Barbara Reinhard, CFA
Senior Managing Director, Chief Investment Officer, Multi-Asset Strategies and Solutions
Since unveiling its latest round of economic stimulus, China’s equity market has seen a dramatic 16% rally and had its best week of performance since 1996. While the recent rally has many considering whether to call an end to Chinese equities’ underperformance, issues regarding the country’s economy remain. Which leaves us to ask, this the dawning of a new era, or is it a dead cat bounce?
Notably, real estate stocks surged by more than 30% last week—not surprising given several measures in the stimulus package aimed at easing home purchases. This surge, however, comes on the back of property sales likely to slump 16% this year, and one of the highest housing price to income ratios in the world (30x).
Officials have signaled that last week’s central bank measures are just the beginning, with more rounds of stimulus and fiscal policy changes potentially on the horizon. But despite these measures, economic growth remains tepid and deflationary threats continue to loom large. The mixed PMI data from last week further illustrates the fragility of China’s recover. While official PMI figures showed a slight rise from 49.1 August to 49.8 in September, private Caixin surveys revealed a contraction in manufacturing activity (49.3 for September, down from 50.4 in August).
The PMI data suggests that the real economy has yet to turn the corner, even as financial markets seem to be stabilizing. At a PE of roughly 11x, Chinese equities are historically cheap relative to U.S. and European equities—and some Chinese firms are reporting growth rates of up to 30%, so the temptation to call a bottom is strong. And, as we saw over the last week, the low equity valuations combined with accommodative policy have turned many investors on to the country’s prospects.
Beyond equities, industrial commodities also stand to benefit from a Chinese recovery. With China the largest marginal player on either side of any given commodity, any stimulus-driven uptick in industrial activity may support prices for materials such as copper, steel, and other inputs. This is good news for global markets that rely on Chinese demand, primarily other commodity-centric emerging market countries.
The Chinese yuan is also worth monitoring going forward. A strengthening yuan is generally export negative, especially as global demand remains fragile. While the yuan has been broadly flat against the dollar for the past year, investors should keep an eye on it as the yuan’s value will play a pivotal role in shaping inflation/deflation dynamics going forwards.
Looking ahead, while the stimulus provides support to Chinese property markets and lenders, the economy’s long-term outlook remains cloudy—and questions remain over China’s ability to sustain its recovery. For now, the rally offers cautious optimism. While there are signs of recovery in corporate earnings and industrial sectors, it’s still early to conclude that this is a full-fledged turnaround for China or for the emerging markets as a whole.
Arjun Kaushik contributed to this article. PE ratio data from Bloomberg.