sector, stimulate consumption, and revive capital markets amid a challenging 2024 economic landscape. The new stimulus package is estimated to total around 7.5 trillion yuan (US$1.07 trillion), equivalent to 6% of China's GDP for 2024, according to Deutsche Bank. 

If fully implemented, this could become the largest stimulus package in China's history in nominal terms. Key components include a 2.5 trillion yuan cut in mortgage debt servicing, 1.6 trillion yuan in new stock market support facilities, and 2 trillion yuan in bond issuances aimed at encouraging consumer spending and local government investment. Additionally, 1 trillion yuan will be injected into major state-owned banks to further bolster the financial system.

When comparing this stimulus package to previous efforts, it could be one of the largest in terms of total value, surpassing the 2015 stock market rescue and the 2020 Covid-19 response. However, in terms of percentage of GDP, this round ranks third behind the 2008 global financial crisis stimulus and the 2015 package. 

The 2008 stimulus remains the largest, as it was a massive 13% of GDP, designed to shield China from the global economic downturn. The 2015 package, which ranks second, was focused on monetary easing to stabilize financial markets after stock market turmoil. In percentage-of-GDP terms, this year's measures are comparable to the 2020 Covid-19 stimulus, both around 6% of GDP, reflecting the scale of China's ongoing economic challenges.

The question is whether investors believe this demonstrates the government's commitment to supporting the economy, with a whatever-it-takes tone that reassures investors of further actions if needed. Think of it as a Fed Put.

As policymakers monitor economic conditions, potential key politburo meetings in October, November, and December could provide additional opportunities for fiscal adjustments, especially if external shocks, such as U.S. election outcomes, impact China's economy. With the possibility of further government bond issuance and other fiscal measures, China's leadership remains flexible in addressing its economic challenges while signaling that more stimulus could be on the horizon.

Does the Stimulus Hit the mark?

China's stimulus measures have aimed to stabilize the financial system and the broader economy, but the results are mixed. On the positive side, the stimulus is helping to restore confidence in the equity markets, which could attract both foreign and domestic capital. This capital infusion could boost productivity, lower the cost of capital for Chinese enterprises, and help mitigate economic risks. Additionally, the central bank's liquidity support for brokerages and nonbank financial institutions is a vital step to derisk the financial system, especially in the face of local government debt concerns. The recent rate cuts, coupled with other monetary measures, are starting to provide a line of support for demand-creating policies, such as lowering mortgage rates, which may offer relief to households and spur limited consumption growth.

However, the stimulus efforts largely focus on financial stabilization rather than addressing China's deeper economic challenges, such as its over-reliance on real estate and malinvestment in sectors with overcapacity. Many analysts believe that while these measures provide temporary relief, they are insufficient to solve China's long-term economic issues, including demographic challenges and an aging population. The risk of either a deflationary collapse, if real estate investments are left to fail, or prolonged stagflation, if China continues to print money to prop up failed sectors, looms large over the country's economic outlook. Furthermore, the lack of significant steps to stimulate household consumption suggests that China's leadership is not yet ready to pivot from its focus on industrial and technological growth to a more balanced economic approach.

Moreover, China's stimulus measures, while initially boosting market sentiment, could be undermined by global geopolitical tensions. Tariffs, sanctions, and trade conflicts between China and the West, particularly if a Republican-led U.S. government takes a tougher stance, pose significant risks to China's economic trajectory. Additionally, while the stimulus measures appear to be crossing into forced demand territory, there remains skepticism about whether these efforts will have the desired long-term impact, especially given the absence of strong, immediate demand drivers.

Another concern for investors is the uncertainty surrounding China's regulatory environment and property rights, which makes Chinese equities a risky investment for many global investors. The government's push to restore confidence in the equity markets might present long-term opportunities, but skepticism remains due to the lack of clear property rights and rule of law. Some investors view China's recent moves as a potential red herring, questioning whether the Chinese Communist Party is genuinely committed to fostering a business-friendly environment or if it is simply implementing measures to maintain control without addressing the structural issues facing the economy.

Monetizing the Stock Market

A key focus of the policies is to revive China's struggling stock market, which has been on a nearly four-year losing streak. In an unprecedented move, the People's Bank of China is encouraging brokerage firms, insurers, and listed companies to use central-bank or commercial-bank funding to purchase stocks, aiming to boost market confidence and stability.

China is working to monetize its equity market in a manner similar to the U.S., where the stock market has become a significant store of value for global investors. By doing this, China aims to drive higher valuations for its equities and attract more capital, extending the life of its economic model. This monetization gives Chinese equities a monetary premium, reflected in higher price-to-earnings (P/E) ratios, as they are increasingly seen as financial assets that store value, much like money under the pre-1971 gold standard.

