Smart money goes beyond the economic debate in China

As Chinese stocks rebound, markets are once again grappling with the tension between President Xi Jinping’s long-term policy priorities and investors’ hunger for short-term stimulus.

The conflict between the long and short views is nothing new. For decades, the Washington Consensus gang has been advising Beijing to recalibrate its unbalanced economy, which free-market advocates view as too dependent on huge, opaque state-owned enterprises and the huge subsidies that support them.

But Xi’s efforts to do just that have often been met with worried investors who appear increasingly unwilling to give Beijing the leeway it needs to get under the hood and turn around its $17 trillion economy.

Until now, perhaps. Over the weekend, the tension between Team Xi and the impatient markets was clearly visible.

On Saturday (October 12), Xi’s Ministry of Finance (MOF) held an unscheduled press conference, with markets buzzing about a potential huge new stimulus boost to ensure China meets its 5% economic growth target for 2024 and new steps to combat increasingly entrenched deflation.

As the MOF focused on broader reform issues and declined to offer a concrete price for the lack of stimulus, futures markets collapsed. But stocks rose on Monday.

Investors concluded that the Treasury Department’s latest statements reflected the pragmatism that markets have long craved from Xi’s inner circle, even as Beijing refrains from deploying its massive stimulus “bazooka.”

Economist Harry Murphy Cruise of Moody’s Analytics said the weekend’s announcement “met most of the right criteria, but lacked details on the scale and scope of the new spending,” noting: “We expect more to come over the course of the year.” Support measures will be announced.” ”

Economist Zhiwei Zhang, president and chief economist at Pinpoint Asset Management, said: “These measures are in the right direction.”

Even after the recent rally, a strong rebound from 2021’s $6.5 trillion collapse, there is a strong argument that Chinese stock valuations are now fairly valued. In fact, Chinese stocks are now trading at far lower valuations than in the US, where new market highs are recorded every day.

“Although there was no major economic stimulus, the Finance Ministry’s press conference was still a positive surprise for us,” explains Jing Liu, economist at HSBC Holdings. “The policy reversal is likely to continue as rising risk appetite creates a wealth effect in both equity and real estate markets.”

However, chances are this is a trust but verify moment for markets. Optimistic investors are partly responding to Beijing’s hints of greater support for the crisis-ridden real estate sector and highly indebted local governments with new, targeted budget injections.

The incentive for further economic stimulus measures is increasing. In September, Chinese exports and imports were weaker than expected, casting new doubts on the economy’s biggest bright spot. International shipments, for example, rose just 2.4% year-on-year, a significant decline from August’s 8.7% increase.

Economist Zichun Huang of Capital Economics says “increasing trade barriers are likely to become an increasing obstacle” to exports and economic growth in the future.

While the shift toward lower interest rates from Washington to Seoul could boost demand in some of China’s key trading partners, policy restrictions on goods such as electric vehicles and other green technologies are creating new headwinds, economists say.

To a greater extent, however, punters are beginning to realize that Xi’s inner circle is aligned almost linearly to catapult China into the so-called Fourth Industrial Revolution by accelerating the shift upward into high-value, technology-driven industries.

Although annual growth targets are important in the short term, Team Xi is more interested in the longer-term prize of technology-driven economic reinvention and domination of the industries of the future.

Given these caveats, investors are delving deeper into the valuations of Chinese stocks compared to other top global markets and are sensing new value.

In the latest Global Risk-Reward Monitor newsletter, Asia Times business editor David Goldman argues that China’s stock market is “a little too low” at a price-to-earnings (P/E) ratio of 11.

At the same time, however, he notes: “There is no reason to believe that Chinese valuations are approaching the S&P (500) valuation of 22 times (forward) earnings.”

One reason, he argues, is that the Chinese government has done everything it can to prevent and reverse the emergence of market-distorting technology monopolies like Google, Microsoft and Amazon.

“No surprise, then, that Alibaba is trading at a P/E ratio of 27 after last month’s rise, versus Amazon’s 43,” writes Goldman. “We have long argued that China’s stock market valuation is too low given subdued but steady economic growth. After last month’s rally, the valuation of the Chinese market appears more reasonable compared to the United States.”

