What Could Turn China Around?

Japanese officials have communicated policy changes to the markets effectively. Most recently with last week's rate hike by the Bank of Japan, which helped the country maintain its place as the world's strongest-performing stock market in 2024 through March 22, 2024, as measured by the Nikkei 225 Index. India has also been transparent in its policy initiatives, maintaining its place as the world's strongest-performing economy in 2024 according to global ratings agency Moody's. India's economic growth accelerated to 8.4% year-on-year in the fourth quarter of 2023, the third consecutive quarter of growth over 8%. Among Asia's biggest three economies the exception to this policy clarity is China, where the stock market is among the weakest and the economy remains under pressure.

One of the big challenges for investors is policy changes, which tended to have a big impact on China's economy in recent years. Policies including zero-COVID rules, the crackdown on big tech companies, and restrictions on leverage at property developers have seemed to come with no warning and little clarity. Much of the recent pressure on China's stock market began in 2020, concurrent with a new government policy restriction on the property market to crackdown on the buildup of leverage in the industry and curb housing speculation. The result starved developers of capital.

Recent measures to revive the Chinese economy have been a slow drip of policies, that have been ineffective and seen by markets as reactive, uncoordinated, and targeted rather than prompt and broad. They have not been sufficient to support a sustainable turnaround in consumer confidence, which remains low due to weakness in their biggest asset: property.

While China's stocks have bounced higher since their multi-year low on January 22, with the MSCI China Index rising 13% through March 21, 2024, sentiment remains pessimistic. China's stocks are flat so far in 2024 and valuations are in line with 20-year lows, as you can see in the chart below. There have been some green shoots, with better-than-expected export growth in the combined January-February data, supported by the global manufacturing recovery we believe has started. However, China's economic growth is likely to remain muted due to the weight of the property market slowdown and modest fiscal support. While policymakers around the world are looking at rate cuts to stimulate growth, high interest rates have not been what ails China's economy—it's weak consumer, business, and investor confidence. There are also the trade risks we covered recently in our take on the impact of the 2024 elections.

On March 5, China's Premier delivered the "Government Work Report" to the National Peoples' Congress. According to the report, the GDP target for the year was set at "about 5%"—the same as last year. Frustratingly, while the report said support was needed on "all fronts," it failed to announce any major new policy initiatives. Chinese policymakers left the fiscal deficit unchanged, avoided major moves to boost consumption and gave few specifics on solving the real estate crisis. It's our belief that without further support, China's economy and stock market may struggle to improve. What unexpected policy changes could China announce to sustainably revive its economy and stock market?

• A government guarantee of homebuyer deposits at troubled property developers could help boost economic growth by turning around consumer confidence from its recession-like lows. Homeowners who put down big deposits with developers to build a home are now worried about not receiving their home or not getting their money back from failing developers, which seems to have prompted them to pull back on their spending. Pent-up savings in China continue to grow and could be unleashed to the benefit of China's economy and businesses (particularly the banks and real estate companies) and to global consumer product makers with exposure to China, particularly European luxury goods producers.
• Loosening capital controls could help boost stocks by easing the ability of cash rich companies to do share buybacks. China's strict rules regarding moving money in or out of the country make share buybacks challenging since most of the earnings of these companies are generated in mainland China, but the shares are listed in New York or Hong Kong. The stock market values of some giant Chinese companies, including those such as Alibaba, Baidu, and JD.com, are approaching the amounts of cash and equivalents on their balance sheets despite these being profitable and growing companies. That may be due to the perception that the Chinese government could announce a policy change at any time, imposing costly new fines, taxes, or regulations. Loosening capital controls could boost confidence by shareholders in the cash stockpiles held by many Chinese companies being distributed to them rather than risk being plundered by policy changes.

• Measures to reduce government regulations and encourage entrepreneurship could support business confidence. Years of abrupt policy changes with tough regulations imposed on educational tutoring, video game developers, businesses consultants, and mobile app creators, among others, may have left both established businesses and entrepreneurs in an unsupportive environment. The latest ruling from Beijing that requires all mobile app providers to submit their business details to the government is one example of policies that may stifle innovation. Reversing some of these regulations could be seen as fostering a more innovative environment. This effect was seen in the performance of video game developers in late December when a regulatory proposal was rescinded that would have required them to implement measures to cap user spending in games and ban "excessive" rewards. The original response to the proposal caused a plunge in China's gaming stocks. China's regulators have followed up by approving more new game titles each month since the shift in policy. NetEase, one of China's biggest gaming companies, rebounded 40% from its lows following the policy change.

There are no signs of any major imminent shift in policy in China. But it is worth keeping in mind that China's policymakers rarely signal such changes in advance. Any surprises could potentially trigger sharp rebounds in China's stock market, like in late 2022 when the zero-COVID restrictions were suddenly dropped. China's stocks shot up 60% over the subsequent three-month period.

Until such a change in policy is made (if at all), China may remain a drag on the MSCI Emerging Market (EM) Index and a key reason emerging market stocks remain less attractive relative to those in developed international markets.