China’s battered stock market is down but not out

Despite the gloom, there is a glaring lack of consensus about the outlook as Beijing signals more aggressive support. Critically, Wall Street banks are not ready to give up on China

Nicholas Spiro

Published: 4:30pm, 9 Feb 2024

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As the Lunar New Year holiday approaches, rays of hope are piercing through the dark clouds enveloping China’s stock market. Mounting speculation that Beijing is readying more forceful measures to prop up the battered market – a staggering US$7 trillion has been wiped off shares in mainland China and Hong Kong since their 2021 peaks – has lifted sentiment.

On Tuesday, the benchmark CSI 300 index had its best day since early November 2022, while the CSI 1000 gauge of small stocks enjoyed its sharpest daily gain since 2008. After so many false dawns, that mere hints of support can still trigger a dramatic rebound shows all is not lost for Chinese equities.

Many foreign investors would disagree. At a recent Goldman Sachs conference in Hong Kong, more than 40 per cent of investors surveyed said Chinese stocks were “uninvestable”. Another recent poll by Bank of America found that “chronic disappointment” had turned investors away from Chinese equities, with nearly 40 per cent looking for opportunities elsewhere.

The damage to investor confidence over the past three years has been colossal. The combination of regulatory crackdowns on parts of the private sector, the draconian zero-Covid policy, a much weaker-than-expected post-pandemic recovery, the housing market crisis and geopolitical tensions has had a devastating impact on sentiment.

The effect has been amplified by the growing appeal of other markets in Asia and Beijing’s woefully inadequate response to China’s grave economic problems. Morgan Stanley says policy easing measures have been “slow, reactive and insufficient”, leaving China with a tighter policy stance than 18 months ago.

Selling pressure in equity markets has been indiscriminate. Even sectors dominated by more resilient state-owned enterprises, such as utilities and industrials, have suffered. Small stocks have borne the brunt: the CSI 1000 is down by more than 18 per cent this year. This has coincided with a rapid unwinding of margin debt for stock trades, increasing the risk of further declines as investors are forced to liquidate their positions.

Investors look at screens showing stock market movements at a securities company in Fuyang, in China’s eastern Anhui province, on January 17. Photo: AFP

Despite the gloom, there is a glaring lack of consensus about the outlook for Chinese shares. Many Wall Street banks are just as eager to present the bullish case as to lay out the bearish one.

Increasingly attractive prices are a key factor. Valuations have sunk to historical lows. According to Societe Generale, the forward price-to-earnings ratio of the CSI 300 stands at 8.3, compared with 11.9 for emerging markets, 20 for the S&P 500 and 22.5 for India’s BSE Sensex. For contrarian investors, Chinese stocks are a screaming buy.

But other factors are at play. First, the consensus on China at the beginning of last year was proved spectacularly wrong and could be wrong again this year. The country’s opaque decision-making warrants a sizeable risk premium, but also increases the scope for positive surprises, like the abrupt abandonment of the zero-Covid policy.

It is conceivable that China’s stock market has bottomed out and catalysts for a meaningful recovery are starting to fall into place. While it would be an exaggeration to say the fear of missing out on an epic rally has taken hold, the stock market is not the economy and the odds of a sharp rebound are taken more seriously by fund managers than the grim headlines suggest.

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Second, Beijing’s growing sensitivity to growth and asset prices marks a turning point in the policy response. Not long ago, investors were worried the economy was not a priority for President Xi Jinping. Today, fear of a self-fulfilling loss of confidence is forcing Beijing to take more aggressive measures.

While one can debate the efficacy of state funds’ intervention in the equity market, Beijing has prioritised market stability. This raises the stakes but also increases the odds of more decisive action. Since a durable rally is contingent on an improvement in the economy, pressure on the government to ramp up support for the housing market by doing whatever it takes to secure the delivery of unfinished homes is bound to intensify.

Third, for all the pessimism about China, the country is at a different point in the cycle from Western economies. In China, all the bad news is priced in and policy is becoming more supportive. In the United States, all the good news is priced in and the risk of a sharper downturn and high interest rates for longer than expected is significant. The euro zone, meanwhile, is struggling to avert a recession.

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Fourth, and perhaps most importantly, many investors have been waiting for a rally in Chinese stocks. Wall Street is not ready to give up on China even though a significant percentage of foreign investors have thrown in the towel.

Some investment banks are quite bullish. Goldman Sachs expects the CSI 300 to deliver a 19 per cent return this year, hingeing on an “effective policy put” or guarantee that Beijing will support the economy and markets.

In a January 23 report, Goldman Sachs presented a “wish list” of measures – which include demand-side stimulus, a government backstop for the housing and stock markets and support for the private sector – that could turn sentiment around. While there were plenty of risks, it said they were skewed to the upside.

Some might say most items on a wish list are unobtainable. Yet wishes are also a sign of hope. China’s battered stock market is down but not out.

Nicholas Spiro is a partner at Lauressa Advisory