The quarter that just ended was pivotal.
Central banks confirmed a major transition from an unconditional battle against inflation to a much more balanced approach, with priorities shifting towards the economy and employment.
As Canada, Switzerland, the Eurozone, the UK (and others) started to cut rates, all eyes turned to the US Federal Reserve. Their September committee didn’t disappoint: A jumbo 50 basis point rate cut, an explicit focus on employment, and an overall dovish guidance. Markets celebrated, expectations adjusted, commentators commented, and the investor community started to relax, thinking that the next big event would not happen before November with the US elections and the next Fed meeting.
Alas, this was not the time to relax.
China changes things around
The next big event was last week, in China, with policymakers surprising markets with a massive and comprehensive plan to support the economy, markets, real estate, everything. As this first of October happens to be the National Day of the People’s Republic of China, we’ll dive in today.
First, a few words of context about China’s economy. The story is known: the government embarked from 1978 in market-oriented economic reforms, which turbocharged the country’s economy at an average annual real growth of close to 9% since.
Per capita income quadrupled, the country became the ‘factory of the world’ in the roaring globalization of the early 2000s, built immense infrastructures, and reached its current status of giant, second only to the US with an annual GDP of more than $18 trillion.
As a comparison, similarly populated India’s GDP is around $4 trillion. China is also bigger that the combined economies of Germany, France, Japan and the UK. Of course, such a gigantic number cannot grow at the same pace as it did in earlier stages.
GDP growth logically dropped from the double digits of the early 2000s to 5.2% in 2023. Interestingly, while China outperformed the world in 2020 and 2021 at the peak of the global pandemic, its activity suffered the following year from strict anti-Covid policies. They were eased, and fast forwarding to 2024, China’s government set a real GDP growth target of 5%.
Quite the stimulus
As always with China, this was ambitious, and this time, many observers were skeptical, due to a difficult international context, including trade restrictions, as well as domestic topics: a never-ending crisis in the real estate sector, and domestic consumption struggling to rebound.
China’s population is ageing, employment is not buoyant for all age groups and geographies, and the property crisis takes a toll on people’s wealth, pushing them to save more than consume. Growth was certainly better than in Europe, but not up to the 5% mark yet.
Something had to be done.
And it was: China came last week with a surprise, massive stimulus plan, spanning across both monetary and fiscal policies, through announcements from the central bank and the Politburo. The People’s Bank of China cut banks’ reserve requirement ratio, unleashing credit, as well as mortgage rates, while opening a funding facility to brokers and asset managers to support the stock market.
On the fiscal side, the Politburo committed to achieve the country’s growth target, with targeted measures on the property market, to combat oversupply and ease transactions, as well as, reportedly, up to 1 trillion renminbi injection of capital into top banks and 2 trillion renminbi of sovereign bond issuance.
If we just sum the reported numbers, the total is close to 3% of China’s annual GDP. This is huge, but what is even bigger is the firm determination from the government, given their immaculate track record of delivering what they promise.
Setting off an investor rush
Turning to investments, this happened at a time when Chinese stock markets were both undervalued and under owned by international investors. Pairing with the fact that some markets will be closed for the national holidays, market reaction was brutal, with a 20% gain for Chinese equity indices in just a few sessions.
I’m happy to say that we were not underweight on China, due to its valuation and unpopularity. But I must admit that we were not overweight: we were not expecting such a plan to happen before the US elections. We were thus, and still are, just neutral within our EM (emerging markets) equity allocation, which means between 1% and 3% of a global diversified portfolio (from cautious to aggressive).
Is it too late to jump in?
Timing is difficult, but China is certainly not an equity market to be neglected, we recommend this neutrality.
First, even after the recent ballistic rerating, valuations are still accessible. Second, international investors did not replenish their allocations to neutral in a few days, there is more to come.
Third, and most importantly, China’s economic issues can be addressed, and we should not dismiss the country’s phenomenal successes in high value industries such as the global EV market. The secular growth story may not be as spectacular as India for the decades to come, but China is certainly not to be forgotten.
Now, volatility will continue to be massive, with brutal rallies and disappointments. The US election outcome may create turbulences. That’s why we are overall defensively positioned – but certainly not absent from Chinese financial markets.
