Chinese stocks rise, then fall – What’s next?

And moves to improve equity market liquidity lifted domestic stocks, with China’s CSI 300 and Hong Kong’s Hang Seng surging. This also extended to stocks with exposure to China, such as European luxury names.

But the exuberance didn’t last as questions grew about what the government in Beijing intended to do next. Chinese stocks suffered huge losses on October 9, with the CSI 300 index down 7.1%, the biggest one-day decline of 2020.

All eyes are now on Saturday, when the finance ministry will hold a press conference to reveal details of the additional support needed to boost consumer and business confidence.

Expect more volatility in Chinese stocks

Nicolò Bragazza, associate portfolio manager at Morningstar Investment Management, says a pullback is to be expected after such a strong market performance.

“The recovery was driven by a significant shift in market sentiment – which was at very depressed levels – following the announcement of new support measures,” he says.

“An example of how depressed sentiment around China has been is the performance of Chinese stocks during the sell-off in early August: Chinese stocks barely moved, and the reason was the already very low level of valuations.”

As the market waits for more clarity on the impact of future policies, Bragazza does not rule out that significant volatility could again cause sudden swings in sentiment.

“The role of fiscal policy is particularly important not only because investors pay a lot of attention to it, but also because balance sheet recessions need this kind of support because monetary policy can prove less effective without coordination with fiscal policy.”

“If the government disappoints, we may see a further pullback in Chinese stocks, but we believe the long-term rationale for such positions remains intact as it is driven primarily by the sharp disconnect we see between company fundamentals and their valuations “, he says. .

What caused the initial rally in stocks?

The bull run that sent China’s stock market higher after years of stagnation was led by Chinese authorities who announced several policies, including a mortgage rate cut for existing homeowners and additional liquidity for securities firms to buy shares and asset managers.

“What has developed in the last two to three weeks is a change in the narrative. It’s more of a change in sentiment as policymakers have finally capitulated and changed the policy narrative to become much more pro-growth and stimulative,” says Jerry Wu, manager of the Polar Capital China Stars Fund, which has a Morningstar rating Silver Medalist.

“But a lot of this narrative shift has started to be digested. Much of this reassessment happened very quickly in a short period of time. We are now at the juncture where policy must deliver,” he adds. Wu believes that the Chinese authorities still need to provide concrete fiscal incentives to deal with the country’s difficult situation of deflation and fragile consumer sentiment.

“We have reasonable confidence that the kind of narrative pivot of a few weeks ago means they’re pretty much set to break out of this downward, deflationary spiral.”

In this policy-driven market, Wu hopes Saturday’s announcement will lead to another rebound for Chinese companies. However, he attaches significant importance to China’s policy towards consumers and property owners to ensure a sustainable economic and capital market boost.

“The reason consumer confidence is very low is that their balance sheets are shrinking. 60% of China’s population has housing assets. But in the last 2-3 years, property prices in China have fallen anywhere from 30% to 40% across the board .”

“So when you have 60% of your balance sheet down and you don’t see the end of the downward revision in prices, you won’t spend even if you have quite a lot of savings in your bank account,” says Wu. .

What do Chinese investors want to see?

Sharukh Malik, portfolio manager of the bronze-rated Guinness China A Share Fund, welcomes the Chinese state’s monetary policy initiatives, but believes that consumer support should be a priority as it has been neglected in the past.

“When the government tried to help the economy, they tried to help businesses first rather than the consumer directly. There was a trade program that was announced a few months ago, which is about $21 billion. So if you have an old laundry room. car or TV, you can trade them in and get a subsidy to buy a new one,” he says.

Despite the exchange program support, compared to last year’s retail sales, this amount of support is only worth 0.3%. Malik believes that this package needs to be significantly expanded.

“There are other ways they try to support consumers, so consumer vouchers are quite new. The government provides cash vouchers and you can spend them on restaurants, hotels, cinemas. We’ve seen Shanghai give $71 million to residents in the last few weeks, it seems like a big number, but compared to retail sales, it’s actually small.”

Malik believes the government will extend support by issuing sovereign bonds, which will allow them to raise capital for a wider trade-in program and “cash loss schemes”, which could even allow the public to trade in used cars for flat rate to encourage the purchase of electricity. vehicles.

“What they’ve done so far makes sense, but it needs to be scaled up. And of course nobody really knows (what they’re going to do). Will it be announced tomorrow or next week? But I can see the path to growth because the government makes it clear in their statements Malik adds.

Is China the next Japan?

For Sandy Pei, portfolio manager of the bronze-rated Hermes China Equity Federated Fund, he believes any fiscal stimulus decision must address Chinese deflation to prevent the country from following in Japan’s footsteps.

“Why are people still not buying? Because people don’t have confidence. If you get confidence back, the economy can work itself,” says Pei.

Pei points to the Japanese housing market, where yields of 20 percent are still not encouraging new buyers, who are concerned about weak housing prices.

“In Japan, because they’ve seen this for so long, I don’t think property prices will ever be able to go up. And that is very dangerous.”

In Pei’s view, Chinese authorities need to act as soon as possible to ensure that consumption is a bigger driver of the country’s economic growth.

What are Chinese stocks to watch?

“So far, the two-week rally has been driven by retail investors and passive buying,” says Pei.

One of the stocks that boosted Pei’s portfolio during the rally was Chinese digital broker and wealth management firm Futu Holdings. YTD, the stock price is up 114% to $110.

“Their business is leveraged by nature and therefore their earnings will accelerate exponentially because trading volumes have increased so much. You’ve seen so many new accounts open, it’s crazy. benefits from market turnover”.

Pei also saw his investments in beer and dairy companies boosted during the rally as the market priced in a possible consumer recovery.

Sharukh Malik also saw many of the more obscure names from his portfolio raised in the rally.

Manufacturer JingSheng Mechanical, consumer chip company Sino Wealth and industrial automation equipment maker Shenzhen Innovision Technology jumped during China’s bull run.

“JingSheng has been one of the worst performers over the past twelve months, although it has risen sharply in this risk environment, even though this type of stock does not offer the greatest exposure to the return,” he says.

“Sino Wealth makes core chips for consumer electronics and battery charging applications. If the consumer receives goods in cash, he will buy more consumer electronics”.

“Shenzhen Innovision Technology is an interesting company, and the stock has made 35% in the last five trading days. The idea is that their downstream consumers will get a subsidy from the government to upgrade their equipment.”

The top 10 holdings in the Morningstar China index also saw their total returns increase with JD.com ( JD ), PDD Holdings ( PDD ) and Meituan ( 03690 ) leading the charge with a total return over the past month of 56,58. %, 55.26% and 51.56% respectively.