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Returning to their offices and workplaces last week from the National Day break, China’s investing public had just one thing on their minds: the stock market. Within 20 minutes of the market opening, Rmb1tn ($141bn) in equity had changed hands. By the end of the day, turnover had hit a record Rmb3.48tn, amid gyrations in prices. It was a display of animal spirits such as China has not seen for some time. The benchmark CSI index has pulled back over the past week, but it is still up by more than 20 per cent in a month.
The sharp market rally marks a partial success for the Chinese authorities, who triggered it with last month’s stimulus package, highlighting the continued potency of their policy toolbox. To turn the rally to good account, the authorities need to follow through in two directions. First, they need to deliver promised reforms to promote better corporate governance, which will underpin a more stable and attractive equity market. Second, they need to tackle China’s underlying deflationary dynamic, by far the greater problem. Boosting the stock market is, in itself, one part of the solution, but stock prices rest ultimately on corporate earnings — and they depend on a strong economy.
In addition to a 50 basis point cut in interest rates, China’s recent stimulus has two elements targeting the stock market. First is a swap line, sized at an initial Rmb500bn, that will let brokers, fund managers and insurers tap central bank liquidity against the collateral of stock and bonds. The second is a Rmb300bn relending facility that will, via banks, provide cheap loans for public companies that wish to buy back shares. These measures are reminiscent of those taken by central banks such as the US Federal Reserve in the wake of the 2008 financial crisis. Together, they will provide a significant injection of funds into the stock market, and justify a degree of investor enthusiasm.
Channelling policy support towards buybacks shows there is a reform agenda at work as well as a desire to goose the market. On the same day as the stimulus, China’s securities regulator published a document on “market cap management”, a set of proposals that will put pressure on companies with shares trading below their book value to take action and boost investor returns. It follows a succession of similar actions earlier in the year.
Getting companies to take shareholders seriously and increasing institutional investment in the stock market, so it is less of a retail trader casino, are necessary for the long-term health of China’s capital markets. Beijing is making some progress.
The dramatic rally in recent weeks shows how oversold the Chinese market had become, especially by foreign investors. To sustain the revaluation, however, investors need confidence in corporate profits. There are three big obstacles. First, for foreign buyers, geopolitics remain a fundamental barrier to a big bet on Chinese stocks. Beijing cannot do much about that. Second, while Beijing may be helping the stock market, there are still big doubts about its attitude to successful private companies following the tech crackdown a few years ago. Investors need to know they can keep their profits if they back a winner.
Third, and most fundamental, is the overhang from the stricken property sector, which is why the stock market is still counting on a large and well-targeted fiscal stimulus. With ongoing reform, and effective macroeconomic policy, equities can become an important home for China’s savings. But a market rally that peters out, leaving another group of disappointed investors, would do more harm than good.
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