By Anton Tonev, head of strategy at Trium Larissa Global Macro
If investors had been investing in Chinese equities based on ‘fundamentals’, they would have been out of business a long time ago. While they say the stock market is not the economy, this is especially true for the Chinese stock market. Take the MSCI China Index in USD compared to China’s GDP in USD: since 1992, the stock market is down 24%, while GDP is up +4,277%.
Alternatively, take individual Chinese tech stocks and compare them to some US tech equivalents. We understand we are looking at apples vs oranges, but at how much of a discount should Alibaba trade to Amazon or Baidu to Google? What if Chinese tech firms appear better than most US tech on fundamental measures?
The ultimate question for an underweight foreign investor in Chinese equities is whether to buy now after the massive rally following China’s recent stimulus package in September and ahead of a US election that will likely be unfriendly to China regardless of the outcome.
Shock stimulus
We have been bullish on China throughout 2024, but we certainly did not expect the kind of bazooka statements we have seen from Chinese officials. When the Shanghai Composite index was approaching that February 2024 low in early September, we were getting apprehensive that if they were to do something again, now was the time.
The barrage of measures that followed, however, was quite extraordinary. The new measures and the way they were delivered suggested that they were coming from the party’s highest echelons.
Chinese households might still be slow to react, having also witnessed officials unsuccessfully trying to stem the decline in the real estate market in the last two years. The one thing China has going, which other developed markets that experienced real estate crashes did not have, is natural property buyers. Urbanisation rates are still lower than developed market averages, and with local mortgage rates and downpayment ratios now close to all-time lows, these buyers might start being more active.
Institutional improvements
What about the China story in the long run? The main difference between emerging markets and developed markets lies not so much in economic fundamentals but in institutional frameworks – the idea being that if an emerging market improves on that front, it can get elevated to developed market status.
For example, in almost any other emerging market, China’s recent anti-corruption policies would have been called a ‘reform’ by Western analysts, but in China, they were characterised as a crackdown. Recent regulations in the tech sector have taken the wind out of the drive for entrepreneurship, but only in the way this is understood in the West, i.e., the incentive for monetary reward. It remains to be seen whether the collective nature of Chinese society can still generate a level of innovation away from monetary reward as the primary driving force.
In 1982, the SEC in the US introduced Rule 10B-18, which effectively made it very straightforward (and perfectly legal) for US companies to buy back their shares. That was the beginning of the shareholder primacy movement, which laid the foundations for the greatest bull market in US history.
China’s Securities Regulatory Commission (CSRC) has recently introduced something similar. In March 2024, it rolled out new regulations encouraging mergers and acquisitions, equity incentives, cash dividends, share repurchases, and other shareholder-friendly actions. These institutional developments could significantly improve China’s attractiveness to investors.
Economic security reigns
Structurally, it is unlikely China will ever adopt a consumer-centric economic development model like the West. Chinese leaders want to have an equal balance between consumption and production driving the economy. This is largely for security reasons, as they do not want economic development to rely on external factors.
This desire for control extends to how China’s leadership has been managing the stock market recently. After the recent rally, the regulator, the National Development and Reform Commission (NDRC), issued “window guidance” to commercial banks, effectively prohibiting credit funds from entering the stock market to avoid a stock market bubble.
To an extent, this could also be the downside of China’s development model: the striving for ultimate control of economic and political outcomes in a world that is becoming increasingly complex and uncertain.
