Why Chinese stocks may have hit the bottom
Chinese stocks are flirting with “bear market” territory at the worst moment possible for President Xi Jinping’s economy.
Having just grown a blockbuster 8.1% in 2021 and curbing the spread of Covid-19 like few other nations, one might expect investors to give China the benefit of the doubt. Not so, though, as the CSI 300 Index edges toward an official correction for the first time since 2018, when the US-China trade war first rocked markets.
Yet two pieces of good news are worth considering. First, today’s turbulence isn’t a repeat of 2015, when Shanghai shares plunged 30% in a matter of weeks. Second, Xi’s team has the scope and the tools to allay investors’ concerns about Asia’s biggest economy in relatively short order.
When HSBC strategist Max Kettner downgraded the bank’s view on US stocks last week, he suggested investors “hide out” in emerging markets, “especially China.”
Even if mainland shares are falling toward the danger zone, Kettner’s rationale still has merit – if for no other reason than the fact China and the US are “at an entirely different stage of the growth/liquidity cycle.”
In Washington, the Federal Reserve is mulling when and how to begin what’s likely to be a multi-step tightening cycle. Earlier this week, Fed Chairman Jerome Powell signaled that a series of interest rate hikes are coming.
One day later came news US gross domestic product (GDP) grew a stronger-than-expected 6.9% on an annualized basis in the October-December quarter.
In Beijing, on the other hand, the People’s Bank of China is in easing mode. On December 17, it enacted its first official interest rate cut since April 2020. It added fresh liquidity to money markets, too.
This divergence is likely to continue as US inflation surges 7%, the most in 40 years. Though China’s factory-gate prices are heating up, mainland producers aren’t passing the full brunt of price increases on to companies and consumers, yet.
That affords PBOC governor Yi Gang considerable latitude both to support growth and calm credit markets spooked by defaults. More importantly, though, prospects for Chinese growth in the 5% range present their own opportunity for Xi’s reform team.
Much of the pessimism about China concerns Xi’s “zero-Covid” strategy. While it worked wonders taming the Delta variant in 2021, Omicron is a very different, far more transmissible, strain. Though Xi’s initial inclination is to stick with what works, there’s been a rhetorical shift in Beijing toward a “dynamic zero Covid” strategy.
This pivot would mean a less dogmatic approach to the pandemic, one that gives greater weight to vaccinations, testing and contact tracing than draconian, growth-killing lockdowns. The hope is that during the February 4-20 Beijing Olympics, Team Xi will showcase a nimbler and more pragmatic policy to tame the virus.
Another big worry is the China Evergrande Group factor. Late last year, the globe’s most indebted property developer rocked Asian markets when it began missing bond payments. Markets stumbled again when debt-laden Fantasia Holdings Group and others defaulted.
Now, there are encouraging signs Xi’s Communist Party is taking on the underlying ailments, not just treating the symptoms. Mainland authorities are mulling a strategy to dismantle Evergrande and sell off its major assets, Bloomberg reported on January 27.
According to the report, the plan would see the company unload most assets except for its separately listed property management unit and electric vehicle business. State-owned bad debt manager China Cinda Asset Management would lead the effort to assume any unsold Evergrande property assets.
It would send a powerful message to investment giants from BlackRock to JPMorgan to UBS rushing China’s way that Xi is fixing the nation’s biggest financial cracks. Japan’s last 30 years are a cautionary tale about the costs of moving too slowly to address bad loan troubles that over time become systemic.
In the late 1990s, China bought on L William Seidman, a former chairman of the US Resolution Trust Corp, to advise the government on debt restructuring strategies. In the 1980s, the RTC plotted America’s way out of its savings-and-loan crisis.
Now, Xi’s team appears to be devising such a mechanism for over-indebted developers, state-run enterprises and entire municipalities to dispose of toxic loans imperiling whole sectors of the economy.
The contrast with the events of summer 2015 would be impossible to miss. At the time, Team Xi took a “kitchen sink” approach – throwing every tool it could think of at cratering share markets: loosening leverage and reserve requirement protocols; turning off initial public offerings and halting trading in thousands of listed companies; allowing punters to put up apartments as collateral so they could buy shares; urging households to buy the market out of patriotism.
Recent events suggest Xi’s men are planning to get under the economy’s hood and strengthen its foundations.
Xi also can cheer markets, if he chooses, by throttling back on crackdowns on tech, education, entertainment and other sectors. The top-down campaign to rein in billionaires like Alibaba founder Jack Ma beginning in late 2020 damaged China’s capitalist credentials.
It included shelving a November 2020 initial public offering by Ma’s fintech outfit Ant Group. That US$37 billion listing in Shanghai and Hong Kong was to be history’s biggest. Team Xi unnerved foreign investors even more by putting the screws on Alibaba, Baidu, Didi Global, JD.com, Tencent and other tech giants.
The fallout continues to divide global investors. On one side are punters like Charlie Munger, Warren Buffett’s long-time partner, doubling down on China Inc. Munger’s media and investment outfit Daily Journal Corp upped its stake considerably in Ma’s e-commerce giant.
Bridgewater Associates founder Ray Dalio is as bullish as ever on Asia’s biggest economy. The US, he says, is in “relative decline,” while “China has been rising.”
On the other side, investors like Jeffrey Gundlach, founder of DoubleLine Funds, argue “China is uninvestable.” Gundlach says “I don’t trust the data. I don’t trust the relationship between the United States and China anymore. I think that investments in China could be confiscated. I think there’s a risk of that.”
Jim Cramer, CNBC’s widely watched market commentator, said last week that Xi-generated regulatory uncertainty is a “total wild card,” dissuading him from calling Chinese shares a “buy.” Xi, Cramer contends, “doesn’t like capitalism” and that the man directing the world’s No 2 economy “may be the first totalitarian dictator in a long time.”
Yet with China’s weighting in stock benchmarks like the MSCI growing, most investors will have to place ideology aside. At the same time, many global funds appear to see the roughly 20% drop in Chinese shares these last 11 months as a buying opportunity.
JPMorgan strategist Mixo Das speaks for many when he concludes that “within Asia, if you just follow policy, China is definitely the place to be.”
In recent days, at least seven mainland mutual funds announced plans to buy their own stock market-related investment products. They include household names like China Universal Asset Management and E-Fund Management. And, analysts say, it hardly seems a coincidence.
With the Winter Olympics starting next week, overlapping with a week-long Lunar New Year break, Team Xi probably wants a tame stock market. In the longer run, though, Xi’s government has several options at its disposal to cheer global investors.
That alone might pull capital China’s way as the Fed puts investors on notice that US markets are heading for a rough patch.
Author: WILLIAM PESEK, Asia Times