China makes a U-turn

The direction of travel—on both fiscal and monetary stimulus—has changed.

The government of China had long resisted calls to stimulate its economy and appeared willing to accept deflation in return for tighter control. Recently, it has made a U-turn and turned to stimulus, first, on the monetary side and now on the fiscal side. This is a significant event for global investors—similar to China’s abrupt lifting of Covid restrictions in December 2022—and heralds the end of a three-year bear market. Though many details of the stimulus remain uncertain, we believe this is a watershed moment and that the direction of travel is clear.  

On the monetary side, actions by the People’s Bank of China were specifically enacted to support the equity and real estate markets. The reserve requirement rate (RRR) was cut by 50 basis points (bps), the short-term repo rate was cut by 20bps with a further 25-50bps of cuts by year-end. Injection of Tier-1 capital for state banks will provide more liquidity. The housing market was stimulated by reducing the average mortgage rate by 50bps and reducing the down payment ratio to 15% from 25%.

While specific fiscal policy measures have yet to be formally announced, it now seems clear they will be forthcoming, with the focus on decreasing local government debt burdens, boosting the position of the banking system, supporting the real estate market and delivering targeted support to key groups.  The central government will be looking to create internal demand to drive consumption. The government needs to get the Chinese consumer reengaged to trigger steady economic growth.

This places a floor under the Chinese equity market for now, but its economy will likely take time to recover. The equity market may yet face a ceiling as it must still contend with a struggling property market, declining demographics and geopolitics.

China’s stimulus, along with the advent of a global easing cycle, will, however, likely trigger a broadening of support for the emerging markets and also for Europe (especially Germany, given how highly leveraged it is to the global economy) since the more economically cyclical portions of the global economy (such as materials and industrials) will benefit. We have had many false dawns. For now, we are overweight Chinese stocks, giving the benefit of the doubt to the government’s commitment to support the economy.

What’s different this time?

• These monetary and fiscal stimulus programs go beyond previous piecemeal efforts. The central government’s comments also point to more determined efforts to steady the economy.
• China’s economic growth is slowing, and the government needs to do something if it hopes to hit its 5% growth target. The International Monetary Fund (IMF), a global organization dedicated to promoting sustainable growth and financial stability, currently projects China’s economy will grow at 4.8% this year and 4.5% in 2025, though the IMF acknowledges that recent moves may improve China’s growth at least in the near term.

What's next?

• Volatility in China’s equity markets will continue as investors respond when (and if) additional fiscal and monetary programs are announced and assess whether they will have a meaningful impact.
• Chinese shares are trading well outside historical averages right now with a 40-60% discount to US and European equities – but as P/E multiples begin to expand we might expect this valuation discount to shrink.