China Stocks’ Lost Decade Means An Uphill Battle To Regain Trust

(Bloomberg) -- A tumultuous week for Chinese stocks underscores Beijing’s challenge in reviving a market that’s already suffered a lost decade of equity returns.  

The MSCI China Index has fallen about 17% since the end of 2013, a period that saw equity gauges in the US and India at least double. It’s a disturbing track record for investors who bought into China’s economic growth story, only to be hammered by sudden flare-ups of geopolitical tensions, unpredictable regulatory clampdowns and the state’s growing control over private enterprises.    

All of this explains the prevailing sense of caution despite a rare string of positive policy news this week. The economy still faces a myriad of problems including a property crisis and deflationary pressure. Some global money managers are asking for bold steps to shift away from the state-driven economic model and reduce frictions with the US — a tough ask that won’t come easily.  

“China turned away from the free markets, leading the stock market to suffer a drastic three-year decline,” said Belita Ong, chairman at Dalton Investments LLC in the US. “The economy is paying the price of a huge real estate bubble, the wolf warrior period hasn’t gained China many friends, and using state owned firms to allocate resources has stunted growth.”

The MSCI China gauge rose more than 3% this week in its first advance in 2024, as the central bank ramped up easing and authorities were said to mull a rescue package including a market stabilization fund. Still, from a peak in February 2021, the gauge has fallen nearly 60%. 

An influx of global money has supported Chinese stocks’ rebound this week. A total $11.9 billion was allocated to Chinese stocks in the week through Jan. 24, the second-highest weekly tally ever, Bank of America Corp. strategists said in a note, citing EPFR data.

The question now is whether the rally will resume, or peter out from here.  

“The latest indication shows that the government certainly wants the capital market to perform better,” said Jian Shi Cortesi, a fund manager at GAM Investment Management. “We expect to see more national team buying.”  

For asset manager VanEck, cheap valuations mean the market faces an “inflection point,” while Gavekal group’s co-founder considers Chinese equities as currently having the best value in the world.

If the rebound continues to falter, however, it will embolden bears who have long doubted China’s investment worthiness. Steadily deteriorating expectations on China’s growth explain about 75% of the equity rout since August, trumping worries about US macro shocks and global risks, a model from Bloomberg Economics shows.  

A puzzle for China watchers is how badly equities have performed despite the economy’s solid growth at about a 6% annual rate over the past decade. While that allowed the country to transition into a formidable global power, aided by export growth and tech prowess, the gains have failed to materialize into sustainable equity returns. 

With concerns that China may even be going through a “Japanification,” investors say stimulus measures including more fiscal support and looser monetary conditions are needed at the very least to revive earnings and consumer spending. 

“To break the confidence trap, market needs to confirm that China has shifted its cards of priorities, to put growth ahead with a rhetoric similar to ‘whatever it takes’,” said Xiadong Bao, fund manager at Edmond de Rothschild Asset Management. “All the supporting measures announced so far are too defensive to revert the deterioration trend.” 

Once that boost has dissipated, however, concerns are that deeper woes arising from its tensions with the US, the suppression of entrepreneurship and an uncertain policy roadmap will again dog markets. President Xi Jinping’s drive for “common prosperity” is also raising uncertainty about business prospects. 

“Xi Jinping continues to scare investors,” said Raphael Gallardo, chief economist at Carmignac Gestion. “The only hope we have is that with the stock market crash, China will perhaps accelerate stimulus.”

--With assistance from Julien Ponthus, Henry Ren and Rheaa Rao.

(Adds details of fund inflow into Chinese stocks in sixth paragraph.)

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