That is not to say Beijing is unaware of the sensitivity of the moment. In a note to clients, Morgan Stanley economists said this moment was “Beijing’s second chance to win over the market” after several tough days.

Still, Xi may have found a happy medium between being willing to provide more stimulus while remaining cautious.

“The latest round of stimulus for China clearly shows that policymakers have made a U-turn on cyclical policy management and increased their focus on the economy,” without exaggerating, said Hui Shan, an economist at Goldman Sachs.

The U.S. investment bank now estimates China will grow 4.9% this year, up from a previous estimate of 4.7%. For 2025, Goldman Sachs expects growth of 4.7%, up from a previous forecast of 4.3%.

One source of Goldman Sachs’ optimism: Treasury officials plan to allocate 2.3 trillion yuan ($325 billion) in special bond funds for local governments in the fourth quarter of this year.

Hui said this suggests a more “deferred” public spending plan, paving the way for a stronger recovery than his bank had previously expected.

Last week, China’s National Development and Reform Commission announced the pre-approval of investment projects worth 200 billion yuan ($28.2 billion) in 2025. Hui’s team sees this as a clear effort by the government to ensure China meets this year’s GDP target of 5%.

Carlos Casanova, an economist at Union Bancaire Privée, notes that investors are finding comfort in Finance Minister Lan Fo’an, stressing that officials have a “fairly large” capacity to increase spending if necessary.

According to Casanova, this includes “implementing some of the most ambitious measures in years aimed at reducing local governments’ debt burdens, revitalizing the struggling real estate market and recapitalizing major banks – all critical to addressing China’s ongoing structural challenges.”

However, Casanova adds: “The timing of fiscal measures remains uncertain. Important announcements may have to wait until the upcoming meeting of the Standing Committee of the National People’s Congress, scheduled for late October or early November.”

Economist Shirley Ze Yu of the London School of Economics says the Foreign Office “gave the strongest possible signal while waiting for NPC approval.”

Larry Hu, chief China economist at Macquarie Capital, doubts Xi’s policymakers will be too specific about dollar amounts.

“First, they don’t need to submit such a figure for the NPC to approve it,” Hu said. “Secondly, it is difficult to give such a number because the line between fiscal, monetary and industrial policy in China is often blurred.”

Still, Hu adds, flooding the economy with stimulus, as Beijing did in 2008 and 2009 amid the global financial crisis, would run counter to Xi’s debt relief goals.

Goldman Sachs’ Hui says investors will be focused heavily on Beijing’s implementation of structural reforms.

“The ‘3D’ challenges – worsening demographics, a multi-year deleveraging trend and the push to de-risk the global supply chain – are unlikely to be reversed by the latest round of policy easing,” Hui argues.

But economist George Magnus from the China Center at Oxford University has to worry that Beijing could continue to take measures that haven’t worked so far.

“A solution would include sustained expansion of the income and consumer demand shares of the economy, an end to the risk of deflation, greater income redistribution, support for private enterprise, and major tax and local government reforms,” Magnus writes in a commentary. Edited for The Guardian.

Magnus adds: “Xi’s more Leninist agenda emphasizes supply and production and what he calls ‘high-quality development’, which is essentially about state and party-led industrial policies, capital for the management and mastery of modern science, “To provide technology and innovation to the global system.”

There is “no doubt that China already has advanced industrial expertise and leadership in some key companies and sectors and wants to expand this,” says Magnus. “Yet these islands of technological dominance exist in a sea of ​​macroeconomic imbalances and problems that can only be truly addressed through more liberal and open economic reforms.”

Bottom line, Magnus adds: “The current focus on economic policy is important not for a few decimal places of GDP, but as a signal of whether the government can or wants to take matters into its own hands.”

Magnus isn’t the only one who fears that political tinkering won’t be enough. Only bold and disruptive steps to reform the state sector, develop deeper capital markets and encourage households to save less and spend more will make China a more competitive and dynamic economy in the long term.

Half-measures, on the other hand, will likely result in China remaining vulnerable to boom-bust cycles caused by capital misallocation, weak debt capacity and mismatches between household income and spending.

The upcoming NPC will be an ideal time to convince investors that comprehensive reforms are in the works. However, more and more investors are now becoming aware of China’s big plan.

Follow William Pesek on X at @WilliamPesek