China’s Market Stimulation Experiment

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Stimulating the China market

On Tuesday, China announced an economic stimulus package with provisions specifically aimed at boosting Chinese stocks. The People’s Bank of China announced a $114 billion credit facility to help asset managers, insurers and brokers buy more shares and help companies do share buybacks. Hong Kong’s Hang Seng rose 5 percent, and the CSI 300 index in Shanghai and Shenzhen rose 6 percent after that. In the past, we have wondered if Chinese stocks are not investable. Does this change the picture?

Probably not much, for several reasons.

First, the real estate market is still in disarray, and real estate is the main asset of Chinese households. So there is little risk appetite among potential retail investors. The economic stimulus package is not big enough to fix this.

Second, the government game in the private sector has become more pronounced. The government’s harsh treatment of entrepreneurs and crackdown on foreign firms is a second blow to confidence. Economic data that has become less reliable has only made matters worse.

Finally, the relaxation of banking regulations and cuts in monetary policy rates support buying bonds rather than investing in stocks. There has already been a rush to bonds that has irked the government. If you think Tuesday’s rate cut is the first of many, bonds are only getting more attractive. Injecting liquidity into the banking system when credit demand is weak can also push banks into the bond market. Yields on 10-year and 30-year Treasuries rose briefly after the announcement, but then began to fall again.

There is a chance for more incentives to come. As Gavekal Dragonomics’ Thomas Gatley points out, Tuesday’s jump could be investors “trying to provide more support.” The PBoC has hinted that it may add more money to the new lending fund for investors and companies, and there should be a Finance Ministry meeting soon that could “give this (rally) a leg up. . . if the MoF is willing to be more aggressive in fiscal policy”. If MF interventions are transformative, there could be the beginning of an investment case here. But if the past is prologue, it will not exist.

(Reiter)

Epiphenomenalism fueled, revisited

We received a lot of comments on our article making the argument that Fed policy might not matter that much in the economy or markets. Several of them were bald assertions that the Fed is not only very strong, but also very stupid. There are a lot of Fed haters out there.

Others have made a critical point which, it pains us to admit, is absolutely true. The title of the piece suggested it was about Fed strength in general, but the body of the piece only made an argument about the Fed’s rate setting, ignoring how the central bank influences market liquidity by growing and shrinking its balance sheet and other market interventions. Is that so. I was just talking about Fed rate setting and should have been clear about that.

Our piece was also non-committal. Do we believe the epiphenomenal view of Fed rate setting held by people like Aswath Damodaran? We don’t, or not at all. Consider the extreme case. Suppose the Fed raised its policy rate to, say, 20% tomorrow. That means anyone wanting to put money to work could invest it overnight at a 20 percent annual rate through a mutual fund that turned around and invested in the Fed’s reverse repo program (thanks to Joseph Wang for that he explained this mechanism to us very clearly. The result would be dramatic: suddenly no one would bother offering mortgages at 6% or corporate bonds at 5% when there was a risk-free, short-term option at 20%. Credit of all kinds would quickly become more expensive to compete with the Fed rate. The economy would cool, however unevenly.

Less dramatic moves in the Fed’s policy rate are probably unimportant in themselves. But the fact that the Fed has the power, in extreme cases, to cool or warm the economy, gives lower rate moves power as signals of intent that have an effect on expectations. Something along these lines is the Unhedged view.

Small caps, revised

I recently presented the case against the much-anticipated small-cap comeback. A few readers disagreed. Two arguments, from small-cap managers Jason Kotik and Tim Skiendzielewski of Rockefeller Asset Management, stood out.

First, there may be a valuation premium for mergers and acquisitions. While private equity is widely believed to have drained high-quality companies from small-cap indexes, there is a silver lining for small-cap investors: It may continue. As lower rates make acquisitions more economical, potential targets should see their stock prices rise.

Kotik and Skiendzielewski also argue that labor tends to be a larger proportion of total costs for smaller companies. This means that if you think the economy is set to recover and earnings are rising, there could be a lot of operating leverage in small caps.

This brings to mind another potential point in favor of small caps: labor hoarding. Surveys suggest that smaller companies may have kept workers they might have lost, either because of paycheck protection programs at the start of the Covid-19 pandemic or because of fears that it would be too hard to be rehired amid a tightening labor market. We see some evidence of this in the data, as employment and firing statistics are still below their long-term averages despite the rate hike cycle. If you believe the economy is set to recover and incomes will rise, small caps can see a huge benefit as underutilized workers become more productive.

It has long been argued that small caps are more economically sensitive than larger companies. That’s one reason people expect a small-cap rebound as rates fall. The pandemic is likely to amplify this effect.

(Reiter)

A good read

Electoral mathematics.

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