Why Chinese stocks are rising on Tuesday

Chinese stocks jumped out of the gate on Tuesday morning, with shares in Pizza Hut and operator KFC Yum China Holdings (YUMC 6.42%) up 6.1% by 10 a.m. ET. Manufacturer of electric cars Li Auto (LI 6.89%) he had won 7.3% and casino power Melco Resorts & Entertainment (MLCO 5.75%) increased by 7.2%.

What is the common thread behind all these movements? As Reuters reports today, China’s central bank just unveiled its “biggest stimulus since the pandemic.”

What is happening in China now

China’s economy is sinking right now and is at serious risk of missing the government’s target of 5% GDP growth in 2024. Weak consumer demand is weighing on the economy and creating “deflationary pressures”. To counter this trend, the government pumps money into the economy and lowers interest rates to encourage spending. The logic is that if interest rates fall, consumers will owe less money on their mortgages and have more disposable income, even though the lower cost of taking out credit card loans makes shopping easier.

As such, consumer-oriented companies such as Yum China (restaurants), Li Auto (cars) and Melco Resorts (gambling) shouldin theory, to be the immediate beneficiaries of the government’s plans.

Specific stimulus measures include lowering interest rates on several forms of loans by 20 to 30 basis points and reducing mortgage rates by 50 basis points. The People’s Bank of China (PBOC) is also lowering China’s minimum down payment for mortgages to 15 percent to encourage more home buying. And in what appears to be a first for the government, China is introducing two new programs — worth a total of 800 billion yuan ($114 billion) — aimed at making it cheaper for institutional investors to buy Chinese stocks and for companies to buy back their own stock.

This looks like a direct boost to the Chinese stock market and helps explain the huge effect on Chinese stock prices today.

Is it time to buy Chinese stocks?

Now here’s the bad news: it might not work.

Analyzing the stimulus measures announced by the PBOC, economists polled by Reuters and The Wall Street Journal today warned that the announced measures “will not be enough to pull China’s economy out of a low-growth phase marked by falling prices, a burgeoning housing crisis and spiraling trade tensions.”

Of particular concern to investors in consumer-oriented stocks such as Yum China, Li Auto and Melco is that, as WSJ points out that “borrowing costs are already low, but credit data suggests that households and businesses are not so keen to borrow”. So cutting the cost of credit card debt by about 0.2 percentage points probably won’t give that much of a boost to consumer spending — especially not with “consumer confidence … near record lows.”

In addition, I would point out that about half of the proposed measures (lower mortgage rates and down payment requirements), as well as easy financing for stock purchases, do not appear to be aimed at alleviating consumer concerns or stimulating consumer spending at all, or at least, not more than tangentially. Investors flocking to Yum, Li and Melco shares today on the theory that just because China WANTS to increase consumer spending, it will be SUCCEED I’m afraid that in the increase in consumer spending they might overreact.

True, I could be wrong and it doesn’t look like these Chinese stocks are that expensive today. The most expensive, Melco and Yum, cost just 14 times forward earnings, while Li shares look positively cheap at 10 times estimated 2024 earnings right now. If China somehow manages to increase its growth rate — hope against hope — today’s investors could be rewarded as the economy revives.

I just don’t think it will happen. Not if these are the best answers the Chinese government can come up with to fix its economy.