Until this week, it seemed like it was the best-kept secret in financial markets. Eclipsed by the dramatic fallout from the aggressive tightening in monetary policy in advanced economies, a two-month-long rally in China’s beaten-down stocks has been gathering steam.
Despite a brutal sell-off across all major asset classes, with the benchmark S&P 500 index experiencing its worst first half of the year since 1970, Chinese equities have continued their ascent.
On Tuesday, the marked improvement in sentiment towards China suddenly took centre stage. David Ingles, a Bloomberg TV anchor in Hong Kong, said in a flurry of tweets, “it’s like a switch just flipped on in Chinese markets”.
The scale of the rally is remarkable. The CSI 300 index of Shenzhen- and Shanghai-listed shares has surged more than 15 per cent since its low on April 26, approaching a bull market that is usually defined as a rise of at least 20 per cent from a previous low. The technology-heavy ChiNext is already in bull market territory, as is the Hang Seng China Enterprises Index.
For the first time since Chinese stocks began to fall precipitously in February last year, a sustained rally has convinced many investors that the tide has turned. While various domestic and external factors are at play, the most important catalyst is the growing belief among traders that the worst of China’s “zero Covid”-induced economic downturn has passed.
Such optimism is hard to square with the persistent weakness of the economy. Retail sales contracted year on year in May while industrial output barely expanded. In the all-important property sector, home sales and investment fell by an annualised 41.7 per cent and 7.8 per cent respectively, according to Bloomberg data.
However, markets are forward-looking and are sensitive to shifts in the economy. At the end of June, only five cities were under full or partial lockdown, accounting for 10 per cent of China’s gross domestic product, according to data from Nomura. In April, as many as 45 cities responsible for 40 per cent of output were affected.
Moreover, investors sense Beijing is willing to be more flexible in pursuing its “dynamic zero-Covid” policy. Signs, albeit tentative ones, that President Xi Jinping wants to redress the balance between containing the virus and supporting the economy have buoyed sentiment.
The government’s decision on Tuesday to cut the required quarantine period for international travellers by half was seized on by markets as evidence of a shift towards looser controls. Never mind that other signals point to stricter nationwide enforcement of measures to stamp out the virus, investors are inclined to take a glass-half-full view of China right now.
The combination of the reporting of no new local infections in Shanghai and Beijing at the start of this week, an attractive valuation gap between Chinese equities and their global peers, stronger efforts to stimulate the economy and investors’ desperate search for a positive story amid the doom and gloom in global markets is giving legs to the rally.
In a report published on Wednesday, JPMorgan said China had hit a turning point. Growth is likely to accelerate sharply in the second half of this year, it said, providing “tremendous support not just to [emerging] Asia assets such as Chinese equities, but also for the global cycle”.
Investors are undoubtedly getting ahead of themselves. The ongoing restrictions, the risk of further outbreaks and lockdowns, and the absence of a pandemic exit strategy will continue to undermine confidence, constraining economic activity. What is more, the government’s easing measures are a peashooter compared with the large-scale stimulus deployed during previous crises.
Yet, while justified, these concerns need to be put in perspective. While the economic damage wrought by China’s dynamic zero-Covid policy remains a threat, there is less scope for it to roil markets and a higher likelihood of positive surprises than in developed economies. This is mainly because all the bad news has been priced in.
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Coronavirus: Chinese tech hub Shenzhen shuts down HK border district for 3 days
Coronavirus: Chinese tech hub Shenzhen shuts down HK border district for 3 days
The improvement in sentiment towards China is amplified by the severity of the shocks in Europe and the United States. In the euro zone, the European Central Bank has not even begun to raise interest rates, yet the bloc is already showing signs of the financial fragmentation that nearly tore Europe’s single currency area apart in 2012.
Although Europe’s dependence on Russian gas supplies makes it acutely vulnerable, it is the US central bank that is more likely to keep raising rates until something breaks. Having been complacent about the threat posed by inflation, the US Federal Reserve has had to slam on the brakes, plunging the global economy and markets into a period of deep uncertainty.
While China is hardly a source of stability, it at least offers a hopeful narrative, underpinned by reopening, attractive valuations and policy support. A lot could still go wrong, but investors are focusing on what could go right.
