Reviving the dragon: China awakens
The story had become all too familiar. China’s economy was stalling, consumer confidence was deteriorating, and the property bubble was deflating. Something had to be done. Yet, month after month, there was little sign of a meaningful response. The People’s Bank of China (PBoC) had cut rates on a number of occasions and had lowered reserve requirement ratios while injecting liquidity. But these measures were just a drop in the bucket compared to what was needed to lift the economy. This was all the more true given that fiscal stimulus measures were only a distant hope.
This period of inaction, which had gradually driven investors away from China, came to a sudden end this autumn. In a coordinated move, the PBoC and the Politburo unveiled a sweeping package of monetary, banking, property and fiscal measures, including: central bank rate cuts, a recapitalisation of more than USD 140 billion for six major commercial banks, an average reduction of 0.5% on rates for existing mortgages, lower down payments on second homes (from 25% to 15%), and fiscal transfers to the poorest households. Although some specifics, such as the distribution of aid to households, still need clarification, the plan is undeniably ambitious and finally is commensurate with the scale of China’s economic challenges.
A number of clues also underline how exceptional these measures are. The first thing that stands out is the coordination of the announcements, which contrasts sharply with the drip-feed actions of recent quarters. Then, the agenda of the September Politburo meeting was devoted to economic issues, which has not historically been the case. Finally, the Politburo’s language is different, openly mentioning “new problems” for Chinese growth as well as a desire to “improve the effectiveness” of economic policy and to “respond to the people’s concerns”.
For investors who had lost faith after a series of false starts, these announcements triggered a sharp rally in Chinese equities – from local A Shares to shares listed in Hong Kong and the US. European equity markets, particularly sectors with strong ties to China such as luxury goods, auto manufacturers, spirits, and mining, also benefited from this abrupt reversal of sentiment. The euphoria surrounding Chinese stocks could last for some time. For now, hedge funds covering short positions are driving the rebound, but investors with an eye on fundamentals have good reason to reconsider China. Portfolio exposure to Chinese equities is at its lowest level in more than a decade, while valuations remain low, both in absolute terms and relative to other emerging markets, with earnings expectations modest.
However, the picture for European sectors exposed to China is less clear-cut. Sectors reliant on a rebound in large-scale demand, like chemicals and steel, could present opportunities. But others, such as automotive and luxury goods, face deeper structural challenges that remain unresolved. In the automotive sector, weak demand within Europe itself, coupled with regulatory pressure and heavy debate on the internal combustion engine, continues to weigh heavily. On Friday, the profit warning from the equipment manufacturer FORVIA and the downgrade to speculative grade of the credit rating of its competitor VALEO were cruel reminders of the sector’s difficulties. Meanwhile, in luxury, declining volumes – driven by exorbitant pricing and the rise of “quiet luxury”[1] – go beyond China. In fact, local Chinese luxury brands are unlikely to suffer in any recovery in consumption – quite the contrary. And both the automotive and luxury sectors are particularly vulnerable to escalating trade tensions between Europe and China.
Without question, these measures from the Chinese authorities mark a potentially pivotal moment for the markets. Neglected sectors could see a resurgence, and Chinese and more generally emerging market equities may reclaim their place in global portfolios. The broader economic outlook will now need to factor in China’s imminent recovery. However, beyond the initial surge of optimism, careful analysis will be required to identify the true beneficiaries of these shifts. Particularly as the possibility of Donald Trump returning to the White House could once again raise doubts about the possibility of American investments in China.
Final version of 27 September 2024 – Enguerrand Artaz, Fund Manager, LFDE