Monetizing equity markets also helps China manage inflation pressures from currency printing. Instead of fueling consumer price inflation, some of the excess money flows into equity markets, mitigating the immediate impact on goods and services prices. Higher equity valuations lower the cost of capital for companies, enabling them to invest more in research and development, which contributes to disinflationary growth by increasing innovation and production capacity.

China's strategy to monetize its equities and attract global capital could position it as a strong competitor to U.S. financial markets in the future. By reducing its reliance on U.S. financial assets and increasing investment in initiatives like the Belt and Road Initiative, China is slowly reshaping the global economic order. Protectionist tariffs from the U.S. could heighten tensions, potentially leading to inflation in the U.S. while having a disinflationary impact on the global economy. If successful, China's plans could challenge the U.S.-led financial system and alter global capital flows.

Conclusion

China's recent stimulus plan provides short-term financial stability and potential productivity gains through market monetization, but significant risks persist. The focus on stabilizing the financial system and local government finances has left household consumption under-supported, which is crucial for long-term growth. Additionally, uncertainties surrounding regulatory policies and geopolitical tensions continue to weigh on investor confidence, raising doubts about China's ability to sustain long-term economic growth and avoid deeper challenges.

While initial measures like central bank rate cuts generated optimism, vague guidance from other economic agencies created volatility and left investors uncertain. Many had hoped for a large-scale stimulus package similar to those seen during past crises, but instead were met with a package of incremental policies. These efforts align with President Xi's focus on strengthening key industries against foreign threats rather than shifting the economy toward consumer-driven growth. The stimulus largely centers on providing liquidity to local governments and major banks, signaling a tactical policy adjustment rather than a broader strategic shift.

We believe the initial rally in Chinese markets is more likely a bear market bounce rather than the start of a sustained bull market. While there is still time for further stimulus announcements, particularly from the Ministry of Finance regarding the real estate market, the current measures are unlikely to provide an immediate boost to the economy. If China can address its property bubble—unlocking significant capital for both consumption and equity investments—it could improve domestic demand and investor sentiment. The upcoming Politburo meeting, and possibly another in December, along with clarity on U.S. tariffs, could open the door for additional stimulus. There is also speculation that China may increase deficit spending, further stimulating the economy.

However, the immediate impact of these measures will likely be limited, and unlikely to be reflected in the upcoming Q3 earnings reports for Chinese ADRs and key economic data like GDP, retail sales, and industrial production. Weak numbers could put pressure on stocks and cause new money to exit the market, especially given the parabolic run witnessed the past few weeks. Despite this, the easing of financial conditions in the country, along with the potential for equity market monetization, should not be overlooked. The success of monetizing equities in the U.S. provides a model China could replicate, provided it can build investor trust and respect property rights.

While we anticipate a pullback in this bear market bounce, there is good reason to believe that over time, these stimulus efforts will take root and boost Chinese equities. Whether this translates into broader economic improvement remains uncertain, but investors should be ready to take advantage of potential buying opportunities if Chinese stocks pull back.

Chinese ETFs to Watch

Here is a summary of the Chinese ETFs for investors to track, with their expense ratios, valuations, dividend yields, and returns:

- EWT (iShares MSCI Taiwan)

  - Expense Ratio: 0.59%

  - Average P/E Ratio: 15.4

  - 12-Month Yield: 3.09%

  - 10-Year Annualized Tax Adjusted Return: 9.38%

- FXI (iShares China Large-Cap)

  - Expense Ratio: 0.74%

  - Average P/E Ratio: 10.6

  - 12-Month Yield: 2.18%

  - 10-Year Annualized Tax Adjusted Return: -0.06%

- KWEB (KraneShares CSI China Internet)

  - Expense Ratio: 0.70%

  - Average P/E Ratio: 14.6

  - 12-Month Yield: 1.32%

  - 10-Year Annualized Tax Adjusted Return: 1.16%

- CQQQ (Invesco China Technology)

  - Expense Ratio: 0.65%

  - Average P/E Ratio: 19.4

  - 12-Month Yield: 0.46%

  - 10-Year Annualized Tax Adjusted Return: 2.08%

- MCHI (iShares MSCI China)

  - Expense Ratio: 0.59%

  - Average P/E Ratio: 12.0

  - 12-Month Yield: 2.32%

  - 10-Year Annualized Tax Adjusted Return: 2.06%