The world's second largest economy gets a boost

China’s central bank lit a fire under mainland and Hong Kong stocks this week when it announced a comprehensive programme of easing measures aimed at boosting liquidity and confidence.

Among the initiatives were a 50 basis-point cut to the banking required reserve ratio; a mortgage interest-rate reduction; lower downpayments on second homes and the creation of a new swap facility to provide securities firms with access to liquidity for stock purchases. 

The breadth of the package took markets by surprise, sending China-related assets sharply higher. 

Weakness in the Chinese economy—underpinned by poor consumer confidence, sluggish retail sales, falling house prices and slower-than-expected GDP growth—has led many investors to urge the Peoples’s Bank of China (PBoC) to throw its weight behind significant stimulus, rather than policy responses that tinker around the margins. 

“[The latest announcement] may be exactly what’s required to finally create rising asset values, which, in turn, will help to revive consumer confidence,” says Jonathan Pines, Portfolio Manager, Asia ex-Japan Equity. “It underlines the government’s seriousness in tackling the problem.”

Chinese earnings estimates have been on the decline almost across the board in recent quarters, Pines says, which has led investors to wonder why the government has not been more aggressive in its response. “The likely reason is the legacy of stimulus following the 2008-09 Global Financial Crisis, which caused excess capacity and a poor allocation of resources,” he says.

As a result, the PBoC ’s incremental approach to addressing the country’s economic challenges has had a limited impact over the past two years, Pines adds. “In our view, carrying out an anti-graft crackdown at the same time hasn’t helped, since it’s arguably scared business leaders away from making big investment decisions.”

“The latest measures are meaningful and convey the message that the government is committed to stabilising the economy,” says Kunjal Gala, Portfolio Manager, Global Emerging Markets.

Notwithstanding the challenges in China’s property sector, the underlying strengths of the Chinese economy remain apparent: world class infrastructure, competitive supply chains, innovative internet companies, leading renewable and electrification technologies, and a rapidly developing capability in semi-conductors, Gala adds. 

“Although China has reduced in relevance in global indices, we believe this is an anomaly. It remains the world’s second-largest economy and can grow sustainably at 3-4% annually. If policymakers can reflate the economy, the outlook for Chinese assets will be brighter in the months and quarters ahead.”

Risks priced in?

For Sandy Pei, Portfolio Manager, China Equity, the valuations on offer for Chinese companies remain attractive even after this week’s stock market rally. 

“The market continues to trade at multi-decade lows for reasons that are well understood by investors, so you can argue a lot of the risk has already been priced in,” she says. “Because of this, it’s fairly straightforward for contrarians to cherry pick the best companies based on their individual investment cases.”

This investment case adds up even in the face of a potential increase in trade tariffs following November’s US election, according to Pei. 

“Chinese exports to the US have declined, but this has been more than offset by the growth of exports to other countries,” she says. “Chinese companies have also set up production bases in southeast Asia, Eastern Europe and Mexico, and this may help them circumvent any additional tariff-related challenges.”