China stimulus: Game changer?

Podcast: CIO's Summer Xia and Kathy Li on China stimulus and equity positioning (9:09)
Podcast: CIO's Xingchen Yu on the latest China stimulus announcement (12:40)

Economic momentum has been slowing in China and deflationary pressures are mounting. Producer prices are falling, core consumer price inflation is at a 3.5-year low, and we see downside risks to this year’s around 5% GDP growth target. New data out Friday showed industrial profits declined 17.8% year over year in August, down from a +4.1% pace in July. China’s all-important property sector remains trapped in the downward spiral that started in 2021. The combination of policy caution and implementation difficulties means that state rescue measures have thus far failed to break the vicious cycle. In August, new home prices declined at their fastest pace (-5.7% y/y) in nine years and home sales remained weak at about 44% below the 2018-21 average.

But is this about to change? China's top leaders on Thursday vowed to step up "necessary fiscal spending" to meet the country's economic growth target, in the clearest signal yet on “forceful” stimulus to support the economy. The Politburo meeting noted "new situations and problems" that require an urgent response, according to the state media summary, and gave a new pledge to stabilize the real estate market.

This followed stronger-than-expected monetary stimulus from China's central bank on Tuesday, including cuts to interest rates and reserve requirement ratios, and some easing of mortgage rules.

From this Monday's close, the CSI 300 and Hang Seng indices have now rallied 14.5% and 13.5%, respectively, reflecting a major improvement in investor sentiment. We see a number of reasons to share that optimism:

Policymakers are becoming more assertive… This week’s interest rate cuts were more aggressive than consensus expectations, reflecting an easing bias to policy not seen since 2012. The announcement of monetary stimulus was followed by more pro-growth pledges, with a September Politburo meeting stressing the need to “stop the property market from falling.” The sharp market reaction to Thursday’s news, building on the rally earlier this week, underscores the significant shift in tone.

…and more stimulus is on the way. We expect further monetary easing beyond what was announced this week—another 50-100bps in reserve requirement ratio (RRR) cuts and 20-40bps in medium-term lending facility (MLF) cuts by end-1Q25. Details on new property sector measures are light so far, but the Politburo language suggests more forceful intervention ahead, so this will be one of the key areas of policy to watch. We also expect more significant fiscal stimulus targeted at long-term demand, with support for affordable housing and improvements to the social welfare net, including healthcare, education, as well as care for the elderly and infants. While local governments are constrained by heavy debts, we see scope for the central government to finance the stimulus.

In addition to support for the economy, the government is also focusing on capital markets. This week, a CNY 500bn swap facility was announced, giving brokers, funds, and insurance companies liquidity to buy stocks, with two more rounds of CNY 500bn mentioned as possible. A CNY 300bn special refinancing facility, with a 2.25% lending rate, will be introduced for share buybacks, and a stock market stabilization fund is also under consideration.

We think this policy shift could be a game changer for Chinese risk assets, but this is contingent on both execution and continuation. Our view is the broad market can rally by another high-single-digit percentage, following the near 14% move since the announcement of the stimulus package. Whether it can rally further than our target will depend on whether the government can execute the plan efficiently and announce more fiscal measures to support growth.

Within Chinese equities, we recommend adding to the growth side of a barbell strategy by boosting exposure to select Chinese internet leaders, while also retaining some value exposure. In particular, we continue to like quality internet names with still depressed valuations, resilient growth prospects, and clear shareholder return policies, which should help them outperform in a broader market rally. Leaders in the sector also appear positioned to benefit from structural trends like AI as China works to build its own ecosystem. We anticipate rate cuts and capital market support to benefit state-owned enterprises (SOEs) concentrated in high-dividend sectors, including utilities, telecoms, energy firms, and financials.

For investors with Chinese government bond (CGB) exposure, we expect yields to head lower in line with the policy rate cut, though the magnitude of this move may be somewhat limited due to increasing supply. We would use any outsized declines in CGB yields to sell and switch into local currency bonds of other Asian economies, which we think can offer more yield pickup and better prospects for price appreciation relative to CGBs.

Downside risks to the CNY have been reduced, and in the near term, the currency could see further gains alongside equity inflows. However, we point out that the People's Bank of China's (PBoC) promise of aggressive monetary easing measures is a constraint on CNY upside. At this moment, we recommend investors focus on the Australian dollar as a key beneficiary from China’s pro-growth measures, rather than chasing the yuan. Property-specific support should help steel-making commodities like iron ore. Two-way risks do remain, however, and investors should be mindful of potential US-election-related pressure on Chinese equities and the CNY should former President Trump win and implement aggressive new trade tariffs.

Investors seeking other proxies for Chinese upside may also look to copper—which remains our preferred metal, with prices forecast to reach USD 12,000/mt over the next 12 months. We also continue to like Australian miners, with a tilt to diversified majors with healthy balance sheets and high-quality portfolio assets.