Newsletter commentary Sep 2024

In the last week of September, the market experienced a significant turnaround, sparked by a press conference from three financial departments introducing new policies for the capital market and real estate. Notably, two innovative tools aimed at boosting stock purchasing power were unveiled. These unprecedented tools, if successful, will become permanent fixtures.

 The timing of the subsequent Politburo meeting was unexpected. During this meeting, a systematic explanation was provided regarding current issues, challenges, and solutions. The discussion covered monetary finance, fiscal policies, real estate, and the capital market. It also emphasized the importance of leveraging the initiative of entrepreneurs and local governments, with a focus on consumer welfare. The market responded very positively, with enthusiasm rising faster than expected. Trading volume quickly surpassed one trillion and then two trillion, leading to a sharp increase in the value of Chinese assets.

 During the National Day holiday, trading activity of Chinese assets remained strong, reversing the previous indifference of overseas investors. Why did such a rapid change occur within a week? Firstly, the prolonged downturn in the Chinese stock market over the past few years created a sense of inertia among investors. Long-term pessimistic narratives became widely accepted, significantly depressing the prices of Chinese assets. At the individual stock investment level, few investors dared to envision long-term prospects. Pessimistic investors focused on short-term high-frequency data, magnifying flaws. This created a situation where those with a negative outlook profited, while optimistic investors found it difficult to make money. Those who were previously pessimistic may now be returning the profits they made over the past few years.

 At the same time, the sluggish prices of real estate and stocks, which are the largest assets for residents, negatively impacted consumption and the overall macroeconomic performance. As a result, many stocks became quite cheap, but few people dared to buy them, fearing further price drops. Some investors questioned the value of these cheap stocks, arguing that they had been cheap for a long time, so what’s the point of being cheap? It is indeed a difficult question to answer, as low prices could persist for a long time. However, when cheap stocks encounter a change, they can easily turn into a sharp rebound.

Over the past few years, China’s economy has been one of the best-performing globally. However, due to insufficient demand and excessive supply, prices were suppressed, making it difficult for businesses to make profits and leading to poor income expectations for residents. The long-standing real estate bubble needs time to be absorbed. When prices have not yet found support, it is difficult to introduce major policies. Residents, local government financing platforms, and some enterprises engaged in deleveraging activities, creating a tightening effect on the economy. This is a painful process. Currently, housing prices have significantly dropped, rental yields in many areas have reached over 2%, comparable to the yields on 10-year and 30-year government bonds. New home sales have also dropped to around 800 million square meters, a level considered more sustainable. A week ago, many companies were priced near their net asset value, and the CSI 300 Index was trading at just over 10 times earnings. Additionally, the continuous rise in asset prices overseas over the past few years has started to reverse. Factors such as interest rate cuts in the United States and increased market volatility elsewhere are causing international capital flows to reconsider their direction. China’s policy space has also expanded accordingly.

Deleveraging can be achieved through deflationary measures like cutting back on spending, a remedy the IMF has prescribed to many struggling countries in the past. This process is painful, and changes in debt levels may still lag changes in nominal GDP. Alternatively, deleveraging can occur during development, under conditions of moderate inflation. This has been our successful approach—solving problems through development. The historical burdens were significant, but a large portion has now been addressed. The conditions are now in place to solve problems through development. 

Patience means waiting for the right timing and circumstances. Currently, both external conditions and internal market corrections have shown signs of improvement, and internal pressures have built up significantly. While we can’t be entirely sure, we maintain a relatively positive outlook.

Looking ahead, it took just one week to completely change the perception of Chinese assets. This is a significant achievement that should be cherished. Prices reflect confidence, and the positive effects are already emerging. The rise in virtual prices has stimulated consumption, leading to short-term increases in orders for travel and automobiles. 

In modern economies, the integration of virtual and real assets is very close. For example, nearly 70% of American residents’ assets are in stocks and real estate, with stocks making up the majority. The stable rise in stock prices is crucial for maintaining their high consumption rates, which may have led them to another extreme. However, effectively leveraging both the virtual and real parts of the economy is indeed very important.

Stabilizing real estate prices and ensuring a moderate, sustained rise in stock prices are fundamental for addressing local government finances, boosting consumer confidence, and facilitating industrial upgrades. Without this stability, even increased central government spending would struggle to achieve these goals, making it a challenging task to drive the economy forward alone.

Based on the spirit of recent meetings, we can expect increased fiscal spending in the future. More promising than the scale of spending is the stance expressed by the central bank governor, showing unwavering support for the goals and a commitment to achieving them. Like Premier Wen Jiabao’s statement that confidence is more valuable than gold, actions must be swift and decisive. Similar to Draghi’s commitment to do whatever it takes to defend the euro, this approach can mobilize more market forces to move in the same direction, achieving twice the result with half the effort. 

Compared to many countries where deficits have remained above 7% post-pandemic, China has numerous areas where significant progress can be made. Thanks to our globally highest savings rate, dual economic structure, and the need to improve our demographic structure, along with many areas that can be strengthened.

In summary, we believe that the recent policy changes likely mark the beginning of a new framework. As we proceed cautiously, the logic surrounding Chinese assets could undergo significant changes. China’s strong supply capacity will better align with domestic demand, restoring corporate profitability, boosting consumer confidence, and revitalizing the enthusiasm of entrepreneurs and local governments. This will also promote industrial upgrades, allowing the economic engine to run smoothly again in its new position. Stock investments will unfold in a more stable economic environment, where broad and rapid increases will be less common.