China stocks bounce after regulatory shock and awe

One year ago this week, President Xi Jinping set in motion what’s come to be known as China’s great “common prosperity” rebalancing. In a move that startled the world, the push started with the November 2020 shelving of an initial public offering by Jack Ma’s Ant Group. It then spread from tech to education to real estate, captivating the globe’s attention. Investors were befuddled. Now, 12 months on, there’s budding optimism that the worst may be over as Shanghai shares rebound. Adding to the rays of hope: Beijing is now widening the channels for investors to bet on Chinese stock and commodity derivatives. The move builds on market reforms that, since 2019, have been eliminating investment quotas for foreigners in stocks and bonds. And it coincides with the inclusion of Chinese government bonds to the FTSE World Government Bond Index. Is it a realistic assumption that the worst is over for China Inc? Only if the next 12 months of Xi policymaking are significantly more stable and transparent than the last 12. The bull case is clear enough. A year on from the Ant IPO drama, enough dust has settled from the initial shock of Xi’s Big Tech crackdown. Many investors have had enough time to adjust to the new normal in Communist Party circles. And to refocus on the narrative that China, for all the political and regulatory risk, is home to a massive pool of consumers destined to become history’s biggest middle-class cohort. The logo of Ant Group in Hangzhou. The dust has settled after the IPO drama. Photo: AFP “Sentiment is starting to recover on signs Beijing is attempting to strike a balance between stabilizing growth and pursuing structural adjustments,” says Mark Haefele, chief investment officer at UBS Global Wealth Management. “We believe Chinese equities are close to the bottom now.” HSBC’s head of Asia-region equity strategy Herald van der Linde thinks investors are too down on mainland sectors like banks, healthcare, industrials and real estate. “We think the baby is being thrown out with the bathwater,” van der Linde says. “Yes, China is struggling with growth and a stronger US dollar is not good news for China’s stock markets. But that’s now well known and is priced in.” Here, the Alibaba Group example could tell a bigger story. In recent weeks, the e-commerce juggernaut Ma founded staged a noteworthy market capitalization rebound – 19% in the last 30 days. Is Alibaba’s rebound emblematic of what’s in for other China-themed stocks? Are shares in Tencent Holdings, Baidu Inc, Didi Global and others about to bounce back next? Perhaps. But a lasting rebound that recoups the losses of the last 12 months requires smoother sailing on the regulatory front. And moves to shore up Asia’s biggest economy must be orderly and sustainable. A few months ago, investors were betting on a “V-shaped” Chinese recovery from the Covid-19-era.  Now, Premier Li Keqiang warns that the economy faces new setbacks that require tax cuts and perhaps subsidies for small and medium-sized enterprises. Though Li was vague on timing or the sectors most at risk, his talk of fresh “downward pressure” and the need for “cross-cyclical adjustments” seems starkly at odds with investors rediscovering Chinese asset markets. Evergrande shows the need to reduce leverage and avoid boom-bust cycles Photo: AFP / Hector Retamal To be sure, not all of China’s troubles are self-inflicted. Surely, traumatized export markets and rising global inflation are major headwinds. Also, says strategist Ken Cheung at Mizuho Bank, the “resurgence of virus spread and worsening supply constraints are dampening China’s growth outlook.” Economist Iris Pang at ING Bank notes that “internationally, the export season for China should come to an end in November, and demand could be soft due to another round of Covid outbreaks in various economies.” Yet the chilling effect from Beijing’s sudden and at times draconian crackdowns these last months, including in the pivotal property sector, must take some of the blame. Regulatory ups and downs From a reform standpoint, there’s great merit to regulators reining in bubble-prone sectors. The headline-grabbing default drama at property developer China Evergrande Group is Exhibit A for the need to reduce leverage and avoid boom-bust cycles. Xi’s heart and head seem in the right place in trying to reduce the number of too-big-to-fail institutions. The last thing China wants is to be blamed for the next Lehman Brothers-like crisis. “Evergrande should be seen as a possible global threat rather than just ‘China’s problem,’” says strategist John Kicklighter at DailyFX. “The company,” he adds, “is systemically important to the Chinese financial system, that had seen its rules eased during the last financial crisis in 2008.” Under such circumstances, Kicklighter adds, “moderate risks can turn into universal hazards. Global investors are not naive enough to believ

China stocks bounce after regulatory shock and awe

One year ago this week, President Xi Jinping set in motion what’s come to be known as China’s great “common prosperity” rebalancing.

In a move that startled the world, the push started with the November 2020 shelving of an initial public offering by Jack Ma’s Ant Group. It then spread from tech to education to real estate, captivating the globe’s attention. Investors were befuddled.

Now, 12 months on, there’s budding optimism that the worst may be over as Shanghai shares rebound.

Adding to the rays of hope: Beijing is now widening the channels for investors to bet on Chinese stock and commodity derivatives. The move builds on market reforms that, since 2019, have been eliminating investment quotas for foreigners in stocks and bonds.

And it coincides with the inclusion of Chinese government bonds to the FTSE World Government Bond Index.

Is it a realistic assumption that the worst is over for China Inc? Only if the next 12 months of Xi policymaking are significantly more stable and transparent than the last 12.

The bull case is clear enough. A year on from the Ant IPO drama, enough dust has settled from the initial shock of Xi’s Big Tech crackdown.

Many investors have had enough time to adjust to the new normal in Communist Party circles. And to refocus on the narrative that China, for all the political and regulatory risk, is home to a massive pool of consumers destined to become history’s biggest middle-class cohort.

The logo of Ant Group in Hangzhou. The dust has settled after the IPO drama. Photo: AFP

“Sentiment is starting to recover on signs Beijing is attempting to strike a balance between stabilizing growth and pursuing structural adjustments,” says Mark Haefele, chief investment officer at UBS Global Wealth Management. “We believe Chinese equities are close to the bottom now.”

HSBC’s head of Asia-region equity strategy Herald van der Linde thinks investors are too down on mainland sectors like banks, healthcare, industrials and real estate.

“We think the baby is being thrown out with the bathwater,” van der Linde says. “Yes, China is struggling with growth and a stronger US dollar is not good news for China’s stock markets. But that’s now well known and is priced in.”

Here, the Alibaba Group example could tell a bigger story. In recent weeks, the e-commerce juggernaut Ma founded staged a noteworthy market capitalization rebound – 19% in the last 30 days.

Is Alibaba’s rebound emblematic of what’s in for other China-themed stocks? Are shares in Tencent Holdings, Baidu Inc, Didi Global and others about to bounce back next?

Perhaps. But a lasting rebound that recoups the losses of the last 12 months requires smoother sailing on the regulatory front. And moves to shore up Asia’s biggest economy must be orderly and sustainable.

A few months ago, investors were betting on a “V-shaped” Chinese recovery from the Covid-19-era. 

Now, Premier Li Keqiang warns that the economy faces new setbacks that require tax cuts and perhaps subsidies for small and medium-sized enterprises. Though Li was vague on timing or the sectors most at risk, his talk of fresh “downward pressure” and the need for “cross-cyclical adjustments” seems starkly at odds with investors rediscovering Chinese asset markets.

Evergrande shows the need to reduce leverage and avoid boom-bust cycles Photo: AFP / Hector Retamal

To be sure, not all of China’s troubles are self-inflicted. Surely, traumatized export markets and rising global inflation are major headwinds. Also, says strategist Ken Cheung at Mizuho Bank, the “resurgence of virus spread and worsening supply constraints are dampening China’s growth outlook.”

Economist Iris Pang at ING Bank notes that “internationally, the export season for China should come to an end in November, and demand could be soft due to another round of Covid outbreaks in various economies.”

Yet the chilling effect from Beijing’s sudden and at times draconian crackdowns these last months, including in the pivotal property sector, must take some of the blame.

Regulatory ups and downs

From a reform standpoint, there’s great merit to regulators reining in bubble-prone sectors. The headline-grabbing default drama at property developer China Evergrande Group is Exhibit A for the need to reduce leverage and avoid boom-bust cycles.

Xi’s heart and head seem in the right place in trying to reduce the number of too-big-to-fail institutions. The last thing China wants is to be blamed for the next Lehman Brothers-like crisis. “Evergrande should be seen as a possible global threat rather than just ‘China’s problem,’” says strategist John Kicklighter at DailyFX.

“The company,” he adds, “is systemically important to the Chinese financial system, that had seen its rules eased during the last financial crisis in 2008.”

Under such circumstances, Kicklighter adds, “moderate risks can turn into universal hazards. Global investors are not naive enough to believe that the company can pull itself out of its hole, rather there is full confidence in the Chinese government to stabilize the situation to avoid economic and societal breakdown.”

Even so, the speed, aggressiveness and poor timing of the crackdown exacerbated the economic pain and fallout. Nor is it clear Beijing is finished, says analyst Joel Liauw at CreditSights.

Stock prices have recently rebounded on the Shanghai Stock Exchange. Photo: AFP / Hector Retamal

Last Friday, the State Administration for Market Regulations signaled China will become stricter about how tech companies are classified and policed. It also said Beijing would be more assertive in demanding large tech platforms do their part to ensure China’s economic success.

“The draft rules represent the continued tough regulatory stance that the Chinese regulators are taking on the technology sector,” Liauw says. CreditSights, he says, views this latest signaling as “credit negative for the Chinese tech companies.”

Here comes the money

Such uncertainty comes as foreign capital is again rushing China’s way. And far more is strategizing over the best way to play mainland markets as the goalposts are being moved in real-time. The Ministry of Commerce reckons that total foreign investment in 2021 will exceed 1 trillion yuan, or $160 billion.

“China’s cross-border investment is expected to exceed the pre-pandemic level again in 2021,” says Zong Changqing, who heads the commerce ministry’s foreign investment department. “With economic development continuing to be stable, the attraction of China’s super-large market will continue to grow.”

At present, Zong notes, China boasts more than 400 million middle-class consumers, representing vast potential. And between January and September, retail sales rose 16.4% year on year.

“China’s comprehensive advantages, such as complete industrial supporting facilities, sound infrastructure and abundant human resources have made China attractive to foreign investment, and foreign investors’ expectations and confidence in investing in China remain stable,” Zong said.

But is China ready to efficiently absorb for all of this incoming capital?

The level of opacity surrounding the Evergrande debacle seems out of step for an economy that’s now the globe’s second-largest. When troubles at another developer, Fantasia Holdings Group, emerged in late September, credit agencies were caught off guard.

Opacity and unpredictability

It wasn’t until early October that global ratings companies downgraded Fantasia. It was during a phone call around then, says Fitch Ratings analyst Samuel Hui, that his team learned “for the first time” about the existence of some $150 million of private bonds.

This is a microcosm of where China’s most important domestic growth engine finds itself as 2022 approaches.

New infrastructure projects have helped generate 8% growth year after year. Photo: China Railway Group Ltd

The same goes for municipalities around the nation. Since the 2008 global crisis, Beijing relied heavily on infrastructure spending by regional governments. An explosion of new highways, bridges, tunnels, stadiums, telecommunications systems and skyscraper-filled business districts around the nation helped Beijing generate 8% growth year after year.

Much of that support was generated via local government financing vehicles, or LGFVs. At the end of 2020, Goldman Sachs analyst Maggie Wei estimates there was more than $8 trillion worth of LGFVs outstanding – roughly twice Germany’s annual gross domestic product (GDP).

The extreme opacity surrounding the LGFV boom creates control problems as Xi’s government tries to deleverage the economy.

“China’s government is now targeting common prosperity, an objective that will be challenging to achieve while managing a potentially destabilizing transition,” says analyst Alexander Perjessy at Moody’s Investors Service.

The global economy has much hinging on the success of this transition. 

FXDaily’s Kicklighter says the “control the CCP has over its own fate is not indomitable. As the second-largest economy in the world, it is deeply connected to the global system which creates limits to its ability to manufacture solutions out of thin air.”

For all the chatter about China’s growing role in global affairs, Kicklighter finds it striking that Xi’s government “has allowed its connections to key economic counterparts to wane somewhat over the past few years while simultaneously concentrating its domestic power.”

Xi’s absence from the recent COP26 climate summit in Glasgow raised eyebrows around the globe. Optically, this looks like an error if Xi is, indeed, seeking to increase China’s role on the world stage. And Xi is a source of global intrigue for another reason: he hasn’t left China in 21 months.

Of course, all these idiosyncrasies may be an acceptable risk for investors giving China another look at a moment when it’s never been easier to access its markets. But with great potential comes great responsibility to get the policy mix right.

For Xi’s government, the really hard part has only just begun.