Chinese stocks have plunged to their lowest levels in 5 years this week, as a perfect storm of weak economic data, limited policy stimulus, and fleeing foreign investors batter market confidence. The benchmark Shanghai Composite index fell below the key 3,000 point level, clocking 4-year lows not seen since the early days of the pandemic.
Deteriorating Economic Outlook Weighs Heavily
The proximate trigger has been a slew of disappointing December economic indicators released this week, which showed activity contracting across industrial production, retail sales and fixed asset investment. This has reinforced fears that China’s strict zero-COVID policies and ongoing property market woes will continue dragging on growth through the first half of 2024.
With policy support also seen as lacking, optimism is in short supply. Global funds made net equity sales of $34 billion in 2022, cutting their average China allocation to record lows of just 31% by year end. The pace of selling accelerated in early 2024, with foreigners dumping a net $11 billion in shares over the first two weeks.
Stocks Plunge Despite Signs of State Support
The mounting gloom has sent the Shanghai Composite into freefall, now Nursing year-to-date losses of over 5%. However, the index did mount a sudden 1.4% rebound on Wednesday afternoon, which analysts attributed to state-backed funds intervening through large purchases of equity ETFs.
China’s “national team” of state-owned investment funds has a track record of stepping in to stabilize markets during routs. There were also unconfirmed reports this week that authorities had instructed major brokerages and institutions not to sell shares.
Nonetheless, the scope of the declines may mean Beijing cannot single-handedly turn sentiment. “It’s too early to tell when the China market will bottom,” said Saxo Bank strategist Adam Reynolds. “We need to see evidence of much more significant policy easing before investors return.”
Bracing For More Downside Before Recovery
Most analysts do expect some further downside over the coming weeks and months before a recovery materializes.
“Chinese equities face substantial near-term risks, with the chances of a single-digit Shanghai Composite index quite high,” warned Bank of America.
Ongoing foreign investor exits, the approach of the long Lunar New Year holiday when liquidity drops, and the potential for more COVID disruptions in winter all pose downside threats in the near term.
However, bargain hunters are starting to nibble in anticipation of longer-term upside. Chinese stocks now trade at just 9 times forward earnings – far cheaper than other emerging markets.
With valuations depressed, optimism is growing that authorities will unveil more significant stimulus and easing measures at the National People’s Congress parliamentary meetings in March.
Policies to Watch Out For
“All eyes are on the meetings for signs of a growth bottom,” said Credit Suisse economist Ning Zhang. “We see potential for a tactical rebound if large scale infrastructure spending is greenlit and lockdowns definitively ease from April onwards.”
Table 1: Key stimulus policies to watch for
| Policy | Probability | Market Impact |
|---|---|---|
| Cut to bank reserve requirement ratios | High | Modestly positive |
| Relaxation of zero-COVID mandates | Medium | Very positive |
| Infrastructure fiscal stimulus package | Medium | Very positive |
| Benchmark lending rate cuts | Low | Significantly positive |
However, some China skeptics caution that even with stimulus, intractable structural drags around demographics, debt, and US-China tensions mean the days of easy returns from Chinese assets may be over.
“Stimulus measures can boost short-term sentiment, but won’t resolve the deeper doubts global investors have,” noted TS Lombard strategist Larry Hu.
Nonetheless, positioning in Chinese stocks remains very light, opening the door for a violent rally if positive catalysts emerge. “Given the global funds washout, the slightest bit of blue sky could prompt a surge back into Chinese equities,” said Bank of Singapore chief economist Mansoor Mohi-uddin. For intrepid investors, greatly out-of-favor China may hold some of the best bargains and upside potential this year.
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