This surge in Chinese stocks is not like the last one
Recent market rally has a different set of drivers from the 2015 boom and bust
The history of China’s stock markets is one of successive booms that ended in tears, most recently in 2015, when the benchmark dropped 47 per cent in a matter of months. But evidence is mounting that there is something new about this latest rally, which means it could have much further to run. It is worth considering whether this time really could be different.
To be sure, the upswing has echoes of the surge and subsequent collapse in share prices five years ago, which spooked not only the ruling Communist party but also global markets. Much like in 2015, cheerleading by state media has encouraged investors to pile into equities, sending a clear signal to a market already primed for gains on the back of a surprisingly robust performance during the Covid-19 lockdown.
Yet the differences are also significant. First, although margin financing has risen fast this year, it remains well below 2015 levels and as a share of overall trading in the A-share market it is at one of its lowest levels. By the middle of 2015, regulators had grown so concerned by the explosion in trading with borrowed money that they curbed the practice, pulling the rug from under the stock market.
Of course, the authorities, for whom reducing risk in the financial system remains a top priority, need to be careful. Nothing attracts money like a rising stock market. But as long as the influx reflects increased risk appetite and not a surge in borrowing, Beijing has little reason to cut it short, especially at a time when debt-for-equity swaps have emerged as the preferred method to clean up bad loans and reduce leverage in the economy.
The second big change is President Xi Jinping’s determination to halt property inflation. For more than three years the Communist party chief has been intoning the mantra that homes are for living in, not for betting on.
Mr Xi views sky-high house prices as widening the divide between rich and poor. He is committed to addressing the massive increase in inequality over the past 20 years that has made China one of the most unbalanced countries in the world, according to IMF data. That is hardly a record to boast about in the same breath as proclaiming your pursuit of “socialism with Chinese characteristics for a new era”.
The Chinese people are finally getting the message that Mr Xi means business: neither the trade war with the US nor the economic havoc wrought by Covid-19 has produced the dramatic easing of housing policy that has typically been part of China’s stimulus efforts.
The significance for the stock market is that Chinese households might start to think twice about automatically pouring their savings into property on the assumption that house prices will keep rising. It is premature to conclude that China is on the brink of a Great Rotation from property into equities. But it would be unwise to rule out the possibility.
The third big difference between 2015 and 2020 is the opening up of China’s financial markets to foreign competition — and the improved governance and risk assessment this will gradually bring with it.
If foreign asset managers professionalise China’s stock market and help its investor base mature, this can only strengthen the case for a diversification strategy away from housing into equities.
China’s stock market has long been disparaged as a casino, but the image needs to be reconsidered. True, retail investors still dominate the market and underlying fundamentals such as profits have a marginal influence at best on prices. Regulators retain a tight grip on the initial public offering process.
But change is afoot. The advance in equities so far this year owes little to visible support from China’s “national team” of state-backed investment institutions. Regulators have learnt the lesson from five years ago that interfering with the market can backfire.
And unlike in 2015, the authorities resisted the temptation in the first quarter to suspend the market, despite the gravity of the coronavirus crisis. Clearly, China is at pains not to deter badly needed flows of foreign capital.
Importantly, too, China is now included in MSCI’s widely followed emerging markets index. Whatever your views on the country, it is a market that can no longer be ignored.
Could the rally since the end of March — in which stocks have risen by more than one quarter — be the start of a long-term bull market in China? This is not currently our medium-term forecast. Even so, investors need to recognise and act on the fundamental changes that have taken place over the past few years.
The writer is chief economist at Enodo Economics